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Money Market Reform: DC Plans Adapt to Sweeping Change

The SEC’s sweeping changes will likely make money market funds less risky – but far less attractive – to participants in defined contribution plans.

Money market reform has arrived. The SEC’s sweeping changes, along with technical and macroeconomic factors, will likely make money market funds (MMFs) safer – if far less attractive – to defined contribution (DC) plan participants. In our view, if plan sponsors want a capital preservation option that has the potential to deliver returns above inflation, it’s time to consider a change, perhaps to stable value, short-duration bonds or even to white label solutions.

The SEC reforms, set to take effect on 14 October 2016, transform key elements that have made MMFs popular since their introduction in the U.S. in 1971. The new rules impose potential liquidity fees and gates on many MMFs and require institutional prime funds to move from fixed to variable net asset values (NAVs). These changes are a response to the events of September 2008, when the bankruptcy of Lehman Brothers forced the Reserve Primary Fund, the oldest money market fund, to “break the buck” by pricing its shares at 97 cents.

DC consultants have recognized that the reforms mark a sea change in an asset class that has been a staple of DC plans. In PIMCO’s 10th Annual 2016 DC Consulting Support and Trends Survey, which captures opinions from 66 U.S. consulting firms that serve over 11,000 clients with DC assets in excess of $4.2 trillion, 95% of consultants said they were somewhat likely, likely or very likely to recommend switching from a money market fund to stable value; 49% had similar views about switching to ultra-short bond funds.

The capital preservation space is not as simple as it once was and optimal solutions change. If a sponsor uses an MMF as a capital preservation option, PIMCO thinks the reforms are a good reason to consider alternatives. This is especially true given the increase in DC litigation in recent years.

Capital preservation and DC

PIMCO believes that capital preservation strategies – along with global fixed income, inflation-hedging options and global equities – are one of four key pillars of a DC plan’s core investment lineup. Each contributes to ensuring a balanced selection of diversifying asset classes (see Figure 1). Capital preservation strategies seek to preserve invested principal, generate income, provide a liquid, low-risk investment during volatile markets or offset riskier investments in a portfolio.

In our view, a successful capital preservation option should meet these conditions:

  1. ΠLiquidity: A significant portion of invested principal can be easily sold or converted into cash under most market conditions without significantly changing the value of the investment.
  2. Low risk: The value of invested principal should be reasonably assured over an appropriate time horizon as determined by the sponsor – daily, monthly or quarterly.
  3. Real return: Investments should seek to generate real returns, or returns over inflation, to help participants maintain and potentially grow the purchasing power of their retirement assets.

However, market dynamics over the past decade – including compressed short-term bond yields, changing supply and demand dynamics and now the implementation of the SEC’s money market reforms – have eroded the ability of MMFs to deliver on all three of these critical aims.

Post-reform realignment

In anticipation of the new regulations, many MMF fund complexes have transitioned much of their prime MMF offerings to government MMFs in recognition of the market’s preference for a $1.00 NAV product without fees and gate complications. (This includes PIMCO, which merged its prime MMF offering into the PIMCO Government Money Market Fund, managed by Jerome Schneider, whom Morningstar named its 2015 Fixed-Income Manager of the Year.)

Moreover, the SEC changes imposed significant changes to structural and operational aspects of MMFs, which created challenges for DC recordkeepers, custodians and trustees. Government MMFs have become DC trustees’ preferred MMF solution because these funds are managed to a fixed $1.00 NAV while remaining exempt from mandatory fees and gates, reducing their operational challenges. The result: Over the past 18 months, many plan sponsors that used prime MMFs received negative consent letters from their service providers; these gave notice that the plan’s capital preservation option had changed from a prime MMF to a government MMF.

In our view, the material SEC reforms and the dramatic realignment of the MMF industry is a prompt to DC sponsors to scrutinize their use of MMFs. This may be particularly urgent given the recent rise in DC-related litigation.

Do MMFs deliver for DC?

In recent years, MMFs have failed to deliver real returns, one of three objectives of any capital preservation strategy. While nominal yields have recently budged from zero, real yields remain negative. And with the SEC reforms further constraining MMFs’ already conservative investment guidelines, future return opportunities will be reduced.

So, with expected returns low, even recent mild inflation can cause negative real returns that will lead over time to an erosion of a participant’s purchasing power. Lost purchasing power could possibly be made up through higher returns in riskier investments, or the participant could endure a lower standard of living in retirement. Neither are particularly attractive options.

While conceivable that MMFs may meet all of the objectives of a DC capital preservation option in the future, we think this is unlikely within the next three to five years. Ultimately, while some plans may face unique situations where MMFs continue to be the best capital preservation option, it is unlikely they will deliver on the general objectives required by DC plans – particularly protecting participant purchasing power to and through retirement.

And the alternatives are?

