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Pity the poor money-market fund operators. In this environment of near-zero short-term interest rates, they have to work very hard just to earn a few bucks on the substantial sums of money entrusted to them.
My colleague, analyst Rich Rockwood, brought the remarkable figures to my attention the other day. For example, the Schwab Government Money Market Fund invested $565 million in an overnight repurchase agreement with Barclays Capital. The next day, Barclays returned $565,000,157 to the fund for a grand total of $157 earned—a whopping a 0.01-percent rate.
The Schwab Government Fund has an average maturity of 42 days. And on a longer-term Federal Home Loan Bank security, the fund will earn $1,767 on a $100 million investment due in February 2012, for a 0.32-percent return.
Most fund managers are absorbing a significant portion of their annual expenses; otherwise, investor returns would be negative. In this case, Schwab has lowered its fees to 0.17 percent on its Government Money Fund from the 0.73 percent it normally would charge. After those reduced fees, the current yield on the fund is 0.01 percent.
Money funds supply grease to the gears of our financial system by investing in short-term government and corporate securities, thereby providing liquidity to the markets. Paging through the holdings of any money fund is an eye-opener to the world of today’s short-term investor: The return on liquid money is virtually nonexistent. In June, the Federal Reserve alerted the markets that this scenario will persist for at least two more years.
The European debt debacle has reignited the discussion of money-market safety. Money-market funds are restricted to investing in securities with maturities of no longer than 397 days (about 13 months) and must maintain a dollar-weighted average maturity of no longer than 60 days. While money-market funds are viewed as ultra-safe, they are not guaranteed by the FDIC or any other government agency.
All told, money-market funds hold $2.7 trillion in assets, with about 40 percent in government funds and the rest in “prime” money-market funds. Prime funds are not limited to investing in government-backed securities and until recently had significant exposure to European banks. According to Fitch Ratings at the end of May, half of all prime money fund assets were invested in European banks. Since then, American money funds have reduced their European holdings 30 percent.
In 2008, the Reserve Primary Fund’s investments in Lehman short-term paper suffered losses that caused its net asset value to fall below the $1-a-share level money-market funds seek to maintain. Known as “breaking the buck,” this event rocked the commercial paper market and caused market liquidity to dry up. To stem a run on the money markets, the Fed created a special lending program to temporarily backstop money funds.
Since then, several ideas have been floated to protect money fund investors from another blowup. They include floating net asset values that would allow fund shares to move in small increments above or below $1 per share. An emergency bank that allows access to funding when needed, and a reserve fund provided by the manager or from retained earnings to support loss protection also have been discussed.
Better, we view Microsoft at a 9 price-to-earnings ratio with a 2.5-percent yield as a money-fund substitute.•
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Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money management firm. His column appears every other week. Views expressed are his own. He can be reached at 818-7827 or ken@aldebarancapital.com.
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