by Tom Snee

The COVID-19 related stock market decline of March 2020 showed that a five-year old SEC rule change can have a potentially destabilizing effect on some money market funds, according to a new study from two University of Iowa researchers.

The study found that prime money market funds, which choose to set their net asset value multiple times a day, offered greater liquidity but also experienced greater outflows than traditional funds during the market downturn at the start of the pandemic shutdowns. Ashish Tiwari, professor of finance in the Tippie College of Business and study co-author, said this could have a troubling effect on funds that are intended to be stable places to park cash.

Typically, a money market fund sets—or “strikes”—its net asset value (NAV) based on the value of its investments only once a day, which was traditionally set at $1 per share, and that’s the value investors receive when they redeem shares that day. But a rule change by the Securities and Exchange Commission (SEC) that went into effect in 2016 requires an institutional prime fund to have a floating NAV that more accurately reflects the market value of the assets in its portfolio. This change prompted some of the institutional prime money market funds to adopt a format where they calculate their NAV several times a day giving investors multiple opportunities to redeem their shares on the same day.

As a result, Tiwari says those funds offer their investors a higher level of liquidity compared to single-strike funds which only offer share redemption at the end of the day. However, when markets are dropping as rapidly as they did in March 2020, such funds see increased volume and speed of outflows.

Tiwari’s research team, which included Wei Li, associate professor of finance at Tippie, analyzed a sample of 34 taxable prime institutional money market funds between October 2016 and June 2020. They compared the cash outflows of 22 funds that allowed multiple intra-day share redemptions to 12 funds that allowed redemptions only once a day.

While cash outflow increased significantly during the 2020 run, Tiwari says the impact was mitigated by the fact that the managers of multiple-strike prime funds tend to have more conservative management policies, held more liquid assets, and owned fewer risky assets, so they were able to meet their redemption obligations without undue stress on the fund. He says the Federal Reserve also provided   support to money market funds as the markets fell by ensuring they would have enough cash to meet their obligations.

The study points out that investments in multiple-strike prime funds continue to grow, so institutional investors seem to want their cash to be more readily available despite the potential risk, particularly during periods of market stress.

The study was co-authored by Lorenzo Casavecchia of the  University of Technology in Sydney, Australia, and Georgina Ge of Macquarie University in Sydney, Australia. It was presented recently at the SEC’s annual conference on financial market regulation and will be presented again at the American Finance Association annual meeting in January 2022.

CONTACT: Tom Snee, 319-384-0010 (o); 319-541-8434 (c); tom-snee@uiowa.edu