With the future of money market funds a bit murky, the ETF industry is seizing an opportunity.
Ever since money market funds got pulled into the craziness of the 2008 market meltdown, money funds have been living under a cloud of regulatory uncertainty and ongoing questions about whether they can weather another crisis.
Unsurprisingly, the ETF industry has been relatively quick to respond to what it clearly sees as an opportunity.
To take full measure of this trend, a bit of background is in order.
Last week, Securities and Exchange Commission Chairman Mary Schapiro canceled a vote surrounding proposals to significantly reform money market funds. The battle centers on whether enough has been done to protect money market fund investors.
Unlike regular mutual funds and ETFs, money market funds have a fixed net asset value (NAV) of $1 that doesn’t change from day to day.
On the upside, investors know—at least the thinking goes—that they can enter and exit at will, all the while preserving principal and collecting prevailing short-term yields in the process.
On the downside, money market funds give up a lot of flexibility, with strict limits on both the duration and credit quality of the debt issues that the funds can hold.
Back in 2008, the money market industry went into full-blown crisis when the Reserve Primary Fund “broke the buck” following the Lehman Brothers bankruptcy.
“Breaking the buck” refers to a money market fund’s NAV falling below $1.
In the ensuing panic following the Reserve Primary Fund’s breaking of the buck, investors rushed to withdraw funds to preserve their capital, which led to a liquidity crunch that led to a devastating freeze of private short-term lending markets.
To return to the present day, all the hoopla surrounding money market funds got me thinking about the options investors have within the world of ETFs and how money-market-fundlike ETFs compare to actual money market funds.
After all, the likes of Legg Mason and BlackRock must have good reason to enter the short-dated fixed-income ETF arena, where the $1.9 billion Pimco Enhanced Short Maturity Strategy Fund (NYSEArca: MINT) has so far reigned supreme since its launch in November 2009.
The main differences between money market funds and ETFs that seek to play the same role in investors’ portfolios stem from the flexibility that money market funds give up in order to offer a fixed NAV that attracts investors.
In the end, eschewing that fixed-NAV mechanism serves as MINT’s competitive advantage.
By floating its NAV and falling in line with other mutual funds, funds like MINT have significantly more leeway with respect to allowed holdings and are able to dial up or dial down credit and interest rate exposure as seen fit.
While any fund literature on money market products will explicitly state that the funds aren’t in any way insured and can lose principal, the implicit expectation many investors have had is that loss of principal can’t or won’t happen.
Well, it can happen and it did happen, and the takeaway isn’t to panic or cry foul, but to recognize that in times of great distress, even the safest, super-short-term debt instruments have risk.
It’s best not to forget that.
Real Risks And Better Yields
In that sense, MINT’s structure serves as a constant reminder to its investors that its holdings are neither static nor risk free.
The floating NAV of MINT and the similarly designed ETFs that will soon come to market—while reducing the ability to know with certainty that 100 percent of invested capital will be preserved—should reflect the current market perception of the value of the fund’s holdings.
But crucially, it also allows for the opportunity in today’s zero-interest-rate environment to actually earn some yield in an ultra-short duration fund.
The question comes down to how sure you need to be about getting back principal.
If it’s of paramount importance to you, then money market funds are still the safer bet. But if you’re willing to handle a bit more uncertainty, MINT and its soon-to-be-launched competitors are worth a closer look.
At the time the article was written, the author had no positions in the securities mentioned. Contact Gene Koyfman at[email protected]