Money market funds are taking advantage of higher short-term interest rates the past few months to reclaim some of the management fees they have been waiving to avoid negative yields.
The $2.8 trillion money fund industry is generating more cash via the types of short-term instruments it invests in, from variable-rate demand debt to floating-rate paper tied to the London Interbank Offered Rate.
While nearly all funds continue to waive some portion of their fees, thanks to higher yields those portions are getting smaller. The average money fund now charges fees of 0.27% of assets, compared with 0.23% in the first quarter, according to iMoneyNet.
“There’s actually a little more yield in money market funds, and therefore a little more fees for us,” Thomas Gibbons, chief financial officer at Bank of New York Mellon, said in a second-quarter conference call.
BNY Mellon, which manages $335 billion in money market funds, has recaptured perhaps a fifth of its waived fees, he said.
The money fund industry invests in highly liquid short-term products to offer investors the equivalent of cash. Short-term rates remain low by historical standards, but have climbed appreciably since May.
Taxable money funds frequently invest in products with rates tethered to Libor. One-month Libor has averaged 0.32% since the beginning of May after averaging 0.24% the first four months of the year.
The $345 billion tax-free money fund industry typically invests in floating-rate municipal debt, backed by bank credit guarantees.
Yields on this type of paper have drifted up to 0.28% in July, from an average of 0.23% in the first four months of 2010, according to a Securities Industry and Financial Markets Association index tracking the asset class.
The impact of these higher yields on money market fund returns is more pronounced in some indexes than in others.
According to iMoneyNet, the average money fund yields 0.04%, up just a basis point since the beginning of the year.
A Crane Data index that tracks yields on the 100 biggest money funds shows a gain of four basis points so far this year — to 0.1%.
One thing is clear, though: the higher yields are allowing complexes to restore fees waived to avoid depleting client assets.
Money fund fees averaged 0.55% of assets before the financial crisis knocked short-term rates to the pavement, according to iMoneyNet. At the beginning of 2010, the variable-rate debt that tax-free money funds invest in yielded an average of 0.15%, the SIFMA index shows.
Charging fees of 0.55% while investing in paper yielding 0.15% was simply untenable. So, money fund complexes opted to waive significant portions of their fees to avoid the cash-management taboo of returning less money to shareholders than they put in.
Charles Schwab Corp., which manages $156.2 billion in money funds, started waiving fees in the first quarter of 2009, with a $6 million concession, and wound up relinquishing a total of $224 million for the year. Waivers peaked at $125 million in the first quarter of 2010.
With $260.5 billion in money market assets under management, Federated Investors began waiving fees in 2008. The Pittsburgh-based company sacrificed $120.7 million in money market fees last year, more than 10% of its revenue.
Federated’s waivers also crested in the first quarter, at $69.5 million — nearly 30% of the company’s revenue. The fund complex said returns on some funds would have been negative had it imposed all the fees to which it was entitled, according to earnings reports. In many cases, Federated cut fees just to get to a zero yield.
The $193.6 million Dreyfus BASIC Municipal Money Market Fund, whose ultimate parent is BNY Mellon, illustrates the dilemma facing fund managers.
Its prospectus lists expenses of 0.65% of assets a year, but charging that management fee on a fund with an average maturity of 44 days would consume all returns generated by the fund’s holdings and then some. The result would be a yield of negative 0.2%.
The fund calls this an “unsubsidized yield.” Waiving about 20 basis points in fees results in a “subsidized yield” of zero.
Some funds waived all their fees in extreme cases, iMoneyNet reported a year ago.
Thomas Donahue, chief financial officer at Federated, said it costs the company about 0.1% of a money market fund’s assets to run it. Federated was willing to cut fees to that floor, even though it was profitless, because of a commitment to the longer term, he said.
At times, when some short-term rates were in the single digits, it seemed like gross yields might not be enough to meet the core expenses of the funds, he said. That time is over.
In reporting their results for the second quarter, many of the biggest money fund complexes indicated that the boost in short-term yields had allowed them to restore some of their management fees. Federated, Schwab, Northern Trust, and BNY Mellon all mentioned lower fee waivers in their second-quarter reports.
“We saw less impact from money market fund yield waivers in the second quarter,” Donahue said.
Federated, which manages 8.2% of all money fund assets in the U.S., estimated that for every 10 basis point increase in yields, the company is able to reduce its fee waivers by a third. Its waivers shrank 16% in the second quarter from the first quarter, to $58.3 million.
Federated expects to waive $11 million to $12 million in fees this quarter, which would be the lowest waiver total since the first quarter of 2009.
The 18 months after the Lehman bankruptcy were exceptionally difficult for the money fund industry. Cutting fees was only the beginning.
The negligible returns on the funds prodded investors out of cash and into short-term bond mutual funds, enhanced cash strategies, or other higher-yielding alternatives.
Investors last year withdrew $540.5 billion from money funds, which held $3.84 trillion on Jan. 1. The funds have coughed up more than $1 trillion in assets since the end of 2008.
For fund complexes that charge fees per dollar under management, the exodus of cash from the industry coupled with the fee waivers to whack profits.
Federated’s profit last year sank 12%, mainly because of the fee waivers. According to iMoneyNet, tax-free money funds coughed up $2.79 billion during the week ended July 26. Based on data from the Investment Company Institute, tax-free money funds have reported outflows of $50.6 billion this year.
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