The Error-Proof Portfolio: Don't Let Daily Money Market NAVs Obscure the Big Picture

Several large fund shops have begun posting daily net asset values for their mutual funds on their websites. The firms are some of the biggest players in the money market fund industry--including Fidelity,  Charles Schwab (SCHW), and  Federated Investors (FII).

This disclosure helps address at least some of what former SEC chairwoman Mary Schapiro aimed to achieve with a money market reform proposal that was scuttled last year: Even though money funds have long offered an implicit guarantee on shareholders' money--cashing them out at a $1 net asset value--in reality the securities in money funds' portfolios may occasionally drop in value, thereby forcing the whole portfolio's NAV below the $1 level.

In the vast majority of such cases, fund companies have quietly stepped in and added their own money to the funds' coffers, thereby making shareholders whole. But there have been a small handful of cases where money funds' losses have translated into shareholder losses. The most famous such case was the Reserve Primary fund, which broke the buck at the height of the financial crisis. The subsequent near-panic among many money market fundholders, in turn, prompted the Federal Reserve to provide a temporary guarantee on the funds.

The new disclosure is designed to give money fund investors a window into just how frequently money funds' NAVs bounce around--or perhaps more likely, don't--and therefore a preemptive grasp on whether investors need to be worried about their money funds. And regardless of funds shops' motives--some industry watchers have suggested that the disclosure is designed to stave off further regulation--more disclosure is a good thing, especially if it helps investors better understand their holdings' risk levels.

But does the availability of new data mean you should add checking your money fund's NAV to your due diligence list? On a daily basis? Probably not, for a few different reasons.

Changes Are Likely to Be Small and Perhaps Even Invisible
The first is that checking for changes in money funds' NAVs is likely to be about as interesting as watching paint dry. In a testimony before the Senate's Banking, Housing, and Urban Affairs Committee in which Schapiro called for money fund reform, she noted that there were 300 past instances when fund companies had stepped in to make shareholders whole because of a slipped NAV. Although that figure was eye-opening in that it provided a window into what has gone on behind the scenes in the fund industry, 300 is still a small number when you consider money funds' 40-year history. That, in turn, indicates that scouting for NAV slippage on a daily basis could be a misspent allocation of investors' precious time. Moreover, many of the firms that have begun providing daily NAV disclosure are broadly diversified firms that could more readily take money from other operations to top up their money funds, thereby keeping the whole firm's reputation intact.

And even if funds' NAVs do fluctuate, they may still not be disclosed. That's because the fund shops that are disclosing daily NAVs are generally providing disclosure out to four decimal places. That means that even if a fund's NAV drops to 0.99992, its NAV out to four decimal places--0.9999--would still round up to 1.0000. Shareholders wouldn't see any notification of the slippage.

'Well-Executed Fiction' Remains Intact
It's also important to understand what the new disclosures don't mean. While some fund shops will be disclosing changes in NAVs, they've all been quick to assure investors that they're committed to redeeming investors' shares at the $1 NAV level. And fund shops have generally made good on that promise. In only two of the 300 "slipped NAV" cases Schapiro cited in testimony have money fund sponsors not made shareholders whole--Reserve Primary and an instance in 1994.

That's not to give the industry a free pass, however. Yes, money fund providers have a great track record of making shareholders whole, but money fund investors still don't enjoy the same guarantees that investors in FDIC-insured vehicles such as bank money market accounts and certificates of deposit do. That's why Morningstar managing director Don Phillips has called money fund purveyors' good behavior "a well-executed fiction."

Other Factors Trump Daily NAVs
Finally, though scouting around for errant money market NAVs might provide fun sleuthing, it would be a shame to let it obscure the more important aspects of due diligence for your cash holdings. Arguably more important when selecting money funds is a check of a fund's yield and its expense ratio, as well as an assessment of your own liquidity needs and your need for true guarantees.

Yields, of course, help you compare products' payouts--not just within the money fund industry but also relative to other competing products such as CDs and money market accounts. Expense ratios, meanwhile, can provide a window into how much risk a fund is likely to be taking to deliver its competitive yield. Of course, the whole exercise is close to moot right now, as yields are tiny and many money market providers are actually subsidizing their products to deliver a positive return. But in a more normal yield environment, the yield/expense ratio combination can be telling. If a fund has a high yield and low expense ratio, that would indicate its portfolio manager doesn't have to venture into risky securities to deliver a competitive yield. A high-yield/high-expense combination, meanwhile, could indicate just the opposite. When Reserve Primary broke the buck in 2008, for example, it was among the highest-yielding funds in Morningstar's database, but its expense ratio was by no means the lowest.

Finally, an assessment of your own liquidity needs and whether you need your money to be guaranteed should also be central to the decision-making process when deciding where to put your cash. Money market fund yields might be lower today than those of competing products such as CDs, but they also offer daily access to your money--a valuable convenience for many. At the same time, as outlined above, money market funds don't offer the same guarantees that FDIC-insured products do. Daily NAV disclosure, while a step in the right direction, doesn't change that.

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