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May 2016

Prime Time to Rethink Prime Funds

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The world of money market funds is in a state of flux. Cash and liquidity investors are examining new regulations taking effect in October 2016 to see if their investment decisions and practices need rethinking. We believe the implications of regulatory reform for certain fund types—though widely discussed—ultimately depend on implementation details. As a result, we expect the impact on cash management practices may come as a surprise to some investors, since many of the details are only now being closely examined.

The biggest change, in our view, is a requirement that institutional prime and municipal money market funds adopt a floating net asset value (NAV). Prime funds are money market funds that primarily invest in corporate debt securities. Municipal money market funds are money market funds that primarily invest in municipal debt securities. This will transform institutional prime and municipal money market funds from a stable $1 price per share to a floating net asset value. These funds will also be potentially subject to liquidity fees and redemption gates if needed to preserve value for all investors in the fund. (Government funds’ features will remain unchanged.) The U.S. Securities and Exchange Commission’s amendments to Rule 2a-7 will allow a money market fund to impose a liquidity fee of up to 2%, or temporarily suspend redemptions (also known as a “redemption gate”) for up to 10 business days in a 90-day period, if the fund’s weekly liquid assets fall below 30% of its total assets and the fund’s board of directors (including a majority of its independent directors) determines that imposing a fee or gate is in the fund’s best interests. Finally, many prime funds will introduce new, multiple intraday price points (“multiple NAVs”) with associated redemption windows during which cash can be accessed by investors. This last change, in our view, will fundamentally alter the role of institutional prime funds to a “plan ahead” vehicle from a same-day liquidity vehicle.

The money market industry’s turn to multiple NAVs reflects an effort to preserve the same-day liquidity benefits that prime funds have historically offered. But we think many investors will find multiple intraday price points and corresponding redemption windows too complex, and will opt instead for government money market funds for daily or unpredictable liquidity needs, since these funds will continue to offer their traditional liquidity features. Investors will need to choose between 1) rapid access to cash and stable NAVs or 2) a potentially more attractive yield with less frequent access to cash and higher principal risk due to potential volatility of NAVs.

Our view is that prime funds can continue to play a vital role serving many investors’ cash and liquidity needs. Like money market funds more generally, prime funds time and again have adapted to new market environments, regulations, and fund features. This time, too, we believe the industry and investors will adapt, likely gravitating to prime funds that offer a single daily NAV, since the simplicity of this approach enables a focus on core features such as same-day liquidity and incremental return. What follows is our roadmap for rethinking the role of prime funds.


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