Things like this, from today’s FT, confuse us:
Money market funds, an increasingly popular place to park cash, will need to raise fees or close to new money to remain profitable as yields hover at near-zero, according to industry managers…
FT Alphaville has noted this in detail before, but as a basic recap: with the Fed’s target rate essentially at zero, the business model of money market funds, or MMFs, is breaking down. That’s because, like the majority of investments, money market funds take a fee for investing in short-term securities — mostly in US Treasuries. Once rates start dropping, those assets stop yielding enough cash to pay the fees and still pay investors a reasonable return.
Then you have a situation where, as The Stalwart puts it:
… risk-averse investors [might] as well put their money under “the mattress”. Which for financial institutions, by using the term “mattress”, I mean other forms of government-insured financial accounts and earn more, or at least earn nothing. Heck buy some corporate bonds backed by a rock-solid corporate with little leverage. They are probably more solvent than the US government and will pay you substantially more.
In otherwords, with extremely low rates in play, money market funds are no longer competitive against things like bank accounts — especially since the Fed has remarked that low rates are likely to be around for a while. Money market funds which specialise in buying treasuries are particularly at risk.
So how will raising fees help as investors deal with increasingly low yields? Wouldn’t it make more sense to, god forbid, lower fees or close out to new investors?
There’s a hint of this — more plausible outcome — in the FT story:
[Jim McDonald of money market fund T Rowe Price] said: “Our Treasury fund yield was net 50 basis points after investor fees, and our expense is 47 basis points. If assets remain unchanged and we continue to roll over securities, our fund will run out of yield in February.
“The board has to make a decision about whether they waive fees. I am not advocating this, but you can also tell shareholders that they will have to pay a fee, an extra fee above what the portfolio earns.”
Fees aside, there’s a bigger problem to do with money market funds. They play a big role as buyers of treasuries — something that becomes more important as the Fed balloons its balance sheet to fund the US bailout. From Bank of America’s Matthew Moore:
The Treasury has admitted to a $1.5bn-$2.0 [trillion] financing need in FY 2009. This financing need is nearly four times the previous highest need in the Treasury’s history. The question is who will surface to purchase this incredible amount of Treasuries at record low yields? Granted, there’s still lots of demand for Treasuries (the latest Fed data shows foreign central banks loading up on treasuries last week) as a relative safe-haven asset — but there’s also, already, talk of a Treasuries bubble. The possibility of foreign governments retrenching from the market is also there — Luxembourg and Norway for instance, started selling Treasuries in October. From BoA’s Moore again (emphasis our own):
In summary, we expect net Treasury sales from oil producers and money market mutual funds but net Treasury purchases from banks (both domestic and foreign) and individual investors. With these groups of investors looking to mostly offset each other, it seems unlikely that traditional buyers will be unable to absorb the full supply of Treasuries hitting the market in FY 2009 at current yields. The solution may be that the FOMC is “evaluating the potential benefits of purchasing longer-term Treasury securities.” Treasury purchases by the Fed may be required to prevent yields from rising even as the economy remains weak.
And BoA’s Michael Cloherty on MMFs specifically:
Nonetheless, we think that the Fed is likely to have to make up some of the shortfall in the money markets by buying more assets. From September 10th to October 7th there was a $460bn decline in prime money market funds. Over the same time frame the Fed’s balance sheet grew by $669bn as it tried to undo the damage that this caused to the market. While the Fed statement mentioned that “the Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities,” we think they will need to focus on supporting money market assets first.
Like a bailout for money market funds then — watch, however, what happens to MMF fees should it come to pass.
Related links:
How low rates break the buck - FT Alphaville
Money market funds reel as yields near zero - FT
Treasuries bubble danger - FT Alphaville
