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Money-Market Funds in a Bind To Maintain the $1 Share Value
Some Funds Aren't Collecting Enough Income From Holdings to Cover the Operating Costs
By KAREN DAMATO
Staff Reporter of THE WALL STREET JOURNAL
The Federal Reserve's latest interest-rate cut ratchets up the pressure on some mutual-fund companies to waive fees or take other actions to keep the share price of some of their money-market mutual funds from dropping below $1, the stable share value those funds strive to maintain.
But the fact that the Fed cut by a quarter point -- and not the half point that some market watchers had anticipated -- "is good for money-market-fund investors as well as for anyone who is involved in the money-market-fund business," says Colleen Denzler, a vice president and senior portfolio manager at fund group American Century Investments in Kansas City, Mo.
The smaller cut means that investors won't see quite as big a drop in their money-fund yields as they might have, and the fund companies won't face quite as steep a bill to keep their money-fund returns in positive territory. The average taxable money fund yielded just 0.64% as of Tuesday, an all-time low, according to iMoneyNet Inc., a money-fund research firm in Westborough, Mass.
The hallmark $1 share price of money funds is one of the fund industry's most significant innovations, but also one that lately has caught some fund operators in a bind: With interest rates lower than at any time since money funds were first created in the early 1970s, some money funds aren't collecting enough income from their holdings of commercial paper and other short-term investments to cover their operating costs. As a result, fund-management companies have responded by cutting their normal fees on those funds in order to keep the share prices from sliding below $1.
Even after the Fed action, money-fund investors have little reason to worry about their money funds dropping below $1 in price, or "breaking the buck" in industry jargon. Fund-company officials routinely say they feel a moral obligation -- and it's also in their self-interest -- to maintain the $1 price. If a money fund broke the buck, "your clients would be gone in a thrice. ... They would say, 'I thought this was safe, but it isn't,' " says John Bogle, founder of Vanguard Group.
Others in the industry agree. "We would do anything we could to avoid breaking the buck," says Elizabeth Krauss, a managing director at State Street Research & Management Co. Indeed, that firm is already losing money on three small classes of shares in its State Street Research Money Market Fund, because the management firm is paying more to reimburse expenses for certain share classes of the fund than it is collecting in portfolio management fees for those shares.
The latest rate reduction "ups the ante" for fund firms in this position, Ms. Krauss says, "but we stand by our commitment to shareholders" -- a promise by State Street Research that it will keep the fund's yield at no less than 0.10%.
To some degree, the fund industry can blame itself for the current bind: The stable $1 share price wasn't standard for all money funds when they first appeared in the 1970s. And it still isn't a requirement. "It's not unlawful to break the dollar," says Robert Plaze, an associate director in the Securities and Exchange Commission's Division of Investment Management, which oversees money funds.
But the stable $1 share price has helped to draw a total of more than $2 trillion in individual and institutional cash into money funds, which account for one-third of the fund industry's $6.5 trillion in total assets. Since individuals look at money funds as bank alternatives, the unchanging $1 value is "what people wanted and that is what they expected," says William E. Donoghue, who in the 1970s and 1980s wrote a newsletter and then a top-selling book about money funds.
The fund industry has gone to great lengths over the years to build confidence in that unchanging price, with fund-management companies repeatedly bailing out their money funds when the $1 price was threatened by fund holdings that defaulted or tumbled in price. That happened in 1994 when some derivative securities went bad and again in 1997 when Mercury Finance defaulted on commercial paper held by some money funds.
Indeed, it appears that there has been only one instance to date in which a money fund -- and a small, institutional one, at that -- actually did break the buck. Community Bankers U.S. Government Money-Market Fund was tripped up by derivatives holdings in 1994 and quickly shut down. The fund, with $82 million in assets, paid investors 94 cents on the dollar at liquidation.
While several large asset-management firms are waiving fees to keep one or more of their money-fund share classes in positive-return territory, money funds holding most of the industry's assets aren't yet caught in the current expense squeeze. Only about 3% of money-fund industry assets currently yield 0.25% or less, the yield level at which new or increased fee waivers will be required in light of the latest Fed rate cut, notes Avi Nachmany, director of research at Strategic Insight in New York.
Analysts generally don't expect the quarter-point cut to reduce earnings at publicly held asset-management firms, although a half-point cut probably would have done so. (About 15% of money-fund assets currently yield 0.50% or less, another indication of the bigger sting that a larger Fed cut would have meant.)
Further, fund investors and observers probably shouldn't shed too many tears for the mutual-fund companies. While running a money fund may be at best a break-even proposition for some smaller fund firms, the money-fund business "is a great business for the players who have a large presence there" and which can thus run a large pool of money with a related small staff, says Ken Worthington, an analyst for CIBC World Markets.
Write to Karen Damato at karen.damato@wsj.com
Updated June 26, 2003
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