Due to an increase in the Bank Term Funding Program, investors may worry about its effect on money market funds. Although traditionally thought of as risk free investments, a money market fund can become illiquid if it holds securities that become difficult to sell or cannot be sold at a reasonable price. Money market funds invest in short-term, low-risk debt securities such as treasury bills, commercial paper, and certificates of deposit, among others. These securities are typically highly liquid and traded in large volumes in the money markets. However, if there is a significant event that affects the liquidity of these securities, it could cause a money market fund to become illiquid.
Here are some factors that could cause a money market fund to become illiquid:
Credit events: Money market funds invest in debt securities issued by various entities, including corporations, municipalities, and financial institutions. If any of these entities default on their debt, it could lead to losses for the money market funds that hold their securities. This could lead to a loss of confidence in the market and a decline in liquidity.
Market disruptions: Market disruptions, such as sudden spikes in demand for liquidity or a lack of buyers in the market, could also cause a money market fund to become illiquid. If many investors are trying to sell their shares at the same time, it could put pressure on the fund's ability to meet redemption requests.
Regulatory changes: Changes in regulations governing money market funds could also impact their liquidity. For example, if regulators restrict the types of securities that money market funds can hold or change the NAV calculation method, it could impact the liquidity of the fund.
Systemic events: Systemic events, such as financial crises or market panics, could also cause a money market fund to become illiquid. During such events, investors may seek to sell their shares in the fund to meet their liquidity needs, which could lead to a decline in the fund's NAV and liquidity.
In summary, a money market fund can become illiquid if it holds securities that become difficult to sell or cannot be sold at a reasonable price due to credit events, market disruptions, regulatory changes, or systemic events. It's important for investors to understand the risks associated with money market funds and the fund's investment objectives, risks, and expenses before investing.
Nothing herein is intended to be investment advice. Investment in the stock market involves risk of loss, including the loss of principal. Past performance is no guarantee of future returns. The content contained in this article represents only the opinions and viewpoints of the Interlaken Advisors editorial staff.