A summary of the SEC money market fund amendments
In July 2014, the Securities and Exchange Commission (SEC) adopted new rules regarding money market funds, sometimes referred to as money market reform. Compliance with the new rules was effective October 14, 2016.
Figure 1 | SEC money market fund amendments
|Money Market Mutual Funds||Liquidity Gates and Fees
|$1 or Floating NAV|
|Pre-Reform||New SEC Rule
(Compliance Date Oct. 2016)
|Pre-Reform||New SEC Rule
(Compliance date Oct. 2016)
Liquidity gates and fees (redemption restrictions)
100% liquidity has long been one of the most attractive features of money market funds. The new rules allow fund boards of retail and institutional prime money market funds to restrict withdrawals in certain circumstances by imposing liquidity gates and fees. These redemption restrictions do not apply to government money market funds (Figure 1).
Stable or floating net asset values (NAV)
The ability to maintain a constant $1.00 NAV has also been a key selling point for money market funds. Under the new rules, institutional prime money market funds must begin using a floating NAV structure. The floating NAVs of institutional prime money market funds will be marked to market out to four decimal places. Government and retail money market funds are not required to adopt a floating NAV structure under the new rules.
Stable value vs money market: structure, performace, volatility
While the objectives of principal preservation and safety are similar for both money market funds and stable value funds, these two asset classes have different risks, different structures, and the benefits and historical performance of each asset class has also been markedly different. We believe it is useful for plan sponsors to understand some of the key structural differences (Figure 2) between stable value and money market mutual funds, given that these are among the most commonly used capital preservation options in defined contribution plans.
Figure 2 | Stable value vs. money market funds: structural differences
|Money market mutual funds||Stable value||Money market mutual funds 1
(Compliance Date: October 2016)
|NAV structure||Stable value funds can have either a floating or a stable NAV. Unlike money market funds, stable value funds seek principal preservation benefits through the use of investment contracts. Investment contracts are used as a vehicle that seeks to protect plan participants from experiencing principal losses.||
Institutional prime money market funds are required to use a floating NAV. Retail and government money market funds may continue to use a stable NAV structure. Money market funds seek principal preservation benefits by investing in eligible money market securities. Money market funds are not permitted to use the investment contracts used in stable value investing to protect participants from experiencing principal losses.
Participants may withdraw assets from their stable value option at contract value (principal plus accrued interest) regardless of financial market conditions. Some transfer restrictions may apply when competing funds are in the plan.
For retail and institutional prime money market funds, mutual fund boards may impose liquidity fees and redemption gates in certain environments to mitigate the risk of a run on the fund. The new liquidity fees and gates were designed to help mutual fund boards slow redemptions during periods of financial stress. Therefore, the fees and gates could prevent participants from accessing their assets during times when they are needed most.
Stable value strategies typically invest in a diversified portfolio of short and intermediate duration fixed income securities (i.e., bonds) coupled with stable value investment contracts which seek to provide a smooth income pattern and protect participants from experiencing principal losses.
Money market funds invest solely in short duration securities as defined in SEC Rule 2a-7. These include securities such as government securities, certificates of deposit, commercial paper and other highly liquid short-term securities.
Performance differences between stable value and money market mutual funds
Figure 3 | Stable value vs. money market funds and inflation annualized returns as of 9/30/2015
|As of 12/31/2015||1 Year||3 Year||5 Year||10 Year||20 Year|
|Wells Fargo Stable Return Fund (before inv. mgmt. fees) 2||1.70%||1.67%||1.91%||3.04%||4.42%|
|Lipper US Index - Inst U.S. Govt Money Mkt 3||0.02%||0.01%||0.01%||1.22%||2.45%|
|Lipper US Index - Inst Money Market Funds 4||0.10%||0.07%||0.09%||1.40%||2.63%|
|CPI (Inflation) 5||1.27%||1.18%||1.64%||1.91%||2.21%|
|Wells Fargo Stable Return Fund (after maximum fees) 2||1.29%||1.26%||1.50%||2.63%||4.01%|
Stable Value has historically outperformed both government and prime money market funds by 150 to 200 basis points (bps) annually with less volatility (lower standard deviation,) while providing the daily liquidity that participants expect from their capital preservation option. In addition to consistently outperforming money market funds, stable value returns have outpaced inflation. This has not always been the case for money market funds, which calls into question their value as a true capital preservation option.
Figure 4 | stable value outperforms money market funds: growth of $10,000 over 20 years 6
Volatility differences between stable value and money market mutual fund
Both stable value and money market funds are considered to be low volatility conservative investment options that are designed to insulate plan participants from return volatility associated with market behavior. The manner in which a stable value portfolio achieves low volatility is quite different from money market funds. Money market funds typically invest in very short duration government securities, certificates of deposit, commercial paper of companies, or other highly liquid and high quality securities which help achieve a low volatility profile. Stable value funds utilize investment contracts which enable stable value managers to invest in short-to-intermediate fixed income securities while insulating plan participants from the volatility of those securities. The investment contract issuer guarantees a crediting rate no lower than 0% (thus providing principal protection). Money market funds do not utilize investment contracts. Investment contracts are unique to stable value and have served as a powerful financial tool for dampening volatility. Over a 20 year period ending December 31, 2015, stable value returns experienced higher returns and less volatility (lower standard deviation) than money market funds.
