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Defined Contribution

Should DC plans give
money market funds another look?

BlackRock |Feb 1, 2019

Rising rates have drawn assets back into prime money market strategies. Can collective funds help DC plans capture money market exposure?

A few years ago, changes to 1940 Act1 money market mutual funds introduced redemption gates and liquidity fees that could potentially be triggered during extreme liquidity events, and, for institutional prime money market mutual funds, a floating net asset value (NAV) requirement. (See below for details on the reform.) At the time, money market yields in general were down to almost 0%2 and spreads between government and prime money market mutual funds were narrow.

Not surprisingly, many investors decided it wasn't worth managing the extra restrictions for the additional potential upside of institutional prime money market funds. For their part, many defined contribution plan sponsors also opted for money fund investment options less affected by the changes.

Time to rethink prime?

Now that interest rates have risen, the difference between prime and government yields has become more significant. As the chart illustrates, prime money market mutual funds have consistently yielded at least 20 basis points more than government money market mutual funds since the beginning of 2017.3

Average prime/government 7-day net yield (Jan 2015-Dec 2018)

Average prime/government 7-day net yield (Jan 2015-Oct 2019)

Source: iMoneyNet, December 2018

Interest in prime money market mutual funds has followed, with assets under management increasing more than 69% since the beginning of 2017.4 If this is the new normal for prime money market strategies, DC plan sponsors may no longer find themselves comfortable leaving potentially significant yield on the table for their participants seeking liquidity and stability.

Which leads to a question: Is there a DC-appropriate investment vehicle that allows plans to capture prime money market yield without adding additional complexity for participants?

Capturing prime yield through collective funds

A prime money market option offered through a collective trust fund (CTF) may help plan sponsors continue to offer a stable NAV investment that may not require liquidity fees and redemption gates, which may help participants who seek to take advantage of the yield spread relative to government MMFs. Additionally, plans can negotiate investment management fee rates with CTF managers, potentially cutting costs for participants. As CTFs are primarily regulated by the Office of the Comptroller of the Currency (OCC) or state banking regulators, they are not subject to the Securities and Exchange Commission's (SEC) money market regulatory requirements.

The changing landscape of investment vehicles used in DC plans

Currently, 59% of DC plans offer a money market investment option,and 3% of all 401(k) plan assets are invested in money market mutual funds.6 Money market mutual funds, however are not the only option.

Not long ago, implementations such as CTFs were found in only the largest DC plans. Today, these vehicles are widely held and adopted in DC plans. There are now more than 75% of plans offering CTFs on their investment lineups in 2018, up from 48% in 2012.7

Plans offering collective trusts within their fund lineup

Plans offering collective trusts within their fund lineup

Source: Callan 2019 Defined Contribution Trends

As CTFs have become more prevalent, many providers have lowered the asset threshold, making these vehicles available to medium and even some small plans. CTFs can offer potential efficiencies of scale that may result in lower fees, as well as a wider range of instruments and strategies to choose from.

Partnering with BlackRock

BlackRock partners with DC clients to help find the right investment solutions to meet their plan’s unique needs. With one of the most experienced teams in the industry, BlackRock offers an investment approach that has been tested over multiple interest rate cycles and varying market conditions and is designed for today’s participants. BlackRock currently manages $19 billion in cash strategies for DC plans and more than $448 billion across corporations, banks, foundations, insurance companies and public funds worldwide.8

Background to reform

The SEC's amended Rule 2a-7 made prime money market mutual funds (40 Act funds) subject to liquidity fees and redemption gates, as well as floating NAVs for institutional prime funds.

The structural reforms were designed to address the potential for “run risk” in a money market fund. They are a response to the events of September 2008, when the bankruptcy of Lehman Brothers forced the Reserve Primary Fund, the oldest money market mutual fund, to “break the buck” by pricing its shares at 97 cents. The amendments have increased transparency and given mutual fund boards additional tools to manage redemptions in the event a money market fund experiences unusually high redemptions.

The SEC requires money market mutual funds to be classified as either institutional or retail based on characteristics of the underlying investors. The new amendment clearly defines DC investors as eligible to invest in retail money market mutual funds. The chart below indicates changes that have been implemented in these fund types:

Net asset valueLiquidity feeRedemption gates
Institutional prime
money market
mutual fund
Floating Up to 2%* Up to 10 business
days in any 90
day period*
Retail prime
money market
mutual fund
Constant at $1 Up to 2%* Up to 10 business
days in any 90
day period*
Government / Treasury
money market
mutual fund
Constant at $1 Optional† Optional†
Collective trust fund Seek to maintain a
constant NAV of $1
Optional† Optional†

* Liquidity fees and redemption gates may be imposed when certain liquidity triggers are met. † Liquidity fees and redemption gates may be imposed, but they must be disclosed.

Because DC plan accounts, including 401(k), 457 and IRAs, are eligible to invest in retail money market mutual funds, plan sponsors can continue to offer constant NAV money market mutual funds as an investment option.