Money-market mutual funds, with $2.64 trillion in assets, are confronting their biggest challenges since they first appeared in 1971. Having survived withdrawals by investors following the September 2008 collapse of the $63 billion Reserve Primary Fund, they now must contend with Treasury yields near record lows, a shrinking supply of debt to invest in, and declining assets. “I haven’t seen an environment like this in my lifetime,” says Kevin Kennedy, who helps manage $114 billion in cash funds for the Western Asset Management unit of Baltimore-based Legg Mason (LM) and has been in the business for three decades.
As yields have come down, fund companies have had to cut their management fees to keep customers’ returns above zero. The average annual fee charged by money funds tracked by Crane Data fell to 0.18 percent in August from 0.37 percent three years earlier. Over the same period, assets have shrunk 23 percent. As a result, the industry’s annual revenue has fallen 62 percent since 2008, to $4.5 billion, according to Crane Data. Tough conditions have led some companies to sell or shutter funds. SunTrust Banks sold assets run by its RidgeWorth Capital Management unit to Federated Investors last year. EBay’s (EBAY) PayPal closed its money fund in July, returning money to investors. The number of U.S. money fund companies reporting data to research firm iMoneyNet, has fallen by 25 percent, to 104, since Sept. 30, 2008, although that is partly the result of mergers and acquisitions such as Well Fargo’s (WFC) 2009 takeover of Wachovia.
Funds have struggled with low yields on their investments since the Federal Reserve began lowering its benchmark interest rate in 2007 to spur lending and economic growth. Short-term rates neared zero in December 2008. The Fed has pledged to keep short-term rates near zero until at least mid-2013.
The European sovereign debt crisis has cut into the supply of safe, short-term debt that money funds can invest in. European bank debt has become too risky for many providers as the region struggles to keep Greece’s woes from spreading. Funds reduced securities from the euro area by $50 billion in August, bringing their holdings tied to institutions in the region to $316 billion, says Alex Roever, head of short-term fixed-income strategy at JPMorgan Chase. In addition, mortgage financiers Fannie Mae (FNMA) and Freddie Mac (FMCC) are issuing fewer notes, Roever says. Overall, the amount of securities money funds can buy has fallen to $9.1 trillion from a peak of $12 trillion in 2008, according to a September report by the International Monetary Fund.
At Fidelity Investments, the annualized seven-day net yield for the $119 billion Fidelity Cash Reserves (FDRXX), the company’s biggest money fund, was 0.01 percent as of Sept. 28, according to Fidelity’s website. A one-year investment of $10,000 at that rate would return $1. The fund’s expense ratio dropped to 31 basis points, or 0.31 percent, after fee waivers, as of Oct. 4, according to Fidelity. It was 45 basis points five years ago, filings with the Securities and Exchange Commission show. Robert Brown, who oversees Fidelity’s money funds, says lower profit won’t make his firm change the way it runs the business. “For us, principal preservation is the most important thing,” he says. “We’re not going to reach for yield.”
Declining yields and falling revenue won’t deter investment firms focused on staying in the business long-term, says Joseph Lynagh, head of retail money funds at Baltimore-based T. Rowe Price Group (TROW). “It’s a troubled product at this point, and we’re not making much money on it,” he says. “But if you take a longer-term perspective, this, like all cycles, will change.”