iShares’ Response to Money Market Fund Reform Is NEAR

by Aaron Levitt | October 4, 2013 8:18 am

For many investors using money market funds, “breaking the buck” — where the usually fixed NAV of shares falls under $1, meaning potentially significant losses for investors — is the stuff of legend. After all, the customary parking place for short-term cash needs are often thought of as savings accounts and are well-protected.

Well, the truth is that money markets still are investments — albeit in very, very, short-term bonds[1] — and some investors found that out the hard way during the financial crisis.

In a response long in the coming, proposed new legislation to “fix” these money market funds has spurred a new product from iShares: the iShares Short Maturity Bond ETF (NEAR[2]).

iShares Gets ‘NEAR’-Sighted

As Lehman Bros.[3] was crashing back in September 2008, the Reserve Primary Fund — which held $785 million of Lehman’s debt — broke the buck as shareholders fearing losses, rushed to redeem their shares. The sizable money market fund wasn’t able to absorb the loss, and the Securities and Exchange Commission was forced to step in. The SEC suspended redemptions of the fund to allow it to be liquidated in an orderly manner. Investors in the fund only received pennies on the dollar for their initial investment.

Since the Reserve Primary Fund “broke the buck” and went under, regulators have been tinkering with the idea reforming just how money market funds work[4]. One such proposal is to have floating NAVs — a move away from the stable $1 value that could completely change the money market industry as investors know it.

To get out in front of a possible approval, BlackRock (BLK[5]) — one of the largest providers of money market funds for institutional and retail investors — recently launched[6] the iShares Short Maturity Bond ETF.

NEAR, an actively managed fund[7], will bet on a range of U.S. dollar-denominated short-term fixed-income securities — such as commercial paper and overnight funding agreements — with an average duration of one year or less. Duration is basically a measure of how the price of a bond will react to a change in interest rates; thus, shorter-duration bonds will move “less” when rates rise than longer-termed bond funds.

Roughly 80% of NEAR will be comprised of investment-grade Treasury and corporate debt. The remaining 20% will be in asset-backed debt and commercial mortgage-backed securities. Expenses will run a cheap 0.25%, or $25 per $10,000 invested.

Shorter-duration funds have become the go-to investment for investors as the Fed still is planning on tapering its quantitative easing programs and has begun raising interest rates. The basic idea is that these funds will have an easier time “rolling-over” their holdings to new higher-yielding bonds as the Fed raises rates. Therefore, their prices shouldn’t drop as much as, say, the Vanguard Extended Duration Treasury ETF (EDV[8]),which bets on the longest bonds issued by the U.S. government.

Precursor to Bigger Things

Aside from completing iShares’ lineup of individual bond ETFs that target the entire spectrum of maturity and duration ranges, BlackRock could be setting itself up for bigger things done the road. Namely, floating-NAV money market funds.

Roughly $2.2 trillion is invested in taxable money market assets. About 60% of that amount is in prime funds — the kind like Reserve Primary Fund. Those funds could see floating NAVs in the future, along with gateways designed to reduce rapid and large redemptions. While some investors might shift assets to Treasury-only money market funds for very short funding needs, many others could find themselves moving into these ETF products.

After all, you’re getting roughly the same yield as a Prime fund, but the ability to move in and out of cash just as fast.

That could be a huge advantage for sponsors of these funds.

Already, investors seem to like the idea of these money market-esque ETFs. The PIMCO Enhanced Short Maturity ETF (MINT[9]) has swift volume, low volatility and has garnered more than $4.2 billion in assets from investors. Meanwhile, it provides a 0.84% yield. (Remember: These funds are for liquidity needs.)

Bottom Line

iShares could have a hit on its hands with NEAR — especially if it begins to market the product to institutional clients. Both active and index mutual funds have to keep a cash cushion for fund redemptions and purchasing securities. The same can be said for hedge funds and pension investors. By getting out in front of the legislation now, BlackRock could be setting itself up for a huge win when money market fund reform finally hits.

As for regular retail investors, using a product like NEAR or the Guggenheim Enhanced Short Duration Bond ETF (GSY[10]) allows them to get a liquid cash-like position while still picking up some — albeit little — yield. That yield should grow, and their price should be pretty protected as the Fed raises rates.

As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.

  1. short-term bonds:
  2. NEAR:
  3. Lehman Bros.:
  4. reforming just how money market funds work:
  5. BLK:
  6. recently launched:
  7. an actively managed fund:
  8. EDV:
  9. MINT:
  10. GSY:

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