During the Great Recession money market investors saw spreads increase hundreds of basis points and unprecedented redemptions of hundreds of billions of dollars in mere days which, according to recent reports, required a number of funds to request support from their fund sponsors. These extreme dislocations in the market resulted in the Reserve Primary Fund breaking the buck. This, in turn, led to a run on money market funds of all types, which was averted only when the United States Treasury guaranteed money fund assets with backing from the Exchange Stabilization Fund.
While these actions did head off the short-term risk of a run on money market funds, the industry suffered a very damaging loss of confidence on the part of corporate investors. This loss of confidence, along with the persistent low yield environment, has led to a large amount of capital being withdrawn from money market funds. The Investment Company Institute reports that assets under management in money market funds have fallen dramatically, from a high of $3.8 trillion in 2008 to roughly $2.8 trillion today, even as corporate cash balances have grown significantly.
Despite the gloomy statistics, these events largely overstate the risks associated with 2a7 compliant funds. It is worth noting that during this period only a single fund broke the buck, and even in this case investors received more than 98 cents on the dollar. This was only the second time a fund has broken the buck in the 40 years since the inception of the first money fund.
The gap between the riskiness of money market funds, which has historically been very low and the perceived risks among corporate investors demonstrates a need for more communication and transparency on the part of money funds. The new 2a7 amendment requires much more transparency than before, including monthly postings of WAM and WAL statistics as well as detailed information on portfolio holdings. While these reforms do provide investors with much more raw data to analyze the overall riskiness of a fund, most investors are unlikely to have the resources to make concrete determinations based on detailed holdings information.
In addition to the portfolio composition and transparency requirements, the new regulation also spells out requirements for stress testing of each fund. These tests specifically detail the conditions, in terms of interest rates, spreads, liquidity and defaults, that would cause a fund to break the buck and highlight exactly how extreme market conditions would have to get before a fund would suffer serious impairment. However, the currently regulation specifies that these results be shared only with the fund's board.
We believe that sharing some of these results with corporate investors could benefit both parties, helping institutional investors understand just how extreme markets conditions would have to get before a fund was compromised and allowing money funds to rebuild confidence in the strength of their risk controls. The vast majority of money funds would break the buck only under the most severe of market conditions, usually requiring hundreds of basis point increases in rates or spreads and redemptions of more than 80 percent of fund assets before a fund would be in danger of breaking the buck, oftentimes well exceeding the conditions seen during the recent crisis.
Alex Russo is Senior Financial Engineer with Investor Analytics.