MIAMI - With the average equity mutual fund portfolio down more than 38% in 2008, money market mutual funds are quickly becoming one of the only safe havens for risk-averse investors. Money market fund assets recently topped $4 trillion for the first time, making money funds the single largest mutual fund group, according to the Investment Company Institute.
However, while the industry certainly has reason to celebrate all that cash piling up, some mutual fund leaders warn that hoarding cash in ultra-safe investments creates its own set of risks. Others note that regulators are bound to change money funds' mandate, and that due to zero yields, many money fund companies are absorbing administration fees to prop up NAVs.
"I'm concerned that money market funds now represent 40% of the mutual fund industry," ICI Chairman John Murphy told MME. "That doesn't necessarily mean that money market funds are too big. It means the other opposite: stocks and bonds have gotten too small."
Since their inception, money market funds have appealed to investors due to their safety and stability, said Murphy, who is also chairman of OppenheimerFunds.
"The bread-and-butter money market fund for retail customers and retail investors is an excellent product," he said.
Money market funds are also useful for institutional investors and businesses that need to have some portion of their investments liquid for purposes like payroll expenditures. In normal markets, the funds' $1 net asset value makes them far too conservative to play a large part in most portfolios. But with performance down in every other asset class, money market funds have swollen to record levels as investors look to protect their assets.
In order to maintain the implied promise of $1 per share during severe bear markets, and as the Fed funds rate has fallen to the 0.25% to zero range, fund companies have been forced to sell off other assets to prop up the money funds.
In September, Reserve Funds' Primary Fund "broke the buck" by falling below the $1 NAV after taking bad bets on commercial paper held by Lehman Brothers. The fund was forced to freeze redemptions, which spurred a panic in other money funds. Shortly thereafter, an institutional fund managed by Putnam Investments saw a run on its assets and was forced to suspend redemptions, as well. It was later saved when Federated Investors acquired it and merged it into a money fund of its own.
"Some institutional money market funds are very big, and there's a tremendous amount of risk in those large, institutional money market funds," Murphy said. "The money fund represents an unconditional put at a dollar. When you've got large investors in there, that's a risky situation. The Putnam institutional fund had no asset issues. The money was invested well, but on the investor side, there became a panic on the part of large, institutional investors that wanted out, and Putnam was not in a position to sell the assets."
In late September, the Treasury Department stepped in to temporarily guarantee the $1 NAV for money market funds until April 30.
Endangered Species
"A lot of fund companies are considering whether to stay in the money fund business," said Timothy Silva, a partner at the law firm WilmerHale, speaking at the National Investment Company Service Association's 27th annual conference and expo held here at the Doral Golf Resort and Spa. "It's really a drag on their business right now."
"Money market funds won't survive in their current form," said Kelley Howes, executive vice president, general counsel and chief administrative officer at Janus Capital Group. "The balance sheet of money market funds is significant and the balance sheet risk is also significant. They are more like a bank investment and should be regulated like one.
Money funds are currently regulated under Rule 2a-7 of the Investment Company Act of 1940, which governs the length of maturity, credit quality and the diversity of debt that the funds can hold. Unlike bank investments, money fund assets are not guaranteed by the Federal Deposit Insurance Corp.
The debate over how money funds should be regulated has rekindled the ancient battle between banks and mutual funds for these trillions of dollars of assets.
Former Federal Reserve Chairman Paul Volcker, who is currently President Obama's Economic Recovery Advisory Board chairman and leader of the international Group of 30, has been very vocal about his plans to require money funds to reorganize as special-purpose banks or become ultra-short-term bond funds with fluctuating NAVs.
"If the recommendations are implemented, there will be no more money-market funds, period," said ICI President and CEO Paul Schott Stevens.
Many financial experts fear that eliminating money market funds could cause another serious panic among investors.
Negative Yield
At this point, many money managers are wondering how money market funds can possibly continue to pay out when everything else continues to sink. The more investors migrate from stocks and bonds to money funds in order to avoid risk, the greater the risk of instability becomes.
"Money market funds have counterparty risk, credit-quality risk, issuer risk and yield risk," said Joan Binstock, a partner and chief of operations, accounting and administration at Lord Abbett. "Right now, the gross yield in Treasuries is less than 1%. After a fund pays its expenses, it could have a negative yield. But a negative yield is different from breaking the buck," she added.
"There won't be a money market fund business if yields keep coming down," said Martin Beaulieu, director of global distribution for MFS Investment Management.
The ICI's Money Market Working Group, headed by Vanguard Chairman John Brennan, has been developing proposals for possible money market reforms and is slated to publish its report by the end of March.
"I think the best we can do is to make sure disclosures are accurate and tell investors that these are not guaranteed, they're not insured, and it may not always be $1," Murphy said. That said, "if markets don't cooperate and performance continues to lag, none of it will matter."
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