Many investors will be familiar with money market funds (MMFs) as they are widely-used short-term cash management tools. Treasurers have likely used the same funds for years and simply refer to them as ‘MMFs’. It’s worth reminding ourselves, however, that there are some nuances below this overall product banner and a handful of different MMF types, as defined under the European Money Market Fund Regulation (MMFR).
The regulation puts MMFs into two categories:
Underneath these classifications, MMFs must be set up as one of the following types:
1) Public Debt CNAV MMF
2) LVNAV MMF
3) VNAV MMF
Let’s clear up what the various acronyms stand for: CNAV = Constant Net Asset Value, LVNAV = Low Volatility Net Asset Value and VNAV = Variable Net Asset Value. The first two types would always be short-term MMFs but VNAV funds are split into two separate options: a short-term VNAV and a standard VNAV (going back to the overarching categories).
Short-term MMFs are primarily invested in short-term debt/money market instruments and have the objective of offering money market rate returns while ensuring the highest possible level of safety for investors. Standard VNAV MMFs have the objective of offering returns slightly higher than money market returns, and they therefore invest in assets that have an extended maturity. As such, Public Debt CNAV, LVNAV and short-term VNAV funds have a maximum weighted average maturity (WAM) of 60 days and weighted average life (WAL) of 120 days. Standard VNAV funds have a maximum WAM of 6 months and WAL of 12 months.
Public Debt CNAV MMFs must invest in government securities and transact at a constant price (although negative yields mean this has not been possible recently). LVNAV fund units can be purchased and redeemed at a constant price as long as the value of the assets (‘market NAV’) does not deviate by more than a 20-basis point collar from the dealing NAV of 1.00. If the limit is breached the fund must convert to VNAV. Their valuation is at amortised cost for instruments with maturities under 75 days and at mark-to-market for instruments over 75 days.
VNAV funds operate on a variable dealing NAV (rounded to 4 decimal places) and on fully mark-to-market pricing hence the pricing/NAV fluctuates.
With regards to liquidity requirements, Public debt CNAV and LVNAV funds must maintain at least 10% of their holdings in daily liquidity assets and 30% in weekly liquidity assets. Both short-term and standard VNAV funds are subject to less stringent requirements, having to hold 7.5% in daily liquid assets and 15% in weekly liquid assets. Standard VNAV funds try to offer enhanced returns through taking on more duration/credit risk. Cash Plus or Ultra Short Bond funds are typically standard VNAV in structure.
Liquidity fees and redemption gates may occur to public debt CNAV and LVNAV funds but do not apply to VNAV funds. These fees and gates can occur when one of the following criteria is met:
If option 1 occurs the MMF board must enact either liquidity fees or a redemption gate and in the case of option 2, the MMF board has the choice to enact fees/gates or can choose to do nothing.
As we’ve touched upon, short-term MMFs do share some characteristics and this also includes the fact that they are typically AAA-rated and seen as cash or cash equivalent funds. Standard VNAV funds do often carry an AAA rating as well but typically settle from T+1 through to T+3, i.e. 1 to 3 days after the transaction date. Investors may be familiar with standard (VNAV) MMFs in the form of some Cash Plus funds. These should not simply be seen as short-term alternatives however, due to their longer durations and hence, investment time horizon. All of the MMF types can offer distributing and accumulating share classes, depending on investor preference.
Given investor preference for constant £1.00 per share pricing, the sterling short-term MMF market is heavily focused on LVNAV MMFs and the short-term VNAV market is relatively small in comparison. Some MMF providers think that this could shift over the long term given the potential for NAV collar breaches and application of fees/gates on LVNAV funds. Some investors will use standard VNAV funds which can offer higher returns due to extra duration being taken on - these are particularly popular in mainland Europe where short-term rates are currently negative.