If a sponsor has decided to consider a different capital preservation option, or just wants to review the alternatives, we see three reasonable choices, with suitability depending on the unique needs and characteristics of the plan and the investment requirements and sophistication of its participants:

  • First, consider stable value. Stable value has been used in DC plans for more than three decades. These strategies are designed to provide participants with money market fund-like volatility, while seeking to deliver returns similar to intermediate-maturity bonds over time.

    Having managed stable value since 1992, PIMCO stands ready to share its expertise. However, we also understand that stable value may not be the optimal solution for every plan. Among other issues, there are unique risks, costs and contractual obligations associated with stable value wrap contracts.

    Nonetheless, stable value remains exceedingly popular: In 2014, it was offered by over 62% of all DC plans, up three percentage points over the previous year, according to the Plan Sponsor Council of America’s 58th Annual Survey of Profit Sharing and 401(k) Plans.

    Moreover, while stable value strategies returned 1.95% annualized over the five years ending 30 June 2016 (as represented by the Hueler Analytics Stable Value Index), the U.S. Bureau of Labor Statistics’ Consumer Price Index rose 1.32% during the period. So, stable value has protected purchasing power far better than the Lipper Money Market Index, which returned a nominal 0.02% over the same period.

  • Second, consider a short-duration bond option. Although some sponsors are reluctant to include a variable NAV strategy as a capital preservation option, ERISA section 404(c) does not expressly require a plan to offer a $1.00 NAV option.

    However, there is a caveat: Sponsors should carefully select a fund specifically designed to address the low volatility needs of plan participants. Typical “off-the-shelf” enhanced cash or low-duration funds, whether actively or passively managed, often have unattractive NAV volatility.

    In recent years, investors have focused on a variety of new approaches, including PIMCO’s Short Asset Investment Fund, which seeks to provide capital preservation and low volatility. These new, “ultra-short” strategies generally invest in ways that are similar to MMFs with a minimal increase in risk and slightly more flexible investment guidelines designed to seek returns closer to inflation.

  • Finally, consider creating a white label capital preservation option. Particularly for larger plans, a white label capital preservation option can optimize a blend of solutions – including short-duration bonds, stable value and even MMFs – and seek a customized level of expected risk and return. Here as well, PIMCO has long experience helping sponsors create custom options.

Being proactive is a best practice

DC plan sponsors who have previously made a decision to use MMFs as a capital preservation option should understand that the SEC’s reforms are material. As the capital preservation needs of every plan are unique, it’s possible that an MMF remains appropriate for a particular DC plan. However, MMFs are likely to continue to generate negative real returns over the next several years, eroding participant purchasing power.

Optimal solutions in the capital preservation space change. If a sponsor uses an MMF as the plan’s capital preservation option, the SEC’s reforms are a good catalyst to prudently review the rationale, especially as fiduciary risks have increased in recent years. In our view, sponsors should look beyond MMFs and consider alternatives that seek to deliver liquidity, limit risk to principal and help protect participants’ purchasing power into retirement.

The Author

Brett Gorman

Account Manager, Defined Contribution

Brian Leach


Related Funds


Investors should consider the investment objectives, risks, charges and expenses of the funds carefully before investing. This and other information are contained in the fund’s prospectus and summary prospectus, if available, which may be obtained by contacting your investment professional or PIMCO representative or by visiting www.pimco.com. Please read them carefully before you invest or send money.

You could lose money by investing in a Government Money Market Fund. Although the Fund seeks to preserve the value of your investment at $1.00 per share, it cannot guarantee it will do so. An investment in the Fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. The Fund's sponsor has no legal obligation to provide financial support to the Fund, and you should not expect that the sponsor will provide financial support to the Fund at any time.

The Morningstar Fixed Income Manager of the Year Award (U.S.) is based on the strength of the manager, performance, strategy, and the firm’s stewardship.

A word about risk:

All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and the current low interest rate environment increases this risk. Current reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Stable value wrap contracts are subject to credit and management risk. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market. Investors should consult their investment professional prior to making an investment decision.

The Consumer Price Index (CPI) is an unmanaged index representing the rate of inflation of the U.S. consumer prices as determined by the U.S. Department of Labor Statistics. There can be no guarantee that the CPI or other indexes will reflect the exact level of inflation at any given time. The Hueler Stable Value Pooled Fund index is an equal-weighted total return average across all participating funds in the Hueler Universe and represents approximately 75% of the stable value pooled funds available to the marketplace. All participating stable value pooled funds are available to investors through employer sponsored retirement plans. The index series dates back to 1983 and is produced on a monthly basis. The Lipper Money Market Fund Index is comprised of funds that invest in high-quality financial instruments rated in the top two grades with dollar-weighted average maturities of less than 90 days. Lipper Fund indices are calculated using a weighted aggregative composite index formula that equal-weights the constituent funds and reinvests capital gains distributions and income dividends. It is not possible to invest directly in an unmanaged index.

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