Money Funds Could Be In For Tough Times

A rate cut could push money fund yields so low the returns would fall below zero, causing investors to flee, according to a Bloomberg news report.   The Fed announced Wednesday that it was cutting both the federal funds and the discount rates by a quarter point. “The Fed is almost forcing everyone to go into the equity market” or into bonds, Bryan White, who manages about $60 billion in money fund assets at Evergreen Investment Management in Charlotte, North Carolina, told Bloomberg. Investors “are going to start reaching for higher yields.”

Yields on money funds, considered among the safest investments, were at a record 0.67% as of June 17, according to the Money Fund Report, an industry newsletter. The Fed’s 12 rate reductions since January 2001 totaling 5.25 % have sent money fund yields down to current levels from more than 6%.

With more than $2 trillion in money market mutual funds, both individual and institutional investors have a lot at stake. The average money fund has about $1.4 billion in assets.   Some funds may have to “cut expenses a lot lower in order to have a positive rate of return,” Steve Traum, who manages more than $8 billion in money fund assets at the Teachers Insurance and Annuity Association-College Retirement Equities Fund in New York, told Bloomberg. Traum’s fund yielded 0.95% as of June 17, after expenses equaling 0.29% of assets.

Sensitive to Fed Rate Targets

Money market mutual funds are among the most sensitive investments to changes in the Fed’s target. The average maturity can’t be longer than 90 days and fund managers are prevented from purchasing assets that mature in more than 13 months, according to US Securities and Exchange Commission regulations.

Money funds must keep the value of each fund share from falling below $1, known as breaking the buck. A share value below $1 means investors have lost money in an investment considered virtually risk free. The SEC has forced only one liquidation in the history of money funds, when the Community Bankers US Government Money Market Fund was sold at 96 cents on the dollar in 1994.

Money funds are considered safe because they invest mostly in Treasury bills, bank deposits, short-term corporate debt, government agency debt and collateralized overnight loans known as repurchase agreements. The SEC requires that 95% of the assets must have the highest credit ratings.

Money fund assets have fallen by just over 5% this year. Asset size is crucial for money funds because income is based on assets, rather than return. Fees are the source of a fund company’s profit.

With money fund giants such as Fidelity Investments’ $56.2 billion Cash Reserves fund and Vanguard Group’s $47.7 billion Prime Money Market Fund yielding less than 1%, some fund managers say investors may seek alternatives. Fidelity’s expense ratio is 0.39 % and Vanguard’s is 0.33%.