Run on Money Funds Ends, But Investors Shift From Prime to Treasuries

Recent moves by the U.S. government to prop up ailing money market funds seems to be helping stem the recent massive run on the funds, another fund implosion like the Reserve's Primary Fund can't be ruled out; managers may be holding investments that turn out to be worthless.

“We are telling our clients that under­lying this whole crisis are an awful lot of toxic instruments, namely collateralized debt obligations, subprime loans and auc­tion rate securities, and, in fact, we don’t know where they are all held—which bro­kers, fund companies, insurance firms and banks hold them,” said Christopher Whalen, senior vice president and managing director at Institutional Risk Analytics, which ad­vises corporate treasurers and chief finan­cial officers on cash management.

For the time being, however, the tide of massive outflows appears to be abating. Investors poured $19.64 billion into money market funds Wednesday, $26.2 billion Tuesday and $1.5 billion Monday, after yanking $186.6 billion, or 6.1%, out of money mar­ket funds the five business days prior, according to Crane Data. By comparison, money market funds had given up just over $7 billion the pre­vious week.

Money fund assets, currently at $​3.​398 trillion, according to the Investment Company Institute, remain up by $​178 billion, or 8.​1% year-​to-​date and still show a huge increase—$​529 billion, or 18.​4%—over the trailing 52 weeks. The government's plan to wipe out $700 billion in rotten subprime debt from investment firms' balance sheets has bolstered investor confidence, along with the news that the Federal Reserve and the Department of the Treasury will loan commercial banks $300 billion to buy back asset-backed commercial paper, with $230 billion of that debt held by money market funds.

Also significant is the $50 billion the government has set aside for investments held as of Sept. 19 in money market funds to ensure they do not break the buck.

There was also the first good news for money market fund investors whose re­demptions have been frozen. Putnam In­vestments struck an unusual agreement with Federated Investors in that share­holders in Putnam’s $12.3 billion Prime Money Market Fund Institutional, which was shut down and liquidated on Sept. 17, will become clients of the Federated Prime Obligations Fund in a “$1-per-share for $1 per-share” deal.

And brokerages TD Ameritrade and Ameriprise Financial set aside $50 mil­lion and $30 million, respectively, to re­imburse their clients in the The Reserve’s $62.3 billion Primary Fund, which is now frozen with a NAV of 97 cents.

The Reserve’s $62.3 billion fund shocked the investment world on Sept. 16 by breaking the buck. Since then, virtually all of the investors in the Primary Fund have headed for the exits.

Nonetheless, “investors still have faith in money market funds,” said Connie Bugbee, managing editor of iMoneyNet. “I am not worried another fund could break the buck.”

Corporate treasurers’ concerns over money market funds are fairly subdued, said Anthony Cargang, a partner with capital management consultancy Trea­sury Strategies.

“Money market funds appear to have survived the selling tsunami caused by Reserve Primary Fund’s breaking the buck,” concurred Peter Crane, principal of Crane Data. “I do not think there are any other money funds out there with the three strikes that took Primary down: lack of the parent company having back-up reserve funds to shore up the NAV, hot money pouring in due to outsized yields and significant positions in the defaulted Lehman Brothers.”

However, safety, diversification and preservation are now the name of money market fund investors’ game, rather than chasing the highest yields. “Investors in prime money market funds are very skittish right now and are moving out of these funds into safer government money market funds,” Bugbee said.

“The entire mindset has shifted from yield at the lowest risk to taking no risk at all,” Whalen agreed “We call this a ‘mini-max strategy’—minimizing the maximum potential loss.”

Thus, last week, money market fund investors stampeded out of funds special­izing in prime institutional debt, shifting the money instead into government in­stitutional funds, data from iMoneyNet shows. In the week ended Sept. 22, inves­tors withdrew $200 billion from prime in­stitutional money market funds, leaving a balance of $954.07 trillion. In the prior week ended Sept. 15, prime institutional money market fund investors withdrew $95 billion, leaving a balance of $1.235 trillion.

By comparison, in the week ended Sept. 22, investors in government institutional money market funds placed an additional $180.07 billion, bringing the total to $865.7 billion. The prior week, they invested $36.7 billion in government institutional money market funds, for a total of $685.68 billion, according to iMoneyNet.

“The shift from prime insitutional funds into Treasury and government money funds has been astonishing,” Crane said. While this is currently putting a great deal of stress on the commercial paper and corporate funding markets, he expects flows to return.

For the time being, Institutional Risk Analytics is advising institutional investors to diversify their cash manage­ment and short-term portfolio instru­ments.

In particular, Institutional Risk Analytics is recommending Treasuries and other government obligations, mon­ey market funds, bank deposits and, for those clients that have the wherewithal to do their own research, commercial paper.

In addition, the firm is recommend­ing that investors spread their holdings among various securities dealers, banks and mutual fund companies.

Meanwhile, the reason for Reserve’s Primary Fund’s implosion came to light: its outsized expo­sure to commercial paper, giving it the No. 1 yield in the money market fund in­dustry of 2.85% on its institutional share class—50 basis points higher than its av­erage competitor. The firm amended the fund’s prospectus in 2006 to allow it to make investments in commercial paper. Those holdings rose to a whopping 53.9% of holdings as of May 31, up from a neg­ligible 0.09% a year earlier. When it broke the buck, it held $785 million in worthless Lehman debt.

In addition, the three enhanced cash short-term bond funds on the market look like they will dissolve, according to iMon­eyNet. On Monday, Moody’s downgraded American Beacon Cash Plus Trust from Aaa to Ba and Reserve Enhanced Cash Strategies Portfolio from Aaa/MRs to B/MR2. Moody’s already downgraded Re­serve Yield Plus after it broke the buck.

In a related development last Wednes­day, Bank of New York Mellon said it will take a charge of $425 million in the third quarter to shore up 10 money market and cash-sweep funds, six of which were in immediate danger of breaking the buck due to exposure to Lehman Brothers.

“These actions will provide support to our clients and, given our size and indus­try leadership, will hopefully contribute to greater stability in the overall market,” said BONY Chief Executive Robert P. Kelly. “We feel this is an important invest­ment in our client relationships.”