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Money market funds safer with new rules

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Highlights
  • After the financial crisis, money market funds came under scrutiny.
  • "Breaking the buck" becomes harder with these guidelines in place.
  • Over time, money market yields could move lower with the new rules.

Though they aren't FDIC-insured, money market mutual funds are supposed to be the safest investment this side of a CD account, and they usually are.

But like most investments, money market funds, or MMFs, got dragged into the financial crisis of 2008, and the regulatory chickens are still coming home to roost. New rules by the Securities and Exchange Commission, or SEC, went into effect in May restricting how money market funds can invest in an attempt to prevent future runs on MMFs.

Money market funds are mutual funds you can purchase through a bank, brokerage or a fund family such as Vanguard or Fidelity. Most retail MMFs are linked to brokerage accounts, giving investors a place to park their cash after the sale of stock. But these investments can also be used to build cash for savings purposes.

Investors buy shares in the fund and the fund's manager invests the money in short-term debt instruments, such as Treasury bills and commercial paper, that mature in less than 13 months.

The new SEC rules are designed primarily to make MMFs safer for investors, especially during times of economic stress, by shortening maturities and improving the credit quality of money-market fund investments, says Sean Collins, senior director of industry and financial analysis with the Investment Company Institute in Washington, D.C.

Breaking the buck

Only two money market funds in U.S. history have found themselves "breaking the buck," industry slang for when shares in a fund fall below $1. When this happens, investors are forced to take less money than they invested.

The most recent was the Reserve Primary Fund, which broke the buck during the financial crisis of 2008, mostly because of a flood of redemption requests and the fund's hefty investments in Lehman Brothers-issued commercial paper, says Collins. That paper plummeted in value when Lehman failed, says Collins.

The resulting panic caused the federal government to step in and offer guarantees to MMF investors that their money would be returned in the event of a fund failure.

Here's a quick look at the biggest SEC changes.

What changed: Money market funds must create two "buckets" in every fund. One holds 10 percent of a fund's assets in securities that are redeemable overnight and the other holds 30 percent in securities redeemable within seven days.

What it means: MMFs will be more liquid, so they'll be better able to handle heavy redemptions in future financial crises, says Collins. The downside will be reduced yields on those very short-term investments, says Anthony Era, vice president of money market funds for USAA in San Antonio.

What changed: Money market funds must invest more of their assets in Tier 1 securities, which receive the highest ratings from credit ratings agencies, and less in Tier 2 securities, which receive slightly lower ratings due to economic conditions within their industry, accounting practices and other factors, Era says.

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What it means: The restrictions may lower MMF yields because weaker credit often forces lenders and other companies with Tier 2-rated securities to offer better terms to entice investors. Forcing MMF managers to avoid them and to invest more heavily in Tier 1 securities will put a damper on future money market fund yields paid out to retail investors, Era says.

"Every which way you turn, the results are going to be compressed yields," Era says.

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