Understanding Low Volatility NAV

Regulatory reform of the European Money Market Fund industry has its origins in the Global Financial Crisis. Whilst no European short term money market fund 'broke the buck' in 2007 / 2008, and the European Securities and Markets Authority, or ESMA, as well as the industry itself, have already undertaken efforts to tighten the qualifications of a short-term Money Market Fund over the intervening years, Low Volatility NAV, or LVNAV, funds have been developed as a concept to address concerns over constant NAV funds' potential role in a future crisis whilst retaining utility for investors.

It is too simple to call LVNAV funds "CNAV" rebranded, however, we believe they will retain much of the administrative utility of a CNAV fund and in all but the most severe stress scenarios one would fully expect the price of an LVNAV fund to remain 1.00.  They will also be required to adhere to the strict maturity and security limits as they do today.  Importantly however, an LVNAV fund is a variable NAV fund - meaning variations in mark-to-market pricing could cause a NAV to be something other than 1.00 - albeit within certain volatility thresholds that will seek to allow the LVNAV to retain a price rounded to 1.00 in normal circumstances. 

An LVNAV fund’s price will be calculated on an amortised basis for all holdings below 75 days to maturity, so long as the market price of an individual asset is within 10 basis points of its amortised cost price, and on a mark-to-market basis for the longer dated holdings.  

Vitally though, we will also produce a full mark-to-market price for the portfolio each and every day. Provided the two portfolio prices overall do not differ by 20 basis points or more, an LVNAV fund will round to two decimal places.  So if the 20 basis points tolerance is breached the fund will price to four decimal places using the mark-to-market NAV of the portfolio, and essentially therefore becoming a Variable net asset value money market fund.

There are three primary differences between the two fund types. Firstly, a short-term variable NAV, or VNAV fund must be priced using full mark-to-market pricing, unlike an LVNAV fund which can amortise certain holdings.

Secondly, the liquidity requirements will be lower in a VNAV fund than in an LVNAV fund.  Whereas an LVNAV fund must maintain 10% minimum daily liquidity and 30% minimum weekly liquidity, a VNAV fund is required to only maintain 7.5% daily and 15% weekly.  This level of liquidity could lead to a difference in the fund yields.  However, if managed with consistent investment objectives, and in order to maintain consistent fund ratings, managers, or at least ourselves at BlackRock, would manage similar liquidity levels,and the yield difference between the two portfolio types would most likely therefore be minimal.

The third differentiator between the two fund types is that LVNAV funds will be required to have provisions for liquidity fees and redemption gates as shareholder protections. Meaning that at certain levels of liquidity, and in certain stress scenarios, a fund Board will have the ability, and in extreme cases the obligation, to charge for liquidity in the portfolio or to prevent redemptions by way of a gate in the fund to stop that run. VNAV funds will not have such prescriptive fees and gate requirements. 

However, most if not all UCITS funds have ‘Duties and Charges’ embedded within their Prospectus so it is not quite correct to say that VNAV will not have fees and gates, rather that they are not prescribed in the new money fund reform regulations in the way that they are for LVNAV funds.

In an LVNAV fund, if weekly liquid assets fall below 30% of the fund AND the fund has experienced daily net redemption greater than 10% of its net asset value, the Board must convene and decide whether or not action is appropriate via the implementation of a small fee for liquidity, a temporary halt for redemptions, or in fact no action at all. 

If weekly liquid assets fall below 10%, the Board would have the obligation to apply either a liquidity fee or halt redemptions with a gate. In reality these are the sort of liquidity levels that we feel prudent managing to today, and these tools would therefore only be used in scenarios where the fund’s Board feels that investors are at risk due to extreme systemic shock.  

An LVNAV fund structure is certainly more complex from a portfolio management perspective and clients should be aware of some of these details.  We believe, however, that if done properly, an LVNAV fund actually provides the best of both worlds as investors will have the utility of a money market fund with a price of 1.00 in what we would expect to be almost all circumstances while being run with the same investment goals of capital preservation and liquidity management employed today. 

We await final confirmation, but importantly it is our expectation that LVNAV will retain 'Cash or Cash Equivalent' status for accounting and client money purposes.

Investors may want to check their Treasury policy, or investment guidelines to permit LVNAV in due course, but a price of 1.00 is a significant utility for investors from an administrative perspective. In addition, in the event of a systemic shock, the fund can be switched to a mark-to-market VNAV, rather than wound down as would have occurred in the past. 

In summary, while the LVNAV is a more complex fund structure from certain perspectives, we believe it is an appealing one for many clients thanks to its administrative ease combined with the enhanced investor protections that it offers.