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Why Your Prime Money Market Funds Have Become Riskier

October 20, 2016

Money market funds are regarded as the safest, most conservative investment. It’s where cash in most checking, savings and brokerage accounts resides. The invested amounts are readily converted into cash when we need to settle transactions and make payments.

During Lehman’s collapse in 2008, however, investors holding positions in these funds faced a serious risk of loss. The decline in value of Lehman Brother’s debt securities pushed the Reserve Primary money market fund’s Net Asset Value (NAV) below $1 per share.

That was a watershed event in the financial industry. In response, the SEC passed a series of amendments in an effort to make money market funds more resistant to market stress.

New Rules For Government And Prime Funds

The amendments are designed to reduce interest rate, credit, and liquidity risk in government funds and set liquidity and redemption rules for prime funds.

Government money market funds now need to hold 99.5% of assets in government securities like Treasury bills or agency discount bills. Meanwhile, non-government money funds, aka prime money market funds, will have to release daily liquidity, cash flow, and NAV reports.

What The Rule Change Means For Investors

The rule change should provide more transparency for investors. But it will also provide tools (often referred as “fees and gates”) for fund managers to prevent mass redemptions in times of market stress.

Prime money market funds will be able to impose a redemption fee if the fund’s weekly liquidity level falls below 30% of the fund’s total assets. Under this threshold, the fund manager may charge investors who want to redeem shares a liquidity fee of up to 2%.

Plus, all prime funds will have to put a 1% fee on redemptions if their weekly liquid assets fall below 10% at the end of any business day—unless it isn’t in the shareholders’ best interest.

Finally, a money market fund manager can now impose redemption restrictions for up to 10 days in a 90-day period to maintain liquidity in a fund.

Trouble Ahead For Prime Funds

The SEC has stated these fees are unlikely to be imposed in normal market conditions. But this is the same governmental organization that was not able to identify Bernie Madoff’s Ponzi scheme. Despite hundreds of tips and clear evidence, the largest Ponzi scheme in history went on for a decade and resulted in billions of investor losses.

While prime money market funds do offer higher yields, they are subject to higher volatility, redemption gates, and liquidity fees in a crisis.

Investors have already shifted billions from prime funds to government funds to minimize potential risks. But with dismal yields from either option, it’s time to rethink your positions.

A Safer Alternative

Traditional paper investments can (and often do) fail investors in a big way, so the best way to minimize risk is to diversify.

From kings to pirates, gold has been a good store of wealth and a crisis hedge throughout history. Plus, physical gold carries no counterparty risk, unlike paper investments such as government and prime money market funds.

It is the oldest—and best—hedge against volatile markets, bank failures, and domestic and global financial instability.


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