PAM
REGULATION
DECEMBER 2014
R E G U L AT O R Y U P D AT E
Michael Kastner, principal at Halyard Asset Management, investigates the impact that
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he Securities and Exchange Commission (SEC)
recently approved rules which it hopes will prevent
a repeat of the investor exodus from money market
funds (MMFs) which occurred during the financial
crisis. However, we fear the changes will have the opposite effect
by worsening, or even hastening, such an exodus.
The most significant regulatory change in this space is that
institutional prime MMFs will no longer be allowed to maintain
a stable net asset value (NAV) and will, instead, be required to
allow the NAV to float. Moreover, both individual and institutional fund managers will be allowed to temporarily block or
‘gate’ investor redemptions. In addition to this gating right, the
fund board will be able to impose a redemption fee of as much
as 2% in the event of a mass exodus of investors. Such an exodus
is defined as a 10% fall in assets under management over the
course of one week. Investors are likely to be shocked to learn
that their MMF has the right to impose a 200 basis point fee,
especially when it is generating no more than a handful of basis
points per annum. With that reality, MMF investors will likely
look for an alternative.
A seemingly feasible alternative to prime funds would be US
government MMFs, funds that invest only in US government
debt. Under the new rules, those funds will be required to hold
at least 99.5% of their assets in government paper, an increase
FAMILY OFFICES SHOULD ADOPT
A CASH MANAGEMENT STRATEGY
SIMILAR TO THAT OF MANY
FORTUNE 500 CORPORATIONS
from the current minimum of 80%. Unlike prime MMFs, US
government MMFs will not be subject to the mandatory redemption gate or fee – unless the board of the fund decides that
a gate or a redemption fee is required, in which case the SEC has
ruled that they may adopt either or both.
Given that US government MMFs invest almost exclusively in
the massive, highly liquid Treasury bill market, such a gate is not
likely to be needed. However, the mere possibility of an exodus
may be enough to discourage investors from using government
MMFs. One only needs to look back to August 2012 for such a
risk, as Congress came within a day or two of defaulting on maturing US Treasury debt. While default was avoided, it’s likely
that US Treasury paper would have dropped sharply in price
prompting a flight from government MMFs, had an agreement
not been reached.
With the coming regulatory changes to MMFs, it’s imperative that family offices understand the risks posed to cash held
in money market funds. Family offices typically carry high
cash balances to meet cash flow needs and as ‘dry powder’ for
unexpected investment opportunities. Such an arrangement
may no longer be feasible given the potential for lock-up and fee
imposition. That could be a blessing in disguise given the high
concentration risk and lack of diversification discussed above.
As an alternative, family offices should adopt a cash management strategy similar to that of many Fortune 500 corporations.
Typically, the CFO of these corporations will hire third-party
managers and work with them to establish a separately managed
account of fixed income securities governed by a strict investment policy statement. A typical cash management investment
policy statement would cap maximum maturity at two years,
establish a minimum weighted average credit rating of “A,” and
maximum holding per position of 2.5%.
By investing their cash in a separately managed account,
the family office immunizes itself from both the risk of having
its cash gated, and the detrimental effect on return when the
MMF manager is forced to sell securities in a falling market to
meet redemptions. Certainly, the separate account may incur a
market-to-market loss during such a run. However, if the cash
is not immediately required, the manager may not be forced to
sell into a falling market and will, thereby avoid locking in a loss.
Moreover, if the manager holds the securities to maturity, no
loss would be incurred at all. In effect, the family office gains full
transparency and decision-making over their cash assets while
broadening the diversification of the portfolio. Q
Halyard Asset Management is an SEC-registered investment
advisor with the mandate of managing fixed income assets.
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