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Funds Don't Shy Away From Shadow NAV

With the Securities and Exchange Commission beginning to post money market funds' shadow net asset values last Monday on Form N-MFP, fund companies and even the Investment Company Institute have been actively trying to educate investors about small variances in value down to the fourth decimal point to prevent investor concerns and possible redemptions.

A shadow NAV is essentially mark-to-market pricing of a money market fund. However, unlike a regular mutual fund, it is based on amortized accounting of securities that can be purchased at a premium or a discount from a $1 NAV. The amount of this premium is then amortized, or spread out, daily over the remaining life of the security. This method of accounting brings the security's value closer to par as the security approaches its maturity date-and almost ensures that the price will not be exactly $1.

"This distinct difference for money market funds is that the investments held by these funds are very short term and when they mature, they mature at face value, so the NAV of the money market fund normally regresses back to $1 over time," said Vanguard Chief Investment Officer Gus Sauter.

Like Sauter, others in the industry has been stressing that variances may occur in the fourth decimal point but that most securities will round up to $1 per share. They are also informing investors that the data is being presented with a 60 day lag and, thus, prices could have corrected themselves in the meanwhile. Changes in interest rates, monetary policy, inflows or the credit quality of a fund's holdings could cause the value of a money fund to be either above or below the $1 NAV, fund companies have been stressing.

But as BlackRock informs investors, "because the instruments money market funds invest in are short in duration, these movements in the mark-to-market NAV tend to be small."

The ICI issued a report on Jan 24 showing that money market funds' shadow prices did fluctuate during the past decade from 2000 to 2010 but in a narrow range well within the $1.0050 and $0.9950 band that fund companies are permitted to have in order to offer shares at a $1 NAV. The average per share market value moved between $0.9980 and $1.0020, the ICI found.

"Money market funds' per-share market values can and do deviate from $1.0000, but these changes are typically small," said ICI Chief Economist Brian Reid.

Ried said it would take major market shifts to swing NAVs much above or below this range. Short-term interest rates would have to rise more than 300 basis points in a single day to reduce a fund's per-share value to $0.9950, Reid said.

The first filings last week showed a number of shadow NAVs for money market funds at $1.0000, such as those from American Funds, Northern Trust and HSBC. Some were even slightly higher, including the American Century Municipal Trust and the Fidelity Money Market Trust, both valued at $1.0001. But the shadow NAV of the Hungtington Tax-Free Money Market Fund in the Jan. 31 filing was $0.9987, and the shadow NAV of the Virtus Insight Tax-Exempt Money Market Fund was $0.9999.

Nonetheless, some in the industry don't think investors will react negatively to the variances or even be particularly concerned, including Peter Crane, president of money fund research firm Crane Data. "I don't believe the shadow NAV is going to be a big issue," Crane said. "Looking at the holdings of a money fund portfolio is like looking at the control panel of a 747. It is not going to make you feel any better, and the pilot is going to say, 'Get the heck out of the cockpit.'

Crane also pointed out that while the new requirement is for the data to be released monthly, the SEC had already required money funds to release their shadow NAVs twice a year.

"Money funds have always produced a shadow NAV. With a 60-day lag, by the time you see a shadow NAV, the vast majority of the securities that have made up that shadow NAV will be gone," Crane said.

Even if a shadow NAV shows a value of $0.9980 or $0.9950 or "whatever the market decides is a dangerous level," it is inevitable that in the 60 day interim "the company would already have taken action to push that back, to support the fund," Crane said.

J. Christopher Donohue, president and CEO of Federated Investors, also doesn't expect investors will react negatively to values showing nines or eights in the third or fourth decimal point since the funds round up to a $1 NAV. "I wouldn't expect to see much flow movement because of this," Donohue said.