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SEC flags ‘accounting fiction’ of money market funds

In a recent op-ed for the Wall Street Journal, SEC chairman Mary Schapiro recommended that U.S. money market mutual funds adopt floating net asset value prices. Canadians should join Ms. Schapiro in the fight.

Ms. Schapiro views the constant unit price of money market funds as misleading, quoting another WSJ article describing them as "an accounting fiction" that leads investors to think the funds are less risky than they really are. The proposed changes are being fought hard by mutual fund companies, notably Fidelity, who fear that investors will abandon money market funds and move their assets into safer but less lucrative options such as savings accounts or bank deposit notes.

Money market fund investors often mistakenly believe the funds are largely made up of government guaranteed T-bills, but the reality is far different. The rules permit money market funds to hold some assets that are highly susceptible to changes in the economy, which could reduce their value.

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Advocates of the new policy point to the "breaking of the buck" of the U.S.-based Reserve Fund during the financial crisis as reason enough to overrule fund company challenges. Because the Reserve Fund was significantly exposed to Lehman Brothers' short-term debt, the firm's collapse obliterated the price of that debt, causing the Reserve Fund's unit price to fall below $1 (U.S.). That in turn sparked an immediate withdrawal of $300-billion in fund assets. Subsequently, the resulting panic spread throughout the industry and the federal government was forced to step in to guarantee money market fund values before a wholesale liquidation occurred.

Canadian investors should also take note. For Canadians and Americans alike, the fixed net asset value of domestic money market mutual funds is the primary attraction, as it implies bulletproof safety of capital. But the top holding in the $2.8-billion RBC Canadian Money Market Fund, for example, is not a T-bill, but an $80-million position in the Bay Street Funding Trust Class A, a vehicle that securitizes corporate receivables.

There are no obvious signs of problems with Bay Street Investment Trust. For what it's worth, DBRS has reviewed the product and notes that it conforms with guidelines designed to limit volatility and credit risk.

It is not difficult, however, to imagine an economic shock that would significantly depress the value of the Bay Street Investment Trust along with other, similar investments. With existing pricing policy, RBC's money market fund would maintain its unchanging price despite the fluctuations in the values of the underlying assets.

There is no reason at present to fear for Canadian money market funds. But the best time to prevent crises is before they begin, and Canadians should carefully consider how much of their savings should be dependent on an accounting fiction.

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About the Author
Market Strategist

Scott Barlow is The Globe's in-house market strategist. He is a 20-year veteran of Canadian investment banks, including Merrill Lynch Canada, CIBC Wood Gundy and Macquarie Private Wealth (MPW). He was a highly ranked mutual fund analyst for 10 years and then, most recently, the head of a financial adviser support team at MPW. More

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