Corporate & Securities Law

The Wall Street Journal is reporting that big money-market mutual funds are trying risk again.  Two years after Reserve Primary fund "broke the buck," some funds are making new bets on risky securities, raising the chances for problems despite new rules designed to make the market safer. 

To make the funds safer and reduce systematic risk, the SEC in January adopted several rules limiting the types of investments money-market funds can hold.  Yet investors, analysts and even some money managers say funds are taking new risks now in part because of unintended consequences stemming from the new rules.

The SEC's rules, which began taking effect in recent months, restrict funds' holdings of lower-quality securities and require them to keep at least 30% of their assets in securities maturing within seven days, to post their holdings online each month and to perform "stress tests" in which they analyze their ability to withstand market shocks.

The goal of the 30% rule, for example, was to ensure that the funds can quickly convert holdings to cash to meet investors' redemption requests.  But many companies that issue such short-term debt, concerned about refinancing on short notice, are now seeking longer-term funding instead.

The result: The pool of available securities for money-market funds to pick from is shrinking, reducing their diversification and adding risk. According to one portfolio manager, "There's an awful lot of money-fund assets chasing limited supply."

A shrinking investment universe has left money-market funds with hefty exposure to the financial sector.  Among U.S. prime money funds rated by Moody's Corp., the top 20 corporate issuers accounted for 36% of assets as of June.  Most of them are big banks in Europe, which has lately been dealing with its own debt crisis.

The dwindling pool of securities has also helped drive down yields, which move in the opposite direction from a bond's price.  Yields were already falling because of concerns about global economic growth.  To boost their returns, some funds are increasingly using complex, and sometimes risky, investments.

Several European banks in recent months have issued "step-up" certificates of deposit that typically allow investors to get their money back within seven days but offer interest that increases periodically if investors don't exercise that option.  That the instruments fit in with the new 30% rule is "a big plus," according to an investment officer.  The more complex instruments might be difficult to sell during a market panic, however.

Some funds are also taking a riskier approach to the common money-market fund strategy of investing in repurchase agreements.  Known as "repos," these are short-term loans, often backed by government securities.  A number of money-market funds have lately broadened the types of collateral they will accept to include not just government securities but also corporate debt and stocks.

At least one money-market fund that bills itself as a government fund has taken this step.  The American Beacon U.S. Government Money Market Select fund this year started investing in non-government repos "to get a better yield," according to its fixed-income officer.  The fund tries to reduce risk by demanding more collateral.

SNSFE will monitor this situation and will seek all investor comments regarding the risk that may or may not be appreciated in these securities.

Source: Wall Street Journal