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Could money market funds break buck again?

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Highlights
  • Money market funds are nicknamed sleep-at-night funds.
  • In September 2008, the Reserve Primary Fund in New York broke the buck.
  • The SEC has lowered the probability of a fund breaking the buck.

Investing » Could Money Market Funds Break Buck Again?

Money market funds are nicknamed sleep-at-night funds because they're largely safe and stable.

They invest in short-term, highly rated debt issued by banks, governments and corporations worldwide. Currently, $2.6 trillion are stashed away in money market funds, waiting to be reinvested.

Yet, in September 2008, the $65 billion Reserve Primary Fund in New York broke the buck -- selling for less than the $1 net asset value of a fund share -- after it was caught holding bankrupt Lehman Brothers debt.

A panicked wave of money market fund redemptions followed, causing the government to step in. "A lot of funds were in danger of going under," says Mike Krasner, the managing editor of iMoneyNet in Westborough, Mass. "Commercial paper was freezing up worldwide."

Could money funds break the buck again?

Money market mutual funds, or MMFs, try to keep their net asset value constant at $1 per share. Only the interest rate fluctuates. But if fund investments perform poorly, the net asset value can fall below $1. That's known as "breaking the buck."

For their part, the money market accounts, or MMAs, offered by banks are deposit-based and don't run the same risk. The accounts also are insured by the Federal Deposit Insurance Corp., up to $250,000.

So, to shore up money market fund safety and liquidity, the Securities and Exchange Commission began tightening money market fund regulations in 2010, asking for better credit quality in investments. One SEC regulation shortens average debt maturities to 60 days rather than the previous 90. Another regulation improves fund liquidity; 10 percent of money market fund assets must now be held in cash or investments that mature in one day. Another 30 percent must be in assets that mature in 60 days or less.

"The SEC has taken as much risk as possible out of money market funds," Krasner says. "And they were low-risk previously -- once-in-100-years happenings."

Also, funds must now post their portfolio holdings on their websites monthly to give investors updated information.

If there is one test of the efficacy of new regulations, it is the exposure of money market funds to Europe's debt woes. From May through September, the 10 largest U.S. money funds reduced their European bank holdings by 37 percent, moving money to Australia, Canada and Japan, according to a Fitch Ratings study.

"There were lots of negative headlines, and fund managers reacted," Krasner says.

Yet, even after breaking the buck, the Reserve Primary Fund only fell to 97 cents per share versus other investments, Krasner says. Investors were eventually repaid 99 cents on the dollar.

One casualty: Yield

Still, the SEC isn't done. It's considering other fixes such as having funds bolster their capital buffers, says Pete Crane, president of Westborough, Mass.-based Crane Data LLC. "The SEC will do more, but no one knows what they will do," Crane says. Still, the SEC has lowered the probability of a fund breaking the buck, he says.

So far, the biggest loss is to yields. Yields could be 0.3 percent less than they were before the new regulations, according to Palisades Hudson Financial Group analyst ReKeithen Miller. Miller also expects fees and expenses to increase as fund management companies comply with new SEC requirements, pushing yields down further.

To buoy yields, money market funds are taking more risk, says Marvin Doniger, author of "Common Sense Prescriptions for Financial Health." That risk may include going with debt instruments with lower credit ratings.

For their part, some money market fund investors are chasing higher yields by moving into riskier investments, such as ultrashort-term bond funds, whose prices can fluctuate by 10 percent to 20 percent as interest rates rise, Crane says.

Still, the likeliest loss for a money market fund is much less -- only pennies on the dollar, he says.

Still safe bets

The vast majority of money market mutual funds still invest conservatively. "These funds have been around for 40 years," Krasner says. Even so, nervous investors do have other options, he says.

Spread your money between two or three money market funds, he says. And stay with the top 10 funds. They include Federated Investors' and JPMorgan Chase & Co.'s funds, Krasner says.

"Stay away from fringe funds, though a lot of them have already gone away," Krasner says. Funds holding only U.S. Treasuries are another option, because they avoid eurozone investments. These days, eurozone investments are especially dicey, as the euro falls and central banks struggle to bolster bank liquidity.

Worried investors also have one other bedrock choice -- parking money in bank money market accounts. As money market accounts pay the same as money market funds, Krasner prefers the FDIC protection afforded money market accounts. These days, it pays to have protection.

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