Money market funds stand out for their meager returns
Money market mutual funds long have been the utility players of the investment world — reliable but boring, and usually garnering attention only when they drop the ball.
Lately, money funds have been making the blooper reels a lot.
In an era of low-yielding investments, money funds stand out for their meager returns. The average fund currently yields 0.04% annually, or a paltry $4 a year on a $10,000 investment.
“Yields are pitiful,” said Greg McBride, an analyst at financial website Bankrate.com.
Beyond that, there are nagging worries about their perceived safety — a potentially big problem since that’s a key reason that investors buy money funds.
Money market funds invest in short-term debt such as commercial paper issued by corporations and Treasury bills issued by the federal government. Unlike bank deposits, money funds are not insured by the federal government and can drop below their universal $1-per-share value.
Only a few have ever “broken the buck,” but the debt crisis in Greece has stoked worries about the potential for losses at U.S. money funds.
Money funds have heavy exposure to European banks, which themselves have sizable holdings of Greek debt. The 10 largest U.S. “prime” money funds have about half their assets stowed in European banks, according to a report from Fitch Ratings.
The fear is that if Greece can’t pay its debts to the European banks then the financial institutions might not be able to pay their debts to the money funds.
Analysts say the worries are overblown.
Even if Greece were to default — and the International Monetary Fund is working to cobble together a bailout to prevent that — European banks still would be able to make good on their own obligations, they say.
“Money funds would have no problem whatsoever from a Greek default,” said Peter Crane, head of money fund researcher Crane Data in Westboro, Mass. “The thought that there was ever any threat to money market mutual funds was, quite frankly, ridiculous.”
Still, the stability issue has persisted because of bad memories from the 2008 global financial crisis. The Reserve Fund, one of the industry’s bigger money funds, broke the buck because of its large holdings of bankrupt Lehman Bros. Holdings Inc.
Investors ultimately lost only a penny a share. But the federal government limited the damage by temporarily extending FDIC-like insurance to money funds. And the episode raised fear that a disruption at one fund could spark a run-on-the-bank response by prompting jittery investors at other funds to rush for the exits.
The Securities and Exchange Commission responded with new rules to ensure that funds have enough cash to pay off departing investors in a crunch without sparking a broad sell-off.
Funds must keep at least 30% of their assets in securities that can be sold within a week and 10% in securities that can be unloaded within a day. Average fund maturity can’t exceed 60 days, down from 90 days previously.
The changes have made the funds safer than ever, said Joseph Lynagh, a money fund manager at T. Rowe Price.
“Money funds have been pushed to a new level of liquidity and safety unheard of in their history,” he said.
Even so, the SEC, federal lawmakers and the fund industry are debating the need for additional measures. One idea is to let fund values “float” above or below $1 depending on the value of the underlying securities. Proponents say that could limit the risk of a run on the bank, but opponents say it could raise unnecessary fears.
“The only two things we know for certain is that there will be additional changes, and no one knows what those changes will be,” Crane said.
The immediate problem for most investors is the lack of a decent return — and Greece can’t be blamed for that.
Money fund yields averaged a respectable 4.5% at the end of 2007, according to Crane Data.
Yields began shriveling the following year as the Federal Reserve lowered interest rates to prop up the economy during the financial crisis. And yields have continued to drift lower as the central bank has kept rates at rock-bottom levels amid the sluggish jobs market.
As investors sought better returns elsewhere, fund assets have shrunk to $2.35 trillion from $3.34 trillion at the start of 2009, according to iMoneyNet.
Many people have turned to bank deposit accounts. Average yields aren’t much better there — 0.44% for a one-year certificate of deposit and a measly 0.15% for a traditional savings account, according to Bankrate.com.
But better returns can be found with a little effort, said McBride of Bankrate.com. The top-performing one-year CDs pay 1.2% to 1.3% and the best savings accounts yield 1.1% to 1.15%.
Bankrate.com lists top-yielding bank products on its website, all from institutions that are FDIC-insured, McBride said.
Fund managers and analysts stress other benefits of money funds, such as their liquidity, and question whether it’s worth the effort to chase a 1% yield on a CD.
“There are a lot of different reasons to be in a money fund beyond the income,” said Lynagh of T. Rowe Price.
Some investors have stayed true to money funds in the belief that interest rates will rise as the economy recovers.
Money funds historically have been preferable to bank accounts when interest rates begin to rise. As the funds’ holdings mature, they invest in higher-yielding instruments. And though banks quickly hike the rates they charge borrowers, they’re typically slow to boost the amount they pay out to savers.
Money funds at least offer the potential for greater returns, but that’s not likely to happen for months. Many experts doubt that the Fed will increase interest rates until sometime next year. That means money fund yields may be stuck until then.
