Despite what you may have heard on television news or read in the headlines, no money-market funds "collapsed" in the past week.
Despite what you may have heard on television news or read in the headlines, no money-market funds “collapsed” in the past week.
While some investors rushed the exits, there were no lost fortunes; the money markets — even at their worst — still felt a whole lot safer than the stock market.
Yet that perspective was missing in much of the reporting on the Reserve Primary fund “breaking the buck” last Tuesday, taking the heretofore unthinkable step of dropping its share price from the static $1 level investors expect from money funds.
And yet, understanding the situation and gauging its true severity are crucial for investors trying to figure out what to do next. With the Treasury stepping in Friday to say it will guarantee any money fund that pays a fee, investors may decide to change how they pick a fund, but they shouldn’t rush for the exits expecting the worst.
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To make that “Should I stay or go?” decision, investors should first understand what happened last week, and what could be next.
On Tuesday, the Reserve Primary fund announced that it had declared $785 million in commercial paper from Lehman Brothers as worthless; as a result, the net asset value of the fund dropped to 97 cents per share.
Further, the fund said that it would take redemption requests, but that it would not send proceeds for a week, invoking a rule in the Investment Company Act of 1940 that lets fund firms put the brakes on redemptions to help them weather big runs on the fund without having to dump the bulk of a portfolio onto the market at distressed prices.
Other fund firms took steps to avoid the same fate.
The banking-company parents of the Evergreen, Dreyfus and Columbia funds all stepped in to take Lehman paper off the hands of their money funds, a move that ensured those offerings would not break the buck.
And Putnam announced it would shut down its Prime Money Market fund, an institutional issue that was struggling with a run of redemptions amid rumors of its Lehman holdings; while the fund had not broken the buck, that remains a possibility as the fund has a week to unload its holdings and distribute the proceeds back to shareholders.
While the news media characterized the Reserve situation as a collapse, the plain truth is that the fund took a worst-case scenario hit — making the Lehman securities worthless — and lost just 3 percent.
An investor who held the fund for the entire year is roughly back to break-even, having given back the income the fund earned through mid-September; that’s a terrible outcome in a fund that should be the safest of ports in the current storm, but it’s not a life-changing event.
An investor looking at a money fund as a safe haven and counting on a 3 percent return could rush for the safety of Treasurys, but would see their current yield fall to about 0.5 percent.
In short, they would lose about as much protecting themselves as in the worst-case scenario of staying put and living through a break-the-buck incident.
In the $3.5 trillion world of money funds, the remarkable thing is how much money has not been affected by the troubles of Lehman, Fannie Mae, Freddie Mac and every other scary situation.
“People are acting as if everything is melting down, when the truth is that virtually all money-market securities have done what they are supposed to do, and have held up in the face of these conditions,” says Peter Crane of Crane Data, which tracks money-fund performance. “The fact that there is so much money in these funds and that the problems, relatively speaking, have been so small actually speaks well for money funds.”
Even so, investors may want to reconsider how they select money-market funds now.
Up to now, investors have typically picked money funds almost entirely based on yield.
Now, nervous money-fund investors today may want to limit their investments to funds that either participate in the Treasury’s new protection program, that invest only in Treasury securities or that come from the big diversified fund or banking concerns, where breaking the buck would kill off the firm’s entire money-management business.
In Reserve’s case, the firm focused on money funds, so its name was turning to mud regardless; indeed, the firm announced on Thursday that it is closing all of its money funds.
By comparison, a banking giant like Wachovia — which owns Evergreen — is better known for its other operations, and would suffer across the board for allowing a money fund to implode; as such, it’s the kind of firm that will buy the Treasury protection or buy troubled securities out of the money fund rather than let its reputation be ruined. There have been about 20 such buyouts the world over the past year.
The money-fund story is big news, but investors need to recognize that it has not meant big losses. And with additional protection from the Treasury, it’s even less likely to mean losses as it plays out over the next few weeks and months.
Chuck Jaffe is a senior columnist at MarketWatch columnist. He can be reached at email@example.com or Box 70, Cohasset, MA 02025-0070.