Money market fund

A money market fund (also called a money market mutual fund) is an open-end mutual fund that invests in short-term debt securities such as US Treasury bills and commercial paper. Money market funds are managed with the goal of maintaining a highly stable asset value through liquid investments, while paying income to investors in the form of dividends. Although they are not insured against loss, actual losses have been quite rare in practice.

Regulated in the United States under the Investment Company Act of 1940, and in Europe under Regulation 2017/1131, money market funds are important providers of liquidity to financial intermediaries.

Explanation

Money market funds seek to limit exposure to losses due to credit, market, and liquidity risks. Money market funds in the United States are regulated by the Securities and Exchange Commission (SEC) under the Investment Company Act of 1940. Rule 2a-7 of the act restricts the quality, maturity and diversity of investments by money market funds. Under this act, a money fund mainly buys the highest rated debt, which matures in under 13 months. The portfolio must maintain a weighted average maturity (WAM) of 60 days or less and not invest more than 5% in any one issuer, except for government securities and repurchase agreements.

Securities in which money markets may invest include commercial paper, repurchase agreements, short-term bonds and other money funds. Money market securities must be highly liquid and of the highest quality.

History

In 1971, Bruce R. Bent and Henry B. R. Brown established the first money market fund. It was named the Reserve Fund and was offered to investors who were interested in preserving their cash and earning a small rate of return. Several more funds were shortly set up and the market grew significantly over the next few years. Money market funds are credited with popularizing mutual funds in general, which until that time, were not widely utilized.

Money market funds in the United States created a solution to the limitations of Regulation Q, which at the time prohibited demand deposit accounts from paying interest and capped the rate of interest on other types of bank accounts at 5.25%. Thus, money market funds were created as a substitute for bank accounts.

In the 1990s, bank interest rates in Japan were near zero for an extended period of time. To search for higher yields from these low rates in bank deposits, investors used money market funds for short-term deposits instead. However, several money market funds fell off short of their stable value in 2001 due to the bankruptcy of Enron, in which several Japanese funds had invested, and investors fled into government-insured bank accounts. Since then the total value of money markets have remained low. For SEC registered money funds, maintaining the $1.00 flat NAV is usually accomplished under a provision under Rule 2a-7 of the 40 Act that allows a fund to value its investments at amortized cost rather than market value, provided that certain conditions are maintained. One such condition involves a side-test calculation of the NAV that uses the market value of the fund's investments. The fund's published, amortized value may not exceed this market value by more than 1/2 cent per share, a comparison that is generally made weekly. If the variance does exceed $0.005 per share, the fund could be considered to have broken the buck, and regulators may force it into liquidation.

Buck breaking has rarely happened. Before the 2008 financial crisis, only three money funds had broken the buck in the 37-year history of money funds.

While money market funds are typically managed in a fairly safe manner, there would have been many more failures over this period if the companies offering the money market funds had not stepped in when necessary to support their fund (by way of infusing capital to reimburse security losses) and avoid having the funds break the buck. This was done because the expected cost to the business from allowing the fund value to drop—in lost customers and reputation—was greater than the amount needed to bail it out.

The first money market mutual fund to break the buck was First Multifund for Daily Income (FMDI) in 1978, liquidating and restating NAV at 94 cents per share. An argument has been made that FMDI was not technically a money market fund as, at the time of liquidation, the average maturity of securities in its portfolio exceeded two years. However, prospective investors were informed that FMDI would invest "solely in Short-Term (30-90 days) MONEY MARKET obligations". Furthermore, the rule restricting the maturities which money market funds are permitted to invest in, Rule 2a-7 of the Investment Company Act of 1940, was not promulgated until 1983. Prior to the adoption of this rule, a mutual fund had to do little other than present itself as a money market fund, which FMDI did. Seeking higher yield, FMDI had purchased increasingly longer maturity securities, and rising interest rates negatively impacted the value of its portfolio. In order to meet increasing redemptions, the fund was forced to sell a certificate of deposit at a 3% loss, triggering a restatement of its NAV and the first instance of a money market fund "breaking the buck".

The Community Bankers US Government Fund broke the buck in 1994, paying investors 96 cents per share. This was only the second failure in the then 23-year history of money funds and there were no further failures for 14 years. The fund had invested a large percentage of its assets into adjustable rate securities. As interest rates increased, these floating rate securities lost value. This fund was an institutional money fund, not a retail money fund, thus individuals were not directly affected.

