While most experts don’t think negative interest rates are likely, the fund industry has recently begun explaining to regulators what to do just in case.
Reverse Distributions – a paradoxical term that sounds almost like Orwellian, like “war is peace” – is exactly what the Investment Company Institute, a fund trading group, describes a December report over Money market capital. The report was designed to address concerns that US money funds, after deducting their fees, cannot deliver even zero returns in a negative interest rate environment – as was the case in Europe since 2014.
How can distributions that you are supposed to receive work the other way around? The ICI paper describes a process in which, instead of an income payment, a reverse distribution mechanism or RDM “a [constant net asset value or] Negative return of the CNAV money market fund due to cancellation of shares in shareholder accounts. It offsets the negative return accrued daily (ie a decrease in the fund’s net assets) by reducing the number of fund shares outstanding. This process enables the Fund to maintain a constant Net Asset Value per Share, typically $ 1.00. “
In Europe, reverse distributions are referred to as much less appealing but simpler “stock destruction” or “stock cancellation”. These terms describe exactly what will happen.
The US $ 1 net asset value has been inviolable to retail investors in US money market funds since its inception in 1971, so investors can think of money market funds as bank accounts even though they are not insured nationwide. The few cases where money market funds have “broken the money” have been during times of extreme market stress. The last case was the decline in the Reserve Primary Fund to 97 cents in 2008 due to the Lehman brother’s bankruptcy.
RDMs create the illusion that investors are not losing money by maintaining the net asset value of $ 1 while the number of stocks goes down. However, the purpose is not to mislead investors, but rather to prevent the Net Asset Value from falling due to fees and falling returns in an environment with negative interest rates below $ 1. “In the current [zero interest rate] Surroundings, [money funds] waive more than half of their fees, ”said Peter Crane, president of money fund tracker Crane Data. “So instead of charging [0.28%], they are charging [0.13%] for now.”
Some money managers say that maintaining a net asset value of $ 1 even when the number of stocks goes down is easier for brokers selling funds to keep track of when they are depositing and withdrawing cash each day. “When you sweep [cash] At the end of each day, developing a stable net asset value product is pretty easy because it only costs one dollar to one dollar, ”said Deborah Cunningham, CIO of Global Liquidity Markets at Federated Hermes, who manages and carried $ 433 billion in marketable assets contributes to the ICI report along with other money market managers. “With this sweep mechanism, there are no computations of stocks versus price, whereas pretty much any other mechanism would require computations of stocks versus price.”
However, there is also a psychological dimension to getting the NAV of $ 1 instead of floating or “floating” it like a normal stock or bond fund. “Our investors want a constant NAV solution,” said Jeff Weaver, senior portfolio manager who oversees money market funds valued at approximately $ 200 billion
Asset Management, which also contributed to the ICI report. “You don’t want a floating net asset value.”
However, institutional municipal debt and premium money market funds already have a floating net asset value that can drop below $ 1 as a result a 2016 regulatory change. According to Weaver, Wells Fargo’s institutional clients want this not to be the case: “Clients in money market funds are trying to get the capital. If a net asset value fluctuates, there is a possibility that you will lose capital. “
Weaver compares the ICI’s report on RDMs to a “contingency plan” because the likelihood of negative interest rates in the US is “very small”. While the Treasury bills briefly fell into the negative yield territory during the pandemic crash last marchThe US has been in recovery mode since then.
However, the coronavirus remains an economic wildcard. The Federal Reserve Bank “said they didn’t want to go negative, but they never say never,” says Crane. “They’re getting another big shock to the economy, pushing us back down, and suddenly negative rates and deflation could be possible again.”
There could also be regulatory hurdles for RDMs. When European interest rates turned negative in 2014, some funds like the BlackRock ICS Euro Government were Liquidity Fund busy RDMswhich the ICI’s RDM design is similar to. Ultimately, EU regulators banned RDMs in 2018and said they weren’t “compatible“Had to use existing regulations and resources Changeover to floating NAVs.
If the RDM scenario is unlikely in 2021, why did the ICI publish a detailed report in late 2020? One reason was to make the RDM case public. The ICIs are issuing this not only for the people in the industry and their customers, but also for the regulators themselves to improve understanding [RDMs] could work, ”says Weaver. The other was customer concern. “The negative interest issue has been so persistent from the start of last year [of the pandemic crisis] In March you couldn’t have a conversation with a customer or colleague without discussing it [it]. ”
If RDMs were to take place, training investors would certainly be a challenge. “This is something that would be new to most investors, especially retail investors,” affirmed Jeff Naylor, director of operations and distribution for the ICI. “We highlight in the paper the need for a communication strategy for both the funds and the intermediaries.”
One thing that could help clear things up is not to refer to them as RDMs, but instead share the destruction. That would be less Orwellian.
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