Money market funds are popular cash management vehicles as they seek to maintain a stable net asset value (NAV) of $1 per share. During the 2008 financial crisis, the NAV of Reserve Primary Fund fell below $1 per share or “broke the buck” causing massive redemptions and the panic soon spread to other funds. The short-term credit markets froze and the Treasury Department had to step in to stop the damage. This event highlighted the risks in money market funds.
Subsequently, the U.S. Securities and Exchange Commission (SEC) introduced new rules and regulations to reduce the risks associated with money market funds. The enhanced disclosure requirements for the “shadow price,” or the market-based price of the fund portfolio introduced in January 2011, were a part of this wider money market fund reform.
In this article, we will examine what a shadow price is and the implications of the SEC ruling for investors.
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What Is a Shadow Price?
A shadow price, also referred to as the mark-to-market NAV per share, is the per share price of a portfolio based on the market value of the securities in that portfolio. As long as the shadow price remains in the range of $0.9950-1.1050, the money market funds can price their portfolio at a stable $1 NAV per share. The term “shadow price” has been used for many years to reflect the fact that the per share market value of a money market fund is expected to closely track or “shadow” the per share value of the fund calculated using the amortized cost method.
A money market fund invests in the highest-rated short-term debt securities, which mature in less than 13 months, such as U.S. Treasury bills and commercial paper. Since the market value of these securities is affected by changes in interest rates, maturity and credit quality, the shadow price of the fund deviates from the $1 per-share value. SEC’s rules and regulations on the quality and maturity of the securities in the fund reduce the interest rate, credit and liquidity risks of the money market funds. This ensures that the shadow price deviates in a very narrow range enabling the fund to maintain a stable NAV of $1 per share.
SEC has mandated the use of floating NAV by institutional prime money market funds. Learn about floating NAVhere.
Shadow Price vs. Daily NAV Per Share
Daily NAV is calculated using the amortized cost method for the securities in the fund portfolio, assuming the securities are held until maturity. The use of the amortized cost method allows money market funds to maintain a stable $1 NAV per share (provided it remains close to per share market value). The per share market value, as discussed above, is the shadow price of the fund portfolio and is calculated based on the actual market values of the securities in that portfolio.
In order to understand how NAV is determined, click here.
Implications for Investors
Money market funds are regulated under the rule 2a-7 of the Investment Company Act of 1940. In the aftermath of the financial crisis, SEC adopted several amendments to rule 2a-7 to strengthen the ability of money market funds to maintain a stable $1 NAV per share and reduce the risk for investors. The rules also included a new disclosure regime to ensure greater transparency.
The enhanced disclosure requirements for shadow prices allow investors to have more information on a fund’s investments and its shadow price, enabling them to better evaluate the money market funds.
Money market funds are required to disclose the fund’s shadow price in SEC’s N-MFP form along with other information on a monthly basis, which can be accessed by the public with a 60-day delay. The information can be accessed through the Electronic Data Gathering, Analysis, and Retrieval (EDGAR) system. The reporting rule also requires money market funds to post more current, but less detailed, information about the fund’s portfolio on their websites within five business days after the end of the month.
The Bottom Line
Money market funds have been required to calculate and monitor the shadow prices of their funds for decades, but they were not required to disclose them to the public. The new disclosure requirements make it imperative for investors to learn about the shadow price of a money market fund. This will allow investors to better understand the money market funds and remain confident in their investment decisions.