No further failures occurred until September 2008, a month that saw tumultuous events for money funds. However, as noted above, other failures were only averted by infusions of capital from the fund sponsors.

September 2008

Money market funds increasingly became important to the wholesale money market leading up to the crisis. Their purchases of asset-backed securities and large-scale funding of foreign banks' short-term US-denominated debt put the funds in a pivotal position in the marketplace.

Events

On Monday, September 15, 2008, Lehman Brothers Holdings Inc. filed for bankruptcy. On Tuesday, September 16, The Reserve Primary Fund broke the buck when its shares fell to 97 cents after writing off debt issued by Lehman Brothers.

Continuing investor anxiety as a result of the Lehman Brothers bankruptcy and other pending financial troubles caused significant redemptions from money funds in general, as investors redeemed their holdings and funds were forced to liquidate assets or impose limits on redemptions. Through Wednesday, September 17, prime institutional funds saw substantial redemptions. Retail funds saw net inflows of $4 billion, for a net capital outflow from all funds of $169 billion to $3.4 trillion (5%).

In response, on Friday, September 19, the US Department of the Treasury announced an optional program to "insure the holdings of any publicly offered eligible money market mutual fund—both retail and institutional—that pays a fee to participate in the program". The insurance guaranteed that if a covered fund had broken the buck, it would have been restored to $1 NAV. The program was similar to the FDIC, in that it insured deposit-like holdings and sought to prevent runs on the bank. The guarantee was backed by assets of the Treasury Department's Exchange Stabilization Fund, up to a maximum of $50 billion. This program only covered assets invested in funds before September 19, and those who sold equities, for example, during the subsequent market crash and parked their assets in money funds, were at risk. The program immediately stabilized the system and stanched the outflows, but drew criticism from banking organizations, including the Independent Community Bankers of America and American Bankers Association, who expected funds to drain out of bank deposits and into newly insured money funds, as these latter would combine higher yields with insurance.

Analysis

The crisis, which eventually became the catalyst for the Emergency Economic Stabilization Act of 2008, almost developed into a run on money funds: the redemptions caused a drop in demand for commercial paper,

The drop in demand resulted in a "buyers strike", as money funds could not (because of redemptions) or would not (because of fear of redemptions) buy commercial paper, driving yields up dramatically: from around 2% the previous week to 8%,

Statistics

The Investment Company Institute reports statistics on money funds weekly as part of its mutual fund statistics, as part of its industry statistics, including total assets and net flows, both for institutional and retail funds. It also provides annual reports in the ICI Fact Book.

At the end of 2011, there were 632 money market funds in operation, with total assets of nearly US$2.7 trillion. however these are different products with differing risks (e.g., money fund accounts are not insured and are not deposit accounts). Since retail funds generally have higher servicing needs and thus expenses than institutional funds, their yields are generally lower than institutional funds.

SEC rule amendments released July 24, 2014, have 'improved' the definition of a retail money fund to be one that has policies and procedures reasonably designed to limit its shareholders to natural persons.

Money fund sizes

As of February 2025 total money market fund assets were $6.9 trillion including $4.1 trillion held by institutional investors and nearly $2.8 trillion held by retail investors. The vast majority of those assets were held in government securities. Among the largest companies offering institutional money funds are JPmorgan, BlackRock, Western Asset, Federated Investors, Bank of America, Dreyfus, AIM and Evergreen (Wachovia). The largest retail money fund providers include: Fidelity, Vanguard, and Schwab.

Similar investments

Money market accounts

Banks in the United States offer savings and money market deposit accounts, but these should not be confused with money mutual funds. These bank accounts offer higher yields than traditional passbook savings accounts, but often with higher minimum balance requirements and limited transactions. A money market account may refer to a money market mutual fund, a bank money market deposit account (MMDA) or a brokerage sweep free credit balance.

Ultrashort bond funds

Ultrashort bond funds are mutual funds, similar to money market funds, that, as the name implies, invest in bonds with extremely short maturities. Unlike money market funds, however, there are no restrictions on the quality of the investments they hold. Instead, ultrashort bond funds typically invest in riskier securities in order to increase their return. Since these high-risk securities can experience large swings in price or even default, ultrashort bond funds, unlike money market funds, do not seek to maintain a stable $1.00 NAV and may lose money or dip below the $1.00 mark in the short term. Finally, because they invest in lower quality securities, ultrashort bond funds are more susceptible to adverse market conditions such as those brought on by the 2008 financial crisis.

