Money Market ETFs: An Opportunity to Attract Mutual Fund Assets

Since they began trading in 1993, ETFs have been steadily encroaching on the various segments of the mutual fund industry. Starting with U.S. large-cap stocks in a passive portfolio, they have moved into almost all areas covered by mutual funds.

Until recently, only one major sector of the U.S. mutual fund market remained safely untouched. That was the $6.6 trillion money market mutual fund segment (MMF). Two months ago, a team at Texas Capital, led by longtime ETF executive Ed Rosenberg, broke through the barriers and launched the first money market ETF, the Texas Capital Government Money Market Fund

Although money market funds are perhaps the most generic and boring investment in the world, $6.6 trillion is a lot of money. Half of MMF assets are held by just 20 funds managed by the biggest investment firms, including BlackRock, Schwab, JPMorgan, and Vanguard, among others. The management fees for just those 20 funds total almost $10 billion annually. Now there is a new competitor to those existing funds. The fight could get fierce!

This new innovation raises the question for investors of how the two wrappers compare.

Looking at their respective portfolio holdings, there is not really any difference between the two wrappers. A government-only MMF buys a portfolio of 60- to 90-day T-bills and other short-term government securities, allowing investors to earn a yield equal to roughly the 90-day T-bill minus the fund expense ratio. Expense ratios are typically between 0.10% and 0.40% annually — MMKT is 0.20%.

Since the holdings are so short term, their price fluctuations are de minimis, allowing the MMF to maintain a constant NAV of, typically, $1. This allows investors to cash in and out at a steady NAV plus whatever interest has been earned. 

Some MMFs also buy short-term, high-quality corporate holdings, getting a slightly higher yield with a slightly higher degree of credit risk. Others may buy short-term, high-quality tax-free municipal debt. 

MMFs have been wildly successful since launching in 1971. Out of the thousands of MMFs, only one retail MMF has ever had an issue, which happened when a fund holding high-quality corporate paper struggled in the 2008 crisis and ended up only returning 99 cents on the dollar to its shareholders.

The holdings of MMKT look the same as for any government MMF out there. When money market ETFs are launched holding high-quality corporate debt, or tax-free muni holdings, their portfolios will also look the same as traditional MMFs.

If both varieties hold the same things, can earn the same yields, can charge the same, and take the same risks, what is the real difference? The real difference has to do with the timing of getting in and out of the fund.

If you place an order to buy or sell a traditional MMF at noon, you will actually be in or out of it at the 4:00 pm ET close. When selling, you typically will not be able to reinvest the proceeds into another investment in your account until the next day. 

With an ETF, if you sell the fund at noon, you can immediately turn around and reinvest the money in something else without waiting. For active traders, this is a huge advantage, and is in fact the key benefit of the ETF over the mutual fund structure.

To create a money market ETF, some changes to the mechanics of a traditional MMF had to be made. First, anything trading on an exchange will have a bid/ask spread between buyers and sellers. If the money market ETFs had a $1 NAV, then a penny spread would be equal to 1% cost to buy or sell. This is too high. But if the NAV was $100, a penny would only be a 0.01% spread/cost. 

Texas Capital went with a $100 NAV, and the bid/ask spread since launch averages 1 to 2 basis points. This is a cost that reduces your overall yield, but it’s a very small amount. And since investors in money funds look at dollars, and not number of shares, the share count difference between a $1 NAV and a $100 NAV itself is just math that means nothing.

The second change made to accommodate exchange listing is accounting for interest. Every day, the MMF or money market ETF accumulates interest. With an MMF, the fund managers declare the interest as dividends daily and then pay it out at the end of the month. That way, the accumulating interest does not alter the $1.00 daily NAV. The money market ETF skips the daily declaration and lets the interest slightly increase the NAV every day. At the end of the month, the money market ETF declares the dividend and pays it. 

MMKT yields around 4.6% as of November 19. With yields where they are now, over the course of the month, NAV increases about a penny or so a day. When the ETF declares and pays dividends, the NAV drops back down to at or near $100 and the process starts all over. 

To conclude, a conventional MMF yielding 4.6% and MMKT will end up in the same place over time but through a slightly different accounting method.

If the money market ETF has the advantage of a quicker turnaround to access the funds, what advantage does the MMF have over the money market ETF? 

First, you can buy a MMF directly from the mutual fund company, so technically you do not need a brokerage account. Additionally, you do not deal with a 1 or 2 basis point trading cost. Finally, with a steady $1 NAV, and no bid/ask spread, it is easier to understand. Other than that, there really is no other advantage of a MMF compared to a money market ETF.

Many MMF users do not move money around enough to care about the advantages of a money market ETF. They are likely to stay with what they have for now. 

However, a meaningful segment of that $6.6 trillion in AUM does move money around more actively. That is the real target market. 

Although Texas Capital is a pioneer in this space, others are close behind and may be more likely to win the race. BlackRock has already filed for money market ETFs, and it is easy to imagine that many major players — such as Schwab, Fidelity, Vanguard, JP Morgan, etc. — are not going to be far behind. 

One potential issue is that some brokerage platforms may gate other issuers’ money market ETFs and not allow them to be  purchased on their platform. They might do this to protect their own products from competition.

Many of the newest ETF innovations offer questionable utility to the average investor. Money market ETFs, however, can offer a simple and real benefit, particularly if the cash yield on one’s current liquidity product is lower than the new offerings. A higher yield may be just a trade away!

Disclosure: The author does not currently own any MMKT. However, for this article, he did purchase, and resell, MMKT shares intraday to confirm the immediate impact it had on cash availability in a brokerage account.

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