Money Funds: Breaking the Buck?
by Ann C. Logue
In normal times, the money market mutual fund is the least-interesting investment out there. Designed as a safe place to keep cash, the funds rarely return much more than the Treasury bill rate. Most usually invest in Treasury bills, although fund managers often try to get a better return with riskier short-term investments such as jumbo bank CDs too large to qualify for FDIC insurance, bonds that are close to their maturity, and commercial paper, which are very short-term corporate bonds. One typical use of commercial paper is to meet payroll. A company has to pay its employees, no matter how much money is in the coffers, and many businesses will borrow money for two or three days to cover it. These transactions are usually safe, because even a company with an uncertain future like an automaker is probably going to be around this time next week.
Because the investments have such a short timeframe, the return comes almost entirely in the form of income. Hence, money market mutual funds are priced at $1 per share. Some offer check-writing privileges, because that $1 return is so predictable. Money market mutual funds seem an awful lot like a bank account that pays better interest.
These are not normal times. When yields are low like they are now, fund managers have a temptation to take on just a bit more risk in order to get just a bit more return. The risk is miniscule, but it's still there. With yields being so low, though, there's less of a cushion in case something goes wrong. If market rates are running at 5%, you might be able to lose money on one bet and still post a yield of 4%. If market rates are running at 0.80%, you might have a problem with one position and end up in negative territory — in which case the fund "breaks the buck" and prices its shares below $1 each. Instead of looking like a bank account, it looks like a disaster.
Breaking the buck is a rare occurrence, especially because fund management companies will usually make up the difference rather than watch their money funds suffer. In 1997, Strong Funds (since acquired by Wells Fargo) paid $30 million to make investors whole when its three money market funds made some losing bets on Mercury Finance, a used-car loan company that went bankrupt. And that's how far back you have to go to find shards of a broken buck.
There are rumblings of trouble, though, over and above the low rates in the market. Many are attracted to money market mutual funds because they offer higher rates than banks, but some investors want an even better rate on a safe investment than money market funds offer. Many turned to auction-rate securities, which are long-term bonds that had rates reset at an auction. The idea was that the frequent rate resets made them behave more like short-term securities, and that the monthly auction created a ready market for buyers and sellers. Many brokers operating these auctions placed the securities with individual investors looking for safety and yield. That was great when markets were functioning smoothly. However, credit markets are really tight these days, and few people have been showing up at the auctions. Holders of auction rates note they are having difficulty selling them, and many brokerage firms are writing down their value.
So far, money market mutual funds do not seem to be affected. (Ironically, many auction-rate securities were issued by closed-end mutual funds as a cheap way to borrow money.) But between the low yields and the problems with at least one money-market-like security, some fund companies are setting aside reserves in order to make their money-market investors whole, if their buck looks like it's about to break. Others are waiving 12b-1 and high management fees that might be bringing the yields on their funds dangerously close to zero or below.
The risk of a broken buck may be greater for the fund management company than for the fund investor. Most fund companies will absorb management fees and pony up extra cash to avoid the ignominy of losing money for money fund investors. After all, who wants to become an anecdote in a mutual fund column 10 or 11 years from now?
Of course, one way to beat the risk is to move the money elsewhere. Given the cheap valuations on stocks, it may be time to transfer money out of a money market mutual fund and into one investing in equity.
This concludes this week's issue of MutualsAdvisor.com Weekly. We encourage you to visit our website to review past issues of MutualsAdvisor.com Weekly: http://www.mutualsadvisor.com/newsletter.cfm
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