Enhanced cash funds

Enhanced cash funds are bond funds similar to money market funds, in that they aim to provide liquidity and principal preservation, but which:

Invest in a wider variety of assets, and do not meet the restrictions of SEC Rule 2a-7;
Aim for higher returns;
Have less liquidity;
Do not aim as strongly for stable NAV.

Enhanced cash funds will typically invest some of their portfolio in the same assets as money market funds, but others in riskier, higher yielding, less liquid assets such as:

Mortgage-backed securities (MBSs);
Structured investment vehicles (SIVs).

In general, the NAV will stay close to $1, but is expected to fluctuate above and below, and will break the buck more often. Different managers place different emphases on risk versus return in enhanced cash – some consider preservation of principal as paramount,

The SEC would normally be the regulator to address the risks to investors taken by money market funds, however to date the SEC has been internally politically gridlocked. The SEC is controlled by five commissioners, no more than three of which may be the same political party. They are also strongly enmeshed with the current mutual fund industry, and are largely divorced from traditional banking industry regulation. As such, the SEC is not concerned over overall credit extension, money supply, or bringing shadow banking under the regulatory umbrella of effective credit regulation.

As the SEC was gridlocked, the Financial Stability Oversight Council promulgated its own suggested money market reforms and threatens to move forward if the SEC doesn't button it up with an acceptable solution of their own on a timely basis. The SEC has argued vociferously that this is "their area" and FSOC should back off and let them handle it, a viewpoint shared by four former SEC chairmen, Roderick Hills, David Ruder, Richard Breeden, and Harvey Pitt, and two former commissioners, Roel Campos and Paul S. Atkins. Finally, the amendments require investment advisers to certain large unregistered liquidity funds, which can have many of the same economic features as money market funds, to provide additional information about those funds to the SEC.

EU regulatory reform

In parallel with the US Reform, the EU completed drafting of a similar regulation for the money market fund product.

On June 30, 2017, Regulation (EU) 2017/1131 for money market funds was published in the Official Journal of the European Union, introducing new rules for MMFs domiciled, managed or marketed in the European Union. This entered into effect in March 2019. The regulation introduces four new categories of fund structures for MMFs:

Public Debt Constant Net Asset Value (CNAV) MMFs are short-term MMFs. Funds must invest 99.5% in government assets. Units in the fund are purchased or redeemed at a constant price rounded to the nearest percentage point.
Low Volatility Net Asset Value (LVNAV) MMFs are short-term MMFs. Funds around are purchased or redeemed at a constant price so long as the value of the underlying assets do not deviate by more than 0.2% (20bit/s) from par (i.e. 1.00).
Short Term Variable NAV – Short-term Variable Net Asset Value (VNAV) MMFs are primarily invested in money market instruments, deposits and other MMFs. Funds are subject to looser liquidity rules than Public Debt CNAV and LVNAV funds. Units in the funds are purchased or redeemed at a variable price calculated to the equivalent of at least four significant figures (e.g. 10,000.00).
Standard Variable NAV VNAV– Standard MMFs must be VNAV funds. Funds are primarily invested in money market instruments, deposits and other short-term assets. Funds are subject to looser liquidity rules than Public Debt CNAV and LVNAV funds AND may invest in assets of much longer maturity. Units in the funds are purchased or redeemed at a variable price calculated to the equivalent of at least four significant figures (e.g. 10,000.00).

Although the starting products were similar, there are now considerable differences between US and EU MMFs. Whilst EU MMF investors mostly moved to successor fund types, investors in US MMFs undertook a huge and persisting switch from Prime into Government MMF.

The EU MMF Regulation does not make any reference to either fund or portfolio external credit rating requirements. Throughout the transition EU MMFs overwhelmingly retained their existing ratings, and the credit rating agencies have confirmed their commitment to the MMF-specific rating criteria they each maintain.

A major difference in scope is that, on a like-for-like basis, US MMFs may be compared only to EU short-term MMFs.

References

External links

ICI Fact Book
Definition of a Money Market Fund and Difference Between Money Market Account
Joan Ohlbaum Swirsky, The Guide to Rule 2a-7: A Map Through the Maze for the Money Market Professional (3rd ed., 2017)