Federated Investors has published a new article entitled, "'Shadow NAV' is no mystery," which says, "In the world of money market funds, the term 'shadow pricing' is often heard by investors -- and just as often misunderstood. Although it sounds mysterious, shadow pricing is simply the precise calculation of a money market fund's net asset value (NAV), reflecting the current market prices of the underlying securities that are in the fund's portfolio."
The piece continues, "For this reason, shadow pricing, which is used to create a fund's 'shadow NAV,' means the same as another, less dramatic-sounding term: mark-to-market pricing. The SEC now requires all money market funds to report their shadow NAVs, or mark-to-market NAVs, on a monthly basis. The SEC will subsequently share these mark-to-market NAVs with the public after a 60-day delay."
Federated explains, "Mark-to-market pricing isn't new. For decades money market funds have been required to obtain market prices as a way to verify that the stated NAV of a fund, commonly $1.00 and derived by using what is called the amortized cost pricing method of accounting, accurately reflects the fund's fair value in the market. Because money market fund assets are of short duration -- the weighted average maturity of a fund's portfolio of securities can't exceed 60 days -- the fund's amortized cost price (the stated NAV) and the underlying market price (the shadow NAV) should be virtually identical. Money market funds attempt to keep their NAV stabilized at $1.00 per share; the mark-to-market or 'shadow' price simply carries this calculation out to four decimal places -- $1.0002, for example, or $0.9998."
The piece includes a Q&A, and asks, "Should investors be concerned about a money market fund with a shadow NAV other than $1.0000? It answers, "No, because the value of the fund will end up being rounded to a dollar. For example, a money market fund with a mark-to-market, or shadow, price of $1.0004 will equal $1.00 when rounded to two decimal places instead of four. Likewise, a shadow NAV of $0.9985 rounds to a $1.00 NAV. In fact, we anticipate that the reported shadow NAVs for most money market funds will likely appear as something other than $1.0000. Furthermore, we believe money market fund investors and the SEC will benefit from seeing the shadow price because it will provide statistical confirmation of the stability of a $1.00 NAV, which for recordkeeping, accounting and valuation purposes, is critical to the nearly $3 trillion money market fund industry."
Federated's article also asks, "What do we mean by using the amortized cost pricing method to value a money fund? They respond, "The amortized cost price of a money market fund reflects the par value, or the stated face value, of the underlying securities in the fund's portfolio, plus any premium paid or minus any discount given at the time the securities were purchased. The amount of the premium or discount is then amortized, or spread out, daily over the remaining life of the security. This method of accounting brings the security's value closer to par as the security approaches its maturity date. Because SEC Rule 2a-7 requires the underlying securities of a money market fund to be of high-quality and short-term in nature, the amortized cost method essentially assumes that the securities will deviate little in value from their purchase to their maturity."
They also ask, "How can the mark-to-market/shadow price affect a money market fund's $1.00 share price? Federated answers, "Under SEC rules, the board of trustees of a money market fund must periodically review the fund's amortized cost price to ensure that the $1.00 NAV fairly reflects the market price of the fund portfolio’s underlying securities. If the market price (the shadow NAV) deviates from the amortized cost-calculated NAV by .50% or more -- that is, $1.0050 and above or $0.9950 and below -- the trustees must consider what action to take, though they are not required to stop using the amortized cost method. A fund will only 'break a dollar' if the trustees determine that a $1.00 NAV no longer fairly reflects the market value of the fund's portfolio, or that the deviation from $1.00 could result in material dilution or other unfair results to the fund's shareholders."
Finally, they ask, "What is Form N-MFP?" Federated says, "It is the new reporting form that money market funds must file with the SEC by the fifth business day of each month. It will include, among other things, the fund's portfolio holdings as of the last business day of the previous month, each holding's market value, and each fund's mark-to-market/shadow NAV. For Federated's money market funds, the first Form N-MFPs -- with shadow NAVs calculated as of November 30, 2010 -- were reported to the SEC by the December 7, 2010 deadline. The information reported on the forms will become publicly available at the end of January 2011 on the SEC website (www.sec.gov), and will be accessible through FederatedInvestors.com."
