Money market reform – driven by the 2008 financial crisis and the rebound from a prolonged period of low interest rates – is changing the way investors think about cash. Learn why many advisers are exploring other options for their clients’ holdings.
Tags: Best practices, Cash flow, Custody, Registered investment advisor
Published: January 23, 2019
The term “cash” means different things to different people. According to Alan Markarian, senior vice president at Baylake Bank and national manager for its Investment Advisor Services group, its definition can vary from investor to investor, advisor to advisor.

“For retirement and core investment accounts, cash generally refers to the transitory cash created from income payments or the rounding that naturally occurs during trade execution,” Markarian said. “For operational accounts that need liquidity to fund activities outside of the investment account, a much larger allocation to cash is possible, which can often be a sizeable portion of a portfolio.”

Ultra-short-term investments
Markarian said he prefers to think in terms of ultra-short-term investments, rather than cash.

“To me, the cash portion of a portfolio is everything that trades same day or T+1 and has a short duration,” he said.

Those buckets include, among others: money market funds, government issued debt, commercial paper, tax-free state-specific funds and bank balance sheets.

Breaking the buck
The first Federal Deposit Insurance Corp. (FDIC) sweeps came onto the scene in the early 2000s, but didn’t really take off until about 10 years ago due to the financial crisis and money market reform.

Prior to the 2008 crisis, investors tended to keep ultra-short-term investments in money market funds.

When Lehman Brothers collapsed, however, the largest of those funds – the Reserve Primary Fund – found itself exposed by its Lehman bond holdings. Institutional investors pulled billions of dollars out of the fund, driving the share price to 97 cents, “breaking the buck.”

And when the Reserve Primary Fund broke the buck, Markarian explained, it created a ripple effect in the psyche of the industry.

Ensuing reforms
The Reserve breaking the buck pushed the Securities Exchange Commission to put in place reforms. Prime institutional money market funds were required to have a floating net asset value rather than a fixed one-dollar share price. The reforms also resulted in the institution of liquidity fees and redemption gates, halting withdrawals to certain money market funds.

“What money market reform did, at least in some people’s eyes, was change prime money market funds from being a true ‘cash sweep’ into a short duration mutual fund that can be traded same day,” Markarian said. “While that distinction might seem like an irrelevant nuance, it’s not. It led to billions of dollars fleeing prime funds in search of a home that makes investors, CIOs and CFOs more comfortable.”

Shifts in holdings
Money market funds are still widely used for ultra-short-term investments, but the financial crisis changed the way their risk is perceived. Money market reform added complexity that makes them more burdensome to hold.

Concurrently, interest rates have started to rise after a long stretch of low interest rates, driving interest in cash as an asset class. The environment has pushed some advisors to shift cash holdings to FDIC sweeps, which spread cash across numerous FDIC-insured accounts, boosting the level of government insurance for large amounts of cash.

According to Markarian, “This combination has contributed to the attractiveness of other options, such as FDIC sweeps and separately managed short-term portfolios.”

Money market reform has affected the way investors think about cash, and the landscape will likely continue to evolve into the future. As it does, an experienced partner can provide resources, expertise and support to help you make the best decisions based on your needs.

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