Money market mutual funds are short-term investments and their yields are affected by movements in the federal funds rate. The Fed has now cut that key rate to 1 percent, a territory it hasn’t visited in more than four years.
The federal funds rate lingered at 1 percent from June 2003 to June 2004. During that time, some money funds waived their management fees to avoid flat or negative yields. Generally, funds that felt the need to take that step had relatively high expense ratios of 1 percent or higher.
Peter Crane, publisher of Money Fund Intelligence, says that the federal funds rate can go to 1 percent without “inflicting serious pain on most money fund expense ratios.”
Too many moving parts
“One percent is the practical lower boundary for a number of reasons, not the least of which is that money market funds would start to feel pain below it,” says Crane. One percent was shown to be the boundary in 2003 to 2004. The Fed had reasons to go lower but stopped there. I’m not concerned about the rate at 1 percent. It will be a nuisance and investors may lose a half-percent, but in this environment not many people are worried about yield anyway.”
But in fact, Crane says that this latest cut, which traditionally should be reflected in money fund yields in a month or so, may or may not take full effect.
“Normally money funds follow the Fed, but in this crazy environment there are just too many moving parts to tell what yields will do here.”
Crane says that a few Treasury funds have waived fees recently as their yields have dipped to rock bottom, but that prime funds have more breathing room because their yields are considerably higher.
The average yield for the Crane 100 Money Fund Index is 2.17 percent and the average expense ratio is 0.37 percent. Some of the most popular funds are sporting much higher yields.
The 7-day yield on Fidelity’s Cash Reserves (FDRXX) had dipped to below 1.5 percent during recent turmoil. It now stands at 2.95 percent and has a 0.43 percent expense ratio. Vanguard Prime Money Fund (VMMXX) has a seven-day yield of 2.78 percent and an expense ratio of 0.24 percent.
Cash pouring back in
Statistics supplied by Investment Company Institute show that cash has poured into money funds in recent weeks after investors bailed on the funds when the Reserve Primary Fund broke the buck in mid-September. ICI reported that total money fund assets decreased by $169 billion that week and by $7 billion the following week. But over the ensuing four-week period, as the government announced it would back money funds, investors pumped more than $138 billion into the funds.
If you’re considering moving money into money funds, be careful of the ones you use. At least 25 advisers have had to prop up their money funds. If a fund that you’re in comes under pressure, you’d want to be sure that the adviser could support it and not allow it to drop below $1 net asset value.
“This is why I deal with big institutions,” says Herb Hopwood, president of Hopwood Financial in Great Falls, Va. “Morgan Stanley can do it, Fidelity can do it, Schwab can do it, but Reserve can’t.”
How much cash do you need?
How long it will take for the landscape to present a clear picture is anyone’s guess. Hopwood cautions against keeping too much in cash in the interim.
“If you’re 45 and looking at retiring at 65 why keep so much in cash? People need to figure out their objectives. What is the ultimate goal for the money? You don’t have to deploy it in the equity markets. We’re seeing some unbelievable opportunities in fixed income — in investment-grade corporate bonds and in municipals.
“I understand that it can be a strategic decision to sit in cash. My concern is the people who just happen to do it and have no idea when they’re going to get back into the markets, whether fixed income or equities.”
As always, if you don’t need the liquidity, but you want to keep maturities short, you could go for short-term Treasuries or you could opt for short-term high-yield CDs.