Figure 5 | stable value higher returns, less risk as of 12/31/2015 1,2
|20 Yr Return||20 Yr Std. Dev.|
|Wells Fargo Stable Return Fund (after fees) 2||4.01%||0.50%|
|Lipper US Index - Inst. U.S. Government Money Market 3||2.45%||0.65%|
|Lipper US Index - Inst. Money Market Funds 4||2.63%||0.66%|
The case for stable value
The fundamental argument for why stable value is an optimal principal preservation option for defined contribution plans remains the same. Galliard believes the new Money Market Fund Reform rules only serve to strengthen the compelling relative value argument in favor of stable value over money market funds.
Stable value has a 40-plus year track record of successfully weathering challenging economic environments and varying interest rate and yield curve climates—all while delivering on its primary objective of principal preservation. The Financial Crisis during late 2008 and early 2009 highlighted stable value’s ability to perform during unprecedented turbulence. While not entirely immune to market stresses, the stable value asset class has repeatedly delivered steady returns and safety of principal during times when plan participants needed it most.
Stable value is an optimal principal preservation option in any market environment.
- Stable value has consistently outperformed inflation
- Stable value has historically outperformed money market funds
- The Financial Crisis during late 2008 and early 2009 highlighted stable value’s ability to perform during unprecedented turbulence.
The compliance date for plan sponsors to implement the new Money Market Fund Reform rules is set for October, 2016. Implementation of the new rules will introduce more administrative complexities for plan fiduciaries. This has prompted many plan sponsors to review their current conservative investment options and determine which option is most suitable for plan participants. Given the compelling investment case in favor of stable value, we believe plan sponsors currently using any type of money market option in defined contribution plans may want to consider stable value as a more attractive principal preservation choice.
1. For more details on the SEC Money Market Fund Reform rules, visit http://www.sec.gov/rules/final/2014/33-9616.pdf
2. The Wells Fargo Stable Return Fund (the “Fund”) is a collective trust fund for which Wells Fargo Bank, N.A. (“Wells Fargo”) is investment manager and trustee. Galliard Capital Management, a wholly-owned subsidiary of Wells Fargo, serves as advisor to the Fund. Amounts designated as being “before investment management fees” include all income, realized and unrealized capital gains and losses (for calendar year and annualized performance) and all annual fund operating expenses. Wells Fargo Stable Value Fund W is 100% invested in the Wells Fargo Stable Return Fund G. While the Wells Fargo Stable Return Fund G has been in existence since 1985, Fund W has only been available with the applicable trustee fee of 3 bps since 2/2/15. In order to illustrate historical performance of the Fund, Fund W’s returns have been linked with the historical returns of Wells Fargo Stable Return Fund G and the resulting amount is reported as performance before investment management fees. Amounts designated as being “after maximum fees” are the “before investment management fees” amounts less the maximum 0.40% fee which may be charged by Galliard for management of each client’s account. Returns may have been impacted by the effect of compounding and have been rounded to the nearest basis point. Fees which may be charged to each client for investment management are described in Galliard Capital Management’s Form ADV Part 2 and on page 2 of this fund fact sheet. Returns for periods less than one year are not annualized.
3. The Lipper US Index – Inst U.S. Gov’t Money Mkt is an average of funds that invest principally in financial instruments issued or guaranteed by the U.S. Government, its agencies, or its instrumentalities, with dollar weighted average maturities of less than 90 days. These funds are eligible to keep a constant net asset value. The total return of the Lipper Average does not include the effect of sales charges. You cannot invest directly in a Lipper Average.
4. The Lipper US Index – Inst Money Market Funds is the average of the 30 largest funds in the Lipper Money Market Funds Category. These funds invest in high quality financial instruments rated in top two grades with dollar-weighted average maturities of less than 90 days. These funds are subject to the floating NAV requirements. You cannot invest directly in a Lipper Average.
5. CPI (Inflation) data is represented by the US BLS CPI All Urban NSA 1982-1984. Source: Morningstar. Figures for 2015 are based on Morningstar estimates.
6. The growth of $10,000 shown in Figure 3 is a hypothetical illustration based on the growth of returns of the Wells Fargo Stable Value Fund W, the Lipper US Index.
The information contained herein reflects the views of Galliard Capital Management, Inc. and sources believed to be reliable by Galliard as of the date of publication. No representation or warranty is made concerning the accuracy of any data and there is no guarantee that any projection, opinion, or forecast herein will be realized. The views expressed may change at any time subsequent to the date of publication. This publication is for information purposes only; it is not investment advice or a recommendation for a particular security strategy or investment product. FOR INSTITUTIONAL INVESTOR USE ONLY. © Galliard Capital Management, Inc.