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Shift to government securities as financial-crisis reform takes effect

Peter in Weymouth, Mass., hadn’t looked closely at his retirement plan for a while, so he was surprised to see a fund he didn’t recognize: a money-market fund in which he holds cash whenever the market makes him nervous had morphed into a “government cash reserves fund.”

“I’m scared about the government with the election and a bond bubble and more and I didn’t want more government bonds,” he wrote, “but they moved me into this government fund. Am I right to be worried?”

About the government, maybe. About the money-market fund, not so much.

Peter’s money wasn’t moved from one fund to another. The fund he owned converted from a prime money fund into one that only holds government securities — something happening throughout the industry as fund sponsors try to beat the clock on new rules that are just weeks away from taking effect.

The change is mostly under the radar, and will have no real impact on risk or return. It’s part of an industry-wide overhaul of the money-fund business that would be getting a lot of attention if the group had a decent yield and investors felt it was anything more than a parking place for their cash.

Money-fund reform has been eight years in the making. It started after the collapse of the Reserve Primary Fund during the financial crisis of 2008. That fund, filled with Lehman Brothers paper that became worthless when the brokerage firm went bankrupt, “broke the buck” — meaning its share price fell below the constant $1-per-share maintained by a traditional money fund.

Firms haven’t been waiting for the latest reforms — agreed to in 2014, requiring compliance by Oct. 14 — to take action. With interest rates so low that most money funds aren’t generating real profits for sponsors, plenty of issues closed rather than change operations to deal with the new world.

Money-fund data provider iMoneyNet forecasts that almost half of the domestic prime money-market funds available a year ago will still be around come mid-October, while the number of government funds will have grown by close to 25%.

To see why that is — and in the process explain why investors like Peter should not worry about the change — we must first examine what is really happening to money funds.

Money funds are built to be boring, pain-free investments, a safe harbor for cash. These funds invest in short-term debt instruments of the government and/or some companies, and any interest the fund earns that could raise the share price gets shaved off and reinvested so that shares are priced at a constant $1.

Until the Reserve Primary fund broke the buck, virtually every time a fund was in danger of losing money, the parent company swooped in, bought up any bad paper, and supported the $1 price.

Reserve Primary didn’t do that. The nation’s oldest and largest money fund lacked the resources, and its troubles started a run of investors fleeing money funds. This dangerously de-stabilizing event forced both the Federal Reserve and Treasury to step in, providing the kind of deposit insurance normally reserved only for bank deposits.

Authorities never want to be in that position again, so they changed the rules. The new guidelines are not really aimed at helping individual consumers — like my mother, a Reserve Primary shareholder who ultimately lost about three cents on the dollar — but instead try to avoid global economic chaos, because a smoothly functioning money-market system is the foundation of the day-to-day markets.

Under the new rules, institutional and municipal money-market funds will move from the stable $1 share price to a floating net asset value. Retail funds sold to individual investors will maintain the buck as their pricing standard.

Further, the rules allow for all money funds to temporarily prevent investors from making withdrawals — or to impose fees on redemptions — during times of extreme volatility.

Funds are moving from prime funds to government funds because the rule changes don’t apply to retail funds that invest only in the debt of the federal government and agencies such as Fannie Mae and Freddie Mac.

Firms including Fidelity Investments, Franklin Templeton and others already have made the change, affecting billions of dollars. Shareholders barely noticed. This isn’t like changing an asset allocation to buy a government bond fund; instead, it’s deciding between safe and safer.

The difference — the cost to you as an investor — is “about 0.1 [percentage points]max,” said Peter Crane of Crane Data, publisher of Money Fund Intelligence, “which isn’t much in real terms, though it is a lot when it comes off a yield of about 0.2 max.”

Investors who don’t want to lose that extra yield can stick with prime money funds.

“The good news for the average retail investor is that they won’t see much change at all,” said Mike Krasner, managing editor at iMoneyNet. “Don’t be surprised or nervous about it. You can be safe in a prime fund and a little safer in a government fund, but all of these changes were about maintaining your safety, not putting you at more risk.”

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