One financial firm takes the view that a floating NAV for money market funds works.
One of the flash points in the dialogue around the proposed changes to money market fund regulations centers on replacing the stable NAV (sNAV) configuration with a variable or “floating” net asset value (vNAV). There has been a chorus of opposition to such a move; however, at least one financial firm, DB Advisors, thinks it’s a good idea.
Historically, MMF investors have become accustomed to stable valuation (the infamous “buck”) and the ease of accounting for income with the traditional MMF products. Consequently, it seems almost counterintuitive to solve for MMF risk by letting the net asset value of a MMF actually float day to day.
But proponents say this is actually a preferred and more prudent approach. “The goal of the [change] is to reduce incentives for a run on MMF’s and create a system that is better at withstanding a stress environment and treats shareholders equitably,” said Kevin Bannerton, managing director at DB Advisors.
Mr. Bannerton believes the first round of reforms was helpful but it only addressed liquidity risk. As such, there is a need for more reforms to address principle risk and here DB Advisors has been a strong advocate of implementing a vNAV product and has actually been working closely with regulators for several years on the matter. Unfortunately, many naysayers have viewed the vNAV option as an either/or approach. However, DB Advisors supports a vNAV product in addition to sNAV, not instead of. “We think there is room for both products. The market has to evolve to address a changing risk landscape and allow clients to adjust their risk objectives,” Mr. Bannerton said.
Commercial Paper Market impact. Although their participation has been muted recently due to the European debt crisis, MMF’s remain among the largest investors in high grade commercial paper issues. Also impacting MMFs was the last round of regulations imposing shorter maturities of those holdings; this in turn shrunk the field of available issues for funds to purchase. But Mr. Bannerton noted that the CP market is also being negatively impacted by rules from Basel III. “There is a disconnect where the market can operate efficiently – MMF’s are getting shorter while issuers are going longer,” he said. A dual fund approach will help. A second type of MMF product will bring an additional source of buyers to the CP market resulting in greater liquidity. And a floating NAV is simply more appropriate to represent longer CP issues. DB Advisors thinks there should be a range of fund types with different characteristics in maturity and quality.
Can a vNAV Option Fly? DB Advisors has been such a strong supporter of floating NAV that it took the step of establishing a vNAV fund in April 2011 partly for the purpose of showing that this type of fund is viable. Admittedly, Mr. Bannerton said, receptivity from institutional investors and from regulators has been cool. But in recent months constituents have begun to warm to the idea and Mr. Bannerton noted that regulators have had a lot of positive responses to DB Advisors’ feedback. “Clients and industry participants view it positively, but they are taking a ‘wait and see’ approach due to regulatory uncertainty,” he said, adding that even in the last few weeks reactions have been more positive as the debate has heated up.
“Clients have thanked us for our explanations and said it has been very helpful in evaluating risks they had not been considered previously,” Mr. Bannerton said. And with the recent focus, people are becoming much more receptive to the notion of a vNAV than has been presented in the media.
A vNAV fund may not be for everyone, but for those who place a higher value on transparency and knowing the true value of their assets each day versus simply maintaining the value of the dollar with a higher risk to liquidity in a stressed environment, it warrants at least a closer look.