Regulators on both sides of the Atlantic have been looking at ways of making the money market fund industry more robust, and one of the options they’ve focused on is moving from a stable, or constant, net asset value (CNAV) model to a floating or variable (VNAV) model.
The prospect of a move to floating NAV faltered in the U.S. in August when Securities and Exchange Commission Chairman Mary Schapiro called off a vote on proposed reforms to money-market funds that included moving to a floating NAV and imposing a capital buffer. Nevertheless, regulators in both the U.S. and Europe continue to focus on a floating NAV as a possible outcome. In October, the International Organization of Securities Commission published a report that suggested, among other things, that stable NAV funds should be converted to floating NAV where workable.
Floating NAV funds do not maintain a share price of $1 (or €1 or £1), unlike stable NAV funds. Instead, the price fluctuates in line with mark-to-market valuations. While some believe this type of fund is more robust and less susceptible to redemptions during a liquidity crisis, the floating NAV model is unpopular among many corporate treasurers. Numerous surveys have shown the majority of treasurers would shift assets out of money market funds if the only type available were the VNAV model. But are their fears justified?
Colin Cookson, managing director of global liquidity at U.K.-based Aviva Investors, argues that they’re not. In 2008, following the collapse of Lehman Brothers, Aviva made the unusual decision to convert all of its stable NAV funds to the floating NAV model.
“We were told by a senior member of the fund community that we’d have no clients left within a week,” says Cookson, pictured above. “Since then we’ve added several billion of assets and new funds. I think the main issue for investors into VNAV funds is the fear of the unknown.”
Proponents of stable NAV funds argue, among other things, that the floating model means additional accounting complexities. “Corporate treasurers like the [stable NAV] function within a money market fund as it holds a stable price of one – and my understanding is this makes it easier to classify as a cash instrument,” observes Jennifer Gillespie, head of money markets at Legal & General Investment Management in London. “Should [money market funds] move to VNAV, then this becomes a daily moving price.”
Nevertheless, this is not necessarily an obstacle. Jarno Timmerman, chief dealer at paint and coatings company AkzoNobel in the Netherlands, says the company has used a VNAV fund. “Although it was a VNAV fund, our systems were set up in a way that enabled us to account for it as though it were a CNAV fund,” Timmerman explains. “If CNAV funds had to become VNAV, that wouldn’t change the way that we use money-market funds.”
It is worth noting that floating NAV funds don’t necessarily experience price fluctuations. Since Aviva adopted the VNAV model, the valuation of its funds has never moved away from one, whether that’s £1 or 1 euro, Cookson says. And he argues that the possibility of variation should be seen as a strength, rather than a problem.
“If a CNAV fund breaks the buck, you have to freeze the fund, lock all the cash in, liquidate the assets and pay investors on a pro-rata basis,” Cookson points out. “That would clearly take time to do, which is no good if you are a pension fund or a corporate treasurer and you need your cash on a daily basis. With the VNAV model, investors know that the worst that can happen is a slight fall in the value of their investment.”
Aviva isn’t the first fund manager to offer floating NAV funds. The money-market industry in France is based upon the VNAV model–and with assets under management of more than $530 billion at the end of 2011, France’s money fund industry is larger than that of any other country aside from the U.S.
Although treasurers prefer stable NAV funds, current market conditions could make the VNAV model more attractive. Indeed, if the European Central Bank cuts rates again, negative yields in the eurozone could make the stable NAV model unsustainable, even without regulatory intervention. In September, Insight Investment announced the launch of a floating NAV euro cash fund, stating that the new fund was being introduced “as a precaution against further rate cuts by the ECB and the difficulties this would impose on managing a stable Euro NAV.”
On the other hand, some treasurers have concerns about the use of money-market funds that go beyond the debate about net asset value. “A lot of companies are not using money-market funds at all because they are still so nervous about what happened four years ago, and they don’t feel that they have sufficient inside knowledge to really understand the mechanics of a money market fund,” says Sander Van Tol, a partner at consultancy Zanders Treasury & Finance Solutions in the Netherlands. “They prefer to go for the easy solution, like investing in T-bills or short-term bonds.”