COLLEGE SAVINGS 101

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Money Market Reforms and 529 Plans
http://www.savingforcollege.com/articles/money-market-reforms-and-529-plans-932

Posted: 2016-05-19

by Brian Boswell

Financial Professional Content

In 2014 the SEC released new rules impacting money market funds that are intended to help increase transparency and reduce the risk of instability during periods of market stress. Asset managers are required to conform to these rules by October 2016. As a result, your clients may be receiving notices from their asset managers that their investments are impacted or changing. Some 529 savings plans are among those that have been impacted, and many plans that hold money markets in their underlying portfolios have been or will soon be making changes in anticipation of the October implementation deadline.

Why are these changes happening?

During the market downturn in 2007 and 2008, the net asset value (NAV) of The Reserve Primary Fund fell from $1 per share to $0.97 per share (commonly referred to as, “breaking the buck”). The Fund was essentially a large money market fund run by a New York-based fund manager called, “The Reserve.” It held a position in short-term Lehman Brother loans that, while small, was still large enough to impact the NAV when those loans defaulted. Thereafter followed a run on the fund, and the fallout resulted in the SEC investigating and, eventually, putting new rules in place.

As a result of the run on the Prime Fund, the SEC adopted rules in 2010 to help address liquidity and quality so that money markets would be more resilient in times of stress. However, the 2010 rules did not fully address all the newly-perceived risks associated with money market funds. For this reason additional rules were released in 2014, and will be enforced later this year.

What are the changes?

Under the new SEC rules there are significant trading restrictions on money market securities. There are four big changes:

  1. Institutional prime money market funds will be required to maintain a floating NAV. This will help reduce what is known as the “first-mover advantage.” With a stable NAV investors who sell first take advantage of the floating NAV, leaving those late to sell to bear the costs.
  2. Fees and gates will be in place to prevent a run on a money market fund. Much like the reserve requirements of banks, money market funds will need to maintain certain levels of liquidity, and pay fees if they are unable to maintain said levels. Money market fund boards can also suspend trading if liquidity were to fall below a certain level, acting as a circuit breaker.
  3. Additional portfolio diversification will be required, as well as additional disclosure to investors, and increased stress testing requirements. Without getting too much into the gritty details, certain affiliates could not be treated as separate entities to meet diversification requirements.
  4. A simplified tax accounting method will be available to floating NAV money market fund investors. This is due to the changes in gains and losses that would otherwise result in burdensome tax reporting for impacted funds and their investors.

The end result of these new rules will be better transparency and reduced risk for investors, but less assurance of a stable NAV. To be fair, there never was complete assurance of a stable NAV, as money markets are not riskless securities. Hopefully, this will be more widely recognized.

Note that US Government and Treasury money market funds are not impacted by the new rules.

How will this impact 529 plans?

Most money market funds used by 529 savings plans have been institutional due to scale, sometimes lower fees, and better potential returns. Since the new rules have been announced, a number of plans have replaced their money market funds with money markets that do not fall under the new regulations or short-term alternatives. These more conservative investments will not have a floating NAV to help ensure that the most conservative options within the plan do not lose value, though there is never a guarantee. This is not a comprehensive list, but here are a few examples of plans that have made changes in their money market options recently:

  • Vanguard has replaced its Money Market Portfolio with its Interest Accumulation Portfolio in a number of states.
  • New York’s Advisor-Guided Plan, distributed by JP Morgan, replaced its Prime Money Market Portfolio with the U.S. Government Money Market Portfolio.
  • Along with a number of other portfolio changes, Oklahoma and South Dakota removed their current Money Market option, transferring the assets of account owners using said option into the PIMCO Short Asset Investment Portfolio.

Should investors be wary of money markets?

Money markets are still sound investment options for most investors. Problems involving institutional trading are being addressed, and 529 plans are swapping to lower-risk money markets or other liquid instruments where it is suitable. The larger risk facing money market holders is inflation risk and, as a result, loss of purchasing power, so it is most important to consider risk and time-horizon when holding assets in money markets.


