The Effect of NAV Flotation on the Management of Prime Money Fund Portfolios

Abstract

The October, 2016 money-fund reform obliged institutional prime funds to start floating their Net Asset Values (NAVs), whereas retail prime funds could continue with stable NAVs. We use this contrast to assess the effect of NAV flotation on fund management. We find that institutional funds reduced their interest-rate, liquidity and credit risk around the reform, contributing to lower yields and NAVs, and less volatile NAVs, but by all measures, their relative risk taking was approximately back to where it was well before the reform by the end of 2017. Prime funds adjusted to their shrinkage largely through transaction sizes, but also somewhat through the number of securities per issuer they invested in, and to a small extent through the number of issuers they invested in. Transaction-size shrinkage harms transaction quality, though the quality of a fund’s transactions relates more strongly to the size of its fund complex than to the size of the transactions themselves.