Last Updated: 31 January 2023
Forbes columnist Ari Weinberg points out that bond ETFs should be seen as the “money market fund of tomorrow”, and he’s right.
Exchange-traded funds (ETFs) are well-positioned to make significant inroads into the US$2.7 trillion money market fund (MMF) sector, which is fighting a fierce rearguard action to maintain the fiction that fund net asset values can be kept stable.
In a vociferous lobbying campaign targeted at the US securities regulator, the Securities and Exchange Commission, a long list of US corporate and state treasurers say they can’t imagine a world in which MMFs might be allowed to “break the buck”—ie, have values that could fall below a dollar a share.
The chairman and namesake of the Charles Schwab Corporation, which manages US$160 million in money market funds, told the SEC last month that MMFs are low-risk. “In 2008, at the depth of the financial crisis,” said Schwab, “only one money fund lost value for its clients. It lost one percent of its value; that is just one penny of the US$1.00-per-share price.”
But SEC chairman Mary Schapiro offers up a different version of events. She pointed out recently that over 300 money market funds have been bailed out by their sponsors since the 1970s. Just because MMF investors lost out only once or twice because fund sponsors stepped in to hide losses on the other occasions doesn’t mean that there isn’t risk to the whole system, in other words.
Regulators worry that MMFs are “banks in disguise” and that losses on their investments may result in another call on public cash, as happened in 2008 (when the US Treasury and the Fed intervened to prevent a wholesale run on MMFs). In his open letter to the SEC, Schwab somehow forgot to mention the US$1 trillion in taxpayer support that was needed only recently to ensure MMFs remained “stable”.
Why the intensity of this debate, one might wonder? Are accountants in the US really unable to cope with a fund value that fluctuates? If you sense the lobbying power of Wall Street behind the scenes, you’re almost certainly right. Money market funds are a huge provider of liquidity to investment banks via the repo market. Decrease the attractiveness of such funds to investors and Wall Street firms will be forced to look for new sources of finance, undoubtedly at higher rates.
But whatever the outcome of the current battle between US regulators and the lobbyists, history and the public mood are surely moving inexorably against the money market fund business.
The idea that any fixed income investment, even in government bonds, can be risk-free has been exposed as fiction by the financial crisis. A business model that relies on credit ratings to judge risk is also inherently flawed. Money market funds offer poor holdings transparency and currently operate with a confusing system of official NAV and unofficial, market-based “shadow NAV” (reported twice-yearly, with a two-month lag). Above all, the move in official interest rates to near-zero in many markets has put commercial strain on MMF operators as a result of their marketing promise of stable fund values.
By contrast, the future is undoubtedly with short-maturity bond ETFs. These funds make no pretence that they will return exactly the amount invested, meaning that there’s unlikely to be any pressure for the injection of taxpayers’ money when fund values fluctuate. ETFs offer far better levels of disclosure than MMFs, publishing their holdings daily. Buying and selling them on online brokerage platforms is easy. All in all, ETFs offer a much more democratic and fairer reflection of the true costs and benefits of running a portfolio of short-maturity bond investments.
This side of the Atlantic there are rumblings about the mandatory reintroduction of charges on bank current accounts. This step, if taken, would also increase the attractiveness of such “cash-proxy” ETFs as savings products.
European money market ETFs, which typically track overnight interest rate benchmarks, have gained substantial assets in recent years. And now actively-managed bond ETFs, offering the prospect of an outperformance of a cash benchmark, have gained traction on both sides of the Atlantic, PIMCO’s offerings (co-managed with Source in Europe) most prominent among them.
I’ve expressed some scepticism recently about one area of dramatic recent growth in fixed income ETFs, high-yield bonds. But money market ETFs, which offer an increasingly compelling alternative to many existing savings products, are surely set to boom in coming years.