Sources

For more information about the aforementioned content, please see some of the following references.

Financial Professional Content

In 2014 the SEC released new rules impacting money market funds that are intended to help increase transparency and reduce the risk of instability during periods of market stress. Asset managers are required to conform to these rules by October 2016. As a result, your clients may be receiving notices from their asset managers that their investments are impacted or changing. Some 529 savings plans are among those that have been impacted, and many plans that hold money markets in their underlying portfolios have been or will soon be making changes in anticipation of the October implementation deadline.

Why are these changes happening?

During the market downturn in 2007 and 2008, the net asset value (NAV) of The Reserve Primary Fund fell from $1 per share to $0.97 per share (commonly referred to as, “breaking the buck”). The Fund was essentially a large money market fund run by a New York-based fund manager called, “The Reserve.” It held a position in short-term Lehman Brother loans that, while small, was still large enough to impact the NAV when those loans defaulted. Thereafter followed a run on the fund, and the fallout resulted in the SEC investigating and, eventually, putting new rules in place.

As a result of the run on the Prime Fund, the SEC adopted rules in 2010 to help address liquidity and quality so that money markets would be more resilient in times of stress. However, the 2010 rules did not fully address all the newly-perceived risks associated with money market funds. For this reason additional rules were released in 2014, and will be enforced later this year.

What are the changes?

Under the new SEC rules there are significant trading restrictions on money market securities. There are four big changes:

  1. Institutional prime money market funds will be required to maintain a floating NAV. This will help reduce what is known as the “first-mover advantage.” With a stable NAV investors who sell first take advantage of the floating NAV, leaving those late to sell to bear the costs.
  2. Fees and gates will be in place to prevent a run on a money market fund. Much like the reserve requirements of banks, money market funds will need to maintain certain levels of liquidity, and pay fees if they are unable to maintain said levels. Money market fund boards can also suspend trading if liquidity were to fall below a certain level, acting as a circuit breaker.
  3. Additional portfolio diversification will be required, as well as additional disclosure to investors, and increased stress testing requirements. Without getting too much into the gritty details, certain affiliates could not be treated as separate entities to meet diversification requirements.
  4. A simplified tax accounting method will be available to floating NAV money market fund investors. This is due to the changes in gains and losses that would otherwise result in burdensome tax reporting for impacted funds and their investors.

The end result of these new rules will be better transparency and reduced risk for investors, but less assurance of a stable NAV. To be fair, there never was complete assurance of a stable NAV, as money markets are not riskless securities. Hopefully, this will be more widely recognized.

Note that US Government and Treasury money market funds are not impacted by the new rules.

How will this impact 529 plans?

Most money market funds used by 529 savings plans have been institutional due to scale, sometimes lower fees, and better potential returns. Since the new rules have been announced, a number of plans have replaced their money market funds with money markets that do not fall under the new regulations or short-term alternatives. These more conservative investments will not have a floating NAV to help ensure that the most conservative options within the plan do not lose value, though there is never a guarantee. This is not a comprehensive list, but here are a few examples of plans that have made changes in their money market options recently:

  • Vanguard has replaced its Money Market Portfolio with its Interest Accumulation Portfolio in a number of states.
  • New York’s Advisor-Guided Plan, distributed by JP Morgan, replaced its Prime Money Market Portfolio with the U.S. Government Money Market Portfolio.
  • Along with a number of other portfolio changes, Oklahoma and South Dakota removed their current Money Market option, transferring the assets of account owners using said option into the PIMCO Short Asset Investment Portfolio.

Should investors be wary of money markets?

Money markets are still sound investment options for most investors. Problems involving institutional trading are being addressed, and 529 plans are swapping to lower-risk money markets or other liquid instruments where it is suitable. The larger risk facing money market holders is inflation risk and, as a result, loss of purchasing power, so it is most important to consider risk and time-horizon when holding assets in money markets.


Sources

For more information about the aforementioned content, please see some of the following references.

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