The Zacks Analyst Blog Highlights:Federated Investors, Wells Fargo,BlackRock, T. Rowe Price Group and Legg Mason

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Mar 31, 2014, 09:30 ET

CHICAGO, March 31, 2014 /PRNewswire/ -- Zacks.com announces the list of stocks featured in the Analyst Blog. Every day the Zacks Equity Research analysts discuss the latest news and events impacting stocks and the financial markets. Stocks recently featured in the blog include the Federated Investors, Inc. (NYSE:FII-Free Report), Wells Fargo & Company (NYSE:WFC-Free Report), BlackRock, Inc. (NYSE:BLK-Free Report), T. Rowe Price Group, Inc. (Nasdaq:TROW-Free Report) and Legg Mason Inc. (NYSE:LM-Free Report).

Today, Zacks is promoting its ''Buy'' stock recommendations. Get #1Stock of the Day pick for free.

Here are highlights from Friday's Analyst Blog:

Money Market Funds Reform: What's the Buzz?

The U.S. Securities and Exchange Commission (SEC) is set to finalize the rules for Money Market Funds that it issued on Jun 5, 2013. Prompted by the financial meltdown, the SEC has been working to reform these funds since Jan 2010 and made several amendments in the Investment Company Act Rule 2a-7 that regulates the money market fund industry.

The Basics of Money Market Funds

Money market funds are a type of mutual funds (also known as money market mutual funds) that generally invest in short-term debt securities like U.S. Treasury bills, commercial paper, etc. Governed by the Investment Company Act of 1940, these funds tend to limit the losses arising from credit, market and liquidity risks. Ensuring credit quality, money market funds purchase securities that mature within 397 days while the maturity period of the portfolio of money market funds must not exceed 60 days.

Money market funds assure dividends as per the prevailing short-term interest rates and can be redeemed on demand. Further, these funds seek to maintain a stable net asset value, which is generally $1.00 and the calculation includes a penny rounding and amortization method, i.e., it does not consider the daily market gain or loss and hence maintains this stable price.

These funds provide stability, liquidity and short-term yields. Owing to these distinctive features, money market funds gained popularity among institutional and risk-averse retail investors. Notably, the money market fund industry is worth about $2.6 trillion.

The Story Behind the Reform

What happens when the net asset value of a money market fund falls below $1.00? Well, such an occurrence is referred to as "breaking the buck." As these funds can be redeemed upon investors' demand, in order to avoid loss an investor can easily opt for redemption in this situation. Notably, investors redeeming early receive a stable price, but this lead to further failure of the fund. So those who redeem later may not get a stable price.

Redemption on a small scale is not a concern; however, when redemptions occur extensively, the entire industry gets affected. Notably, Lehman Brothers' bankruptcy followed by the financial crisis of 2008 forced the Reserve Primary Fund, one of the oldest money funds, to write off the debt amount invested in commercial papers issued by Lehman Brothers. Consequently, the share price of the Reserve Primary Fund fell below $1.00, triggering massive redemptions, which ultimately disturbed the global credit market. Eventually, the government had to intervene to control the situation.

In light of such events, regulators like the SEC recognized the need to make amendments in the money market industry to sustain financial stability, improve standards and mitigate systematic risk.

The Proposed Alternatives

The SEC's proposal issued in Jun 2013 for public comments primarily focuses on two alternatives. The SEC intends to implement either of the alternatives or a combination of both.

The first alternative requires money market funds to adopt the floating NAV approach, i.e, such shares would be sold and redeemed at value based on the current market price rather than maintaining a stable price of $1.00. The purpose of this alternative is to reduce heavy redemptions, limiting investors from benefiting from early redemption and improving transparency since this approach will reflect the market gains and losses.

The second option holds the stable price approach. However, as per this option, when a fund's liquidity falls below a certain level, liquidity fee can be imposed on the funds and these can be temporarily suspended from redemptions, i.e., "gates". This alternative is proposed to curtail high degree of redemptions at stressed times when it is too costly for the fund to provide liquidity.

Notably, retail investors are exempted from the above mentioned alternatives. This is because retail investors have exhibited minimal redemptions compared to institutional investors in stressful times. As institutional investors have a larger amount of capital exposed to market stress risk, they opt for more redemption than retail investors.

Expected Results

The SEC believes the reforms would be attractive for investors in the long run and increase competition in the market against other investment vehicles. At the same time, it believes there may be shifts in the short term from the money market funds to other investment alternatives that could have an unfavorable impact on short-term debt security issuers as well as the short-term financing markets.

Industry Response

The proposed rules drew some flak from the industry. The asset management firms seek to have a broader exemption of money market funds under the floatation NAV rule. Financial institutions like Federated Investors, Inc. (NYSE:FII-Free Report) and Wells Fargo & Company (NYSE:WFC-Free Report) have cited reasons for not supporting the first alternative. These companies believe that such an option is not adequate to reduce systematic risk and will make prime institutional money market funds less lucrative or even unviable for many investors who prefer ease in liquidity, which would ultimately affect the money market fund business.

Further in Oct 2013, 9 companies including Wells Fargo, BlackRock, Inc. (NYSE:BLK-Free Report), T. Rowe Price Group, Inc. (Nasdaq:TROW-Free Report) and Legg Mason Inc. (NYSE:LM-Free Report) presented a new definition of retail investors to the SEC.

Under the SEC definition, retail funds are those that are prohibited from redemption of more than $1 million securities on any business day. However, the companies urge to define retail funds as ones which are limited to natural persons based on factors like social security numbers, retirement plan and trust account.

Conclusion

Considering the response and the partial criticism received from the asset management companies, the SEC is contemplating on making some changes in their proposed rules issued in Jun 2013. Even if SEC fine-tunes its proposed rules, the attractiveness of these funds will no doubt reduce. However, for the credit market, these rules will perhaps act as protection from collapsing.

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