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Rate cut adds up to trouble for
some money market funds
By Laura Bruce
• Bankrate.com
Fed rate cuts may or may not help the ailing economy,
but they're definitely not what the doctor ordered for your money
market fund.
Rate cuts that make it cheaper to buy a mortgage or
car loan also cut the return on interest-based investments such
as money market funds.
"Income investors have been getting punished
for two years, and these lower rates are doing more pain than good,"
says Peter Crane, vice president and managing editor at iMoneyNet,
provider of money market mutual fund data. "The buying power
of savers has been reduced by hundreds of billions of dollars since
the beginning of 2001."
The Fed's decision to cut the Fed fund rate by a half
percent probably will take a few weeks to affect most money market
funds. Some fund companies will have tough decisions to make, Crane
says.
"A half-percent cut means 70 or 75 funds will
drop below 1 percent. We're still only talking about the funds with
the highest expenses. Thirty funds are below a quarter point. They'll
have to waive expenses to stay above zero."
A negative yield, meaning no return on your investment,
is different from the often written about "breaking the buck."
Breaking the buck means that the net asset value, the price per
share, of the fund drops below $1.
If the yield sank into negative territory and, instead
of waiving expenses, the company deducted them from the NAV; the
dollar would be in danger.
Only once has a money market fund's NAV dropped below
a dollar.
In 1994, Community Bankers U.S. Government money market
fund, which invested in risky derivatives, liquidated when its NAV
fell to 94 cents. The industry made up the difference to investors
so no one lost principal.
Money market funds are not FDIC insured, but the Securities
and Exchange Commission now strictly regulates them. Funds are primarily
limited to high-quality, short-term debt, such as Treasury bills.
Peter Rizzo, head of Standard & Poor's money market
mutual fund ratings team, says he expects any fund that has a negative
yield will waive fees.
"They want to maintain the stability of the fund.
Would you want to put your money in a fund that didn't do that?
It's their reputation. I can't foresee any companies that would
have a tough time waiving fees unless it's a small investment shop
that needs the fees to survive."
If you want to avoid buying a money market fund from
a small shop that needs the fees to survive, you may want to check
out Standard
& Poor's money market fund ratings.
The company rates money markets on credit quality,
market price exposure -- the potential for a decline in the market
value of the fund's assets -- and management. S&P only ranks
the funds that ask the company for a rating. Most receive the top
rating of AAA, but you will see some As and even a B here and there.
"Consumers should look at the overall credit
quality of the investments the fund buys and the maturities. You
also want the management team to be experienced. Some shops might
put their least experienced manager on a money market fund because
it's not a sexy fund. You have to read the prospectus," Rizzo
says.
It's always smart to look for a money market fund
that has low fees. Why have your yield gobbled up by fees? But also,
a fund that charges just a quarter percent in expenses will have
a better chance of avoiding negative yield problems than a fund
that charges 1 percent. The average fee is about half a percent,
but many can be found at a quarter percent or less.
-- Posted: Nov. 8, 2002
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