The Securities and Exchanges Commission’s proposal last month to impose new regulations on money-market mutual funds raises questions of what might happen if the SEC does allow net asset values (NAVs) on around $1 trillion of assets in institutional money funds—or about a third of all money-market fund assets—to “break the buck.” One question that’s coming into focus for advisors who use ETFs is whether it might make more sense in the future to forgo money market funds and go into alternative short-duration options, like the FlexShares Ready Access Variable Income ETF (RAVI).
Shundrawn Thomas, managing director of the exchange-traded funds group at Northern Trust, sat down with IndexUniverse’s staff writer Hannah Tool to explain how he views the SEC proposals, and the potential for any new rules to influence investors seeking cash-equivalent options, such as his firm’s RAVI.
IndexUniverse.com: Can you explain this proposed SEC regulation?
Thomas: First, we’re talking about proposals for money-market fund reform. We haven't yet put in place new rules.
When you look at what's going on currently at the SEC, there are effectively two proposals out there. The first proposal basically puts forward a floating NAV for prime institutional funds. When you look at the universe of money market funds, I think it may be as much as 30 percent that are prime institutional funds.
There are certain money market funds that invest in government securities that would not apply. They would, however, potentially propose to apply that to muni funds. The easiest way to say it is that there would be an exemption for retail money market funds and government money market funds. So that’s the first proposal.
The second proposal is a position that they would impose a 2 percent redemption fee on funds when the liquid assets fall below a certain minimum level. There also could be a temporary suspension of redemptions for up to 30 days.
You could have an instance where one or the other is adopted; you could have an instance where both are adopted; or, you could have an instance when neither are adopted.
IndexUniverse:If one or both of these proposals is adopted, what would that mean for ETFs?
Thomas: I think you have two things working together:A combination of the persistent low-interest-rate environment, and the uncertainty for money market funds. These two factors have already caused investors to think very critically about how they're managing their cash.
A short answer to your question is that if you're going to have change, regardless of what that change is, investors are going to demand new alternatives. So that’s going to create opportunities for providers of ETFs, as well as other strategies, to deliver short-duration or liquidity-oriented products.
IndexUniverse: How do you propose investors plan to “hedge against” the impact of these SEC changes, should they take effect?
Thomas: I'm not being flippant, but it’s almost impossible to hedge against regulatory risk. Because there are so many components of this, it’s hard to predict exactly what the outcome will be. But let me tell you what investors can do.
Investors have not really distinguished how they’ve looked at cash in their portfolio. We think the single best thing that investors can do is distinguish those things.
What do I mean by that? If you're an institution or an individual, and you have an immediate need for use of the cash in your portfolio—let’s call it “mattress money”—there's a way that you probably want to invest that. I think the emphasis there is on principal protection.
You have to orient yourself to the fact that, particularly in this low-rate environment, you're going to get paid very little in the way of yield or return. And in certain environments, you may, from a real-return standpoint, have to pay for that security.
Think about a portfolio where you may have some allocation to cash. Historically, people have allocated, say, 3 to 5 percent to cash, because they want that there to take advantage of, say, opportunities that come up in the marketplace, or stresses. Investors want it to be liquid.
But by the same token, since it’s getting counted against their comprehensive investment return, and it’s affecting the risk of their portfolios, they want some sort of appropriately risk-adjusted return on that.
I think, in that category, that’s where people can and should think differently about how they invest that strategic cash. And I think ETFs can be a very viable alternative, in terms of delivering a product there.
IndexUniverse:Do you think that short-duration funds like Northern Trust’s RAVI and the SPDR Barclays 1-3 Month T-Bill (BIL) will be in higher demand if and when these SEC regulations get imposed?
Thomas: I really don’t comment specifically on competitive funds. But what I would say is this:In an environment where you have changing macro factors—like what we talked about in terms of the persistent low-rate environment—and the potential for changing regulatory environment, it always produces opportunity for new strategies.
Setting aside whatever the investment merit of those strategies are, those kinds of things will create opportunities for more sponsors. So, not speaking to any of those specific funds, yes, as a class, I absolutely believe those types of products will draw interest from investors, because investors will be looking for alternatives.
IndexUniverse:Bernanke’s comment on May 22 seems to have set things into disarray, and yet people aren't rushing into these short-duration, money-market proxy funds like RAVI or MINT. Is it because investors don’t want to pay to essentially get nothing, in terms of yield? Could you address that in the here and now, and also over the arc of time?
Thomas: One thing that we have to keep in mind, with that question, is that there's the prospect for change, but nothing has actually changed with respect to the regulations around money market funds.
Money market funds still provide what they have been providing, and they still can operate under the rules under which they have been operating. That has not changed. In light of what we’ve seen in this sort of recent market volatility, it would be hard for that right now to cause a lot of change in terms of how people think about how they’ll gain exposure to cash, because they don’t have to right now.
I think what will happen, generically, is as people get more clarity on what’s specifically going to happen, you will then see people react. But right now, all investors are looking at is the potential for something to change. I think that’s why something like Bernanke’s comments don’t necessarily spur any big rush to those kind of products.
IndexUniverse: Do you think the issue of “paying something for nothing” in terms of yield minimizes as rates normalize?
Thomas: I know people don’t seem to like to talk about this outcome, but rates could continue to be lower for a longer period of time. I think what will happen is there will be a “shakeout”— a class of investors, or a particular point in time where somebody is investing, where they are willing to, in a sense, get very little or no return for cash because of their view on the marketplace, or how it affects their portfolio.
I really want to stress that point because I think people totally miss it. If you think about why you own any kind of fixed-income instrument, there are three reasons. You want some sort of predictable, stable cash flow. You want to capture some level of appreciation or return on investment. But the third one is really important. You are thinking about the benefits that it provides to an overall portfolio.
In a very volatile environment, where will people go? They’ll go to cash, or short-duration-type instruments, or government-type instruments. It would make sense to be there. And if my option is earning nothing or losing very little, versus losing a lot, that’s actually a good relative trade.
I think people tend to think of it as a stand-alone, as opposed to thinking about it in the portfolio context. So the argument that there is no rationale for owning something that pays a relatively low yield in every environment, I personally think is a flawed one.
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