Money market mutual fund yields are dropping hard and that’s causing a number of firms to waive some fees and close funds to new investors.

Breaking the buck is always the big headline — that’s when a money fund’s net asset value, or NAV, falls below $1 per share — but that’s not the real danger at this point. The immediate threat is a negative yield.

When the income that the fund receives from investments is lower than expenses, something’s got to give or it will result in a negative yield. While a firm may partially waive fees, expenses have to be paid and, eventually, the situation can worsen to the point where the fund breaks the buck. But there are several things that fund companies can do to ease the negative yield situation and head off the more distant possibility of breaking the buck.

Treasury funds most at risk
“The risk to investors is way overblown.”

The negative yield problem is most seriously affecting Treasury money funds which, at this point, are invested in extraordinarily low-yielding securities. Prime money funds, which can invest in somewhat riskier, but higher-yielding commercial paper, are sporting yields that, while low, are still well above expenses for all but the most expensive funds.

For example, compare Vanguard Prime Money Market Fund (VMMXX) with an expense ratio of 0.28 percent and a seven-day yield of 1.64 percent to Fidelity’s U.S. Treasury Money Market Fund (FDLXX), now closed to new investors, with an expense ratio of 0.45 percent and a seven-day yield of 0.20 percent.

“The risk to investors is way overblown,” says Peter Crane, publisher of Crane Data and Money Fund Intelligence. “Investment managers, of course, have protected investors from a lot of losses. You likely would have seen other funds break the buck last year had advisers not stepped in to purchase securities. But investors, as far as the rates they’re getting, have to be resolved to the new reality, which is yields of 2 percent, 1 percent, or less. They all stink but it beats the 40 percent losses you’re seeing in the broader market.”

Reduce fees or cut off new money

As mentioned, in addition to purchasing troubled securities as many fund companies did last fall, firms can also protect the yield by reducing fees or closing funds to new investors. When new cash comes into a fund it’s used to buy additional securities which, right now, are paying very low yields. That reduces the overall return to current investors. By cutting off new money, the fund can keep its yield propped up longer.

“We’re already seeing action by certain fund companies to support current investors in Treasury money funds,” says Jeff Tjornehoj, senior research analyst at Lipper. “That way they preserve the portfolio of higher-yielding securities and don’t have to go shopping for lower-yielding ones just to accept new money. (Funds) everywhere are cutting expenses. Among Treasury money funds, many firms are cutting expenses to keep the yield above zero or, at the very minimum, at zero.”

Well over a dozen fund companies have waived fees or closed funds to new investors, including the giant mutual fund companies. Fidelity has closed four Treasury funds to new investors; Vanguard has done the same with its popular Vanguard Admiral Treasury Money Market Fund and Vanguard Treasury Money Market Fund.

The worst may be over

Still, Crane says that while additional fund closings and fee waivers are sure to come, the worst may be over because Treasury yields are starting to show ever-so-faint signs of life.

“Investors should not be scared out of cash because of low yields. In the money markets you take what the Fed gives you. You don’t push the envelope because that’s where accidents happen. You basically have to suck it up and realize that you’re subsidizing the recovery for all those debtors!

“The other thing to keep in mind is that rates will be back. We saw a very similar period in 2003 and 2004. From 2000 to 2003 the fed funds target went from 6.5 percent to 1 percent. It stayed at 1 percent for a year and then went back up to 5.25 percent.”

If you own shares of a money market fund that participates in the U.S. Treasury’s Temporary Guarantee Program for Money Market Funds, then any money you had in the account as of the close of business Sept. 19, 2008, is protected if the fund fails to maintain a net asset value of $1 per share. You would be fully reimbursed under the terms of the guarantee, which is slated to expire April 30, 2009. Treasury officials will review the program at that time to decide if it should be extended until Sept. 19, 2009.

Look for the best money market rates by searching Bankrate’s rate tables.