Money Funds Come Out of the Shadows

Investors in U.S. money market mutual funds, whose shares they expect to stay steady at $1, will see something new beginning the week of Jan. 31—and it has fund companies nervous. Under rules passed last year, the U.S. Securities and Exchange Commission will disclose, with a 60-day lag, a measure of each fund's worth known as "shadow" net asset value, or shadow NAV.

Money funds, unlike other mutual funds, book the value of holdings at the price paid for them. They also round collective holdings to the nearest penny, so even a realized loss of less than half a cent goes unnoticed. Beginning with data for last November, shadow NAVs will show holdings at market prices and to four places past the decimal, revealing fund values typically ranging from $0.9995 to $1.0005.

Since funds round to the nearest penny, a shadow NAV between $0.9950 and $1.0049 will have no impact on the $1 share price. Still, companies managing the $2.7 trillion in such funds worry some investors will panic if they see a number below $1. "They're very concerned about how the public and media will interpret the numbers," says Michael Krasner, managing editor for iMoneyNet, which tracks the industry. Late last year, Charles Schwab spent $132 million, and T. Rowe Price (TROW) $17 million, to erase losses of less than half a cent in some funds so they would show $1 shadow NAVs come Jan. 31.

To educate consumers, fund companies such as Vanguard and BlackRock (BLK) put articles on their websites and sent them to customers. Fund trade group Investment Company Institute also released a paper and held a press seminar. Their message: Don't worry—a shadow NAV slightly above or below $1 is normal. According to Krasner and Peter Crane, president of money fund research firm Crane Data, companies are right in most cases to tell investors not to fret. Shadow NAVs could reveal a small number of troubled funds. "Anything below $0.999 will be an outlier," Crane says.

The disclosure is part of a package of SEC rule changes designed to make money funds more liquid, more transparent, and safer. Regulators want to prevent the recurrence of a 2008 run on the industry that helped cripple global credit markets. On Sept. 16, 2008, the $51 billion Reserve Primary Fund closed and stopped honoring withdrawals when losses on debt issued by bankrupt Lehman Brothers Holdings caused its share price to fall to 97 cents, an event known as "breaking the buck." (The fund has since been almost wholly liquidated.) Many more investors, unsure if other funds held debt from Lehman or other shaky U.S. banks, withdrew about $230 billion over three days.

Because money funds are the largest buyers of commercial paper, that froze the $1.1 trillion market. To ensure that companies from General Electric (GE) to McDonald's (MCD) could sell commercial paper, the Treasury Dept. temporarily guaranteed money funds against additional defaults, and the Federal Reserve opened two programs to buy commercial paper directly from issuers and funds.

Regulators tied the panic in part to investors not knowing enough about the type and value of holdings in their funds. Now shadow NAVs are filed monthly with the SEC, which posts them on its EDGAR website. George "Gus" Sauter, Vanguard's chief investment officer, says barring a normal dip after an interest rate hike, a shadow NAV below $.998 is a red flag. Says Krasner: "Look at the info, read the manager's explanation. If you're still concerned, call them. If you're not comfortable with the answer, move your money."

The bottom line: Fund companies worry investors will overreact if they see money funds' "shadow" NAVs dip slightly below $1 a share.

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