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Some thoughts on Money Market Funds

A client recently asked if, given the turmoil in Europe and the substantial stake that US Money Market funds have invested one way or another with European banks, he should be reconsidering money market funds, and particularly, whether perhaps he should be parking cash in a savings account or other alternative.

He provided the link to an interesting article in Reuters about the issue:

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My response was basically that the biggest risk in the money market funds was not really that any investment within the fund would go to zero in value, but rather that if it did break the buck because more than a tiny slice of the fund did go to zero (when the Reserve Primary Fund broke the buck in '08 due to Lehman bonds, it went to

97 cents on the dollar) - the real danger is everyone running for the doors at once on the fund. If in fact the assets go under a buck, they have to redeem at NAV anyway, even if that NAV is less than a buck. Nobody got completely cleaned out by this, mostly it just may take a little while to sort it out.

That said, it still makes sense to minimize risks. If you are using a money market fund as a cash alternative, stick with a large, well-run, *cheap* fund such as Vanguard's Prime MMF or other similar funds.

One more point in favor of the cheap funds - they can afford to keep the most conservative portfolios since they don't need to take the risks which come with higher yielding securities to make up high costs. Most of them have large allocations to US treasuries.

And regarding any concern that treasuries might default, the alternatives are no better - a bank savings account backed by FDIC is, ultimately, still backed by the same government which is backing the treasuries.

On the way to all of this, though, I found an interesting letter that an advisor was sending to his clients. He uses Fidelity as a custodian and was moving all their (taxable) money market funds from Fidelity's Cash Reserves (their default money market fund) to Fidelity's US Treasury MMF. His reasoning was this - neither of them was generating enough internal income to pay the yield they are paying out in the first place - both have equal non-existent yields of 0.01% right now, and most of even that is due to the fund company waiving fees to make it happen. So long as you are ending up with the same thing in your pocket either way, his logic was to take advantage of Fidelity and put the money into the less (credit) risky of the two funds.

Interesting logic, and sensible, however, it does require that if the crisis passes and ultimately yields start to go back up, you need to watch the two funds and, probably, will want to move back to the one which is less subsidized by the fund company. Those subsidies do eventually have to go away and at that point, there will again be a real yield difference between the two.

I'd love to hear other folks thoughs on the issue.

Thanks

--David

Reply to
David S Meyers CFP
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Yes. That's why the Treasury provided an insurance program in 2008 for MMFs.

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could do it again if there appeared to be a system-wide risk of a run.

Agree that if return difference is minimal, Treasuries (assuming the MMF is open) offer more protection. An intermediate move might be to a muni MMF. Despite all the dire warnings about muni bankruptcies, municipalities will do everything they can to preserve access to credit markets; I consider these somewhat safer than taxable MMFs (except for Treasury funds).

Regarding Fidelity in particular - they now enable most accounts to use certain FDIC-insured bank accounts as the core (transaction/sweep) account. Not sure about trusts; can be used for personal accounts, IRAs (except inherited IRAs). That looks like a more "rewarding" bet - slightly higher rates than the MMFs (Treasury or otherwise).

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Reply to
Mark Freeland

The problem with treasuries is that at the short end they sometimes have negative yields. Not sure how that gets priced into these funds? I guess they must give negative returns too.

Reply to
anoop

Scottrade uses a "Bank Deposit Program" for otherwise uninvested cash in a brokerage account whereby they sweep the cash and deposit it into one or more FDIC insured bank accounts (as many as are necessary for the cash, up to $1million). In order for that program to work, the brokerage account must be an individual, joint, IRA, custodial or trust for which the beneficiaries are natural persons or sole proprietorships.

The FDIC coverage doesn't apply for accounts maintained in the name of business entities, for example.

Of course, like money-market funds, they're paying squat on the cash. 0.01% up to $10,000, ramping up to 0.15% on accounts between half and one million.

As compared to IBCData (iMoneyNet)'s listing of current highest yielding retail "prime" MMFs: Fidelity Select is paying a whopping 0.10% and rounding out the top 10 are Vanguard's Prime MMF at 0.03% at #9.

And for government MMFs, the top yield right now is the JPMorgan Federal MMF at 0.04% and the funds at #6-10 on the list all are paying 0.01% - including Vanguard's Treasury MMF, as well as Fidelity's and two Schwab ones.

In other words, you don't get paid more than a couple of hundredths of a percent to take money-market risk outside of treasury bonds -- and as piddly as the returns are in the "core" accounts farmed out to FDIC-insured bank accounts, they are still better than the MMFs - it's basically all a wash at this point. But I'd still prefer keeping only at the highest quality money-market funds - Vanguard's and Fidelity's - if not sticking with an FDIC- insured bank deposit program.

Further notes: SHV, the Barclays Short Treasury Bond Fund has an SEC yield of 0.0% right now. You got that: zero. The WAC of the holdings is 1.18%, but the holdings in the fund must all be trading at a premium, so that the realized yield is wiped out -- and that's with an average maturity of a touch under half a year. You have to go out to the similar 1-3 year fund, SHY, with a WAM of 1.85 years to get a positive SEC yield of 0.12% in a 100% treasury fund. Both of these ETFs have expense ratios of 0.15%. Never forget how much expenses matter!

However - short-term investment-grade *corporates* are paying a (relatively) lot more: the BarCap 1-3 yr corporate bond index, as realized through SPDR's SCPB, has a SEC yield of 1.92%. Note, of course, that by taking on that credit risk, the volatility goes up -- this fund is actually showing a *negative* return over the quarter ended 9/3/2011, even with that yield which is so much higher than treasuries.

Reply to
David S Meyers CFP

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