Basic Facts about Money Market Funds
Money market funds are also known as money market mutual funds. They are usually open-ended mutual fund programs. These programs invest in various short-term debt securities like commercial papers and U.S. Treasury bills. Money market funds are normally as safe as bank deposits or certificates of deposits (CDs), though the yields from money market funds are normally higher than that from CDs. Money market funds provide strong liquidity to all financial intermediaries and the Investment Company Act of 1940 by the Securities and Exchange Commission (SEC) of the United States regulates these money market funds.
The main purpose of money market funds is to limit exposure to financial losses arising out of market, credit, and liquidity risks. Rule 2a-7 of the 1940 act restricts the maturity, quality, and diversity of the investments under the money market funds. The money fund should always buy the highest rated debt, maturing within 13 months under this act. Further, the fund portfolio should maintain the principle of weighted average maturity (WAM), which should be for 60 days or less. Moreover, the fund should not invest over 5% in any debt security from a single issuer. However, the repurchase agreements and government securities are exempt from this 5% limit.
Nearly all the money market funds try to maintain the value at $1 per share on a stable basis. In this manner, the money market funds differ from other financial instruments. Money market funds could pay dividends to their investors. If the net asset value (NAV) of the funds drops below $1 per share, the fund is said to have ‘broken the buck’. However, only three funds have encountered this situation in 37 years up to 2008. On most occasions, the companies offering the money market funds would intervene to support the NAVs to avoid ‘breaking the buck’. This is mainly due to the reason that the value of reputation and lost customers would be much greater than the bailout amount required to keep the NAV at $1 per share.
However, the financial crisis that began in August 2008 was a turbulent period for all money market funds. Most funds imposed restrictions or redemptions or liquidated assets to infuse funds to keep the NAV from breaking the buck. Subsequently, the U.S. Department of the Treasury announced on September 19, 2008 an optional program that allowed all eligible publically offered retail and institutional money market funds to pay a fee for participating in insuring their holdings. The insurance would guarantee the restoration of the NAV to $1 if the fund covered under the insurance program happened to break the buck.
According to the data that Investment Company Institute reported at the end of 2011, the number of operating money market funds in the United States was 632, with total assets of around $2.7 trillion. The total assets under management by retail money market funds were $940 billion, while the assets held by institutional funds amounted to $1.75 trillion. Considering the above facts, money market funds are safe investment instruments and offer better yield than CDs.
