Will Money Market Fund reform create bond market orphans?

by Pat Luby

The deadline to implement the new reforms to money market funds (requiring floating NAV for institutional funds) looks like it will result in tighter focus on which securities portfolio managers will be considering for their funds. A recent Bloomberg article drew attention to a letter to clients from BlackRock in which “[T]he company said it would have funds that limit holdings to securities with maturities of seven days or less.”  The company cites the reduced supply of short maturity U.S. Treasury securities and the reduced liquidity in the repo market as important factors in how they are adjusting their product line-up. (For an update on the repo market, WSJ subscribers should read Pressure in Repo Market Spreads, April 2, 2015.)

Increased demand and reduced supply = lower yields.

Well before the required change, the markets can be expected to differentiate between the securities eligible for the MMFs to invest in and those that are excluded (the “orphans”), with yields on the excluded securities likely to be higher. With lower yields for investors in the money market funds, the yield-hungry may be tempted to look at the higher-yielding “orphans” for their “liquid” holdings. But holding securities that will not have bid-side support from institutional portfolio managers means that even short-duration securities could be at a disadvantage in choppy market conditions. There is still much to be revealed about how the changes will filter down to the specifics of security selection, but everyone should be paying attention to the news flow.  (Bloomberg Business has a Money Market Fund news page available.)