Money Fund Managers Can’t Catch a Break
Kevin Kennedy says it’s tougher now to be a money-fund manager than at any point in his three decades in the business.
The industry’s annual revenue has fallen 62 percent since 2008 to $4.5 billion, according to Crane Data LLC in Westborough, Massachusetts. Funds charge half as much per dollar invested, and assets have shrunk 23 percent. Europe’s debt crisis is squeezing the supply of securities available for purchase.
“I haven’t seen an environment like this in my lifetime,” said Kennedy, who helps manage $114 billion in cash funds for the Western Asset Management unit of Baltimore’s Legg Mason Inc. (LM)
Money-market mutual funds, with $2.64 trillion in assets in the U.S., are confronting their biggest challenges since they first appeared in 1971. Having survived mass withdrawals of assets by investors following the September 2008 collapse of the $63 billion Reserve Primary Fund, they now face Treasury yields near record lows, a shrinking supply of available debt and potential new restrictions from regulators. Most managers have been forced to cut fees to keep customer returns above zero, and some have abandoned the business.
The number of U.S. money-fund companies reporting data to research firm iMoneyNet, also based in Westborough, has fallen by 25 percent to 104 since Sept. 30, 2008.
Exiting the Business
“Some people will review the business and determine if it’s something they want to stay in,” said John Donohue, chief investment officer for the global liquidity business at New York-based J.P. Morgan Asset Management’s global and fixed- income currency group.
Firms that have sold or shuttered funds include Atlanta- based SunTrust Banks Inc. (STI), which dealt assets run by its RidgeWorth Capital Management unit to Pittsburgh’s Federated Investors Inc. (FII) last year, and San Jose, California-based EBay Inc. (EBAY)’s PayPal, which closed its money fund in July. The number was also reduced by mergers and acquisitions such as San Francisco-based Wells Fargo & Co. (WFC)’s 2009 takeover of Wachovia Corp.
Charles Schwab Corp. (SCHW), the largest independent brokerage by client assets, closed its $23.7 billion U.S. Treasury Money Fund as a sweep option for new account holders. A sweep automatically deposits excess cash into a fund, often on a daily basis.
It eliminated the option “due to historically low yields and the tight supply of U.S. Treasuries,” Schwab said in a statement on its website Sept. 26. Additional deposits could lower yields for existing customers, the company said.
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. When short- term rates neared zero in December 2008, they initially affected only fund customers by reducing returns. Eventually, fund yields fell so far that most providers were forced to cut fees to prevent negative returns.
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.
The Fed has pledged to keep short-term rates near zero until at least mid-2013 in an effort to support the economy.
European bank debt, which money funds turned to in order to lift their yield, has become too risky for many providers as the region struggles to keep the Greek sovereign debt crisis from spreading.
‘Shareholders Are Unsettled’
Funds reduced securities from the Euro area by $50 billion in August, bringing their holdings tied to institutions in the region to $316 billion, said Alex Roever, head of short-term fixed-income strategy at New York-based JPMorgan Chase & Co. (JPM)
“There is headline risk and shareholders are unsettled by what they hear,” Roever said.
The European sovereign crisis has worsened a supply shortage of safe, short-term debt that money funds can invest in. The amount of securities money funds can buy fell from a peak of $12 trillion in 2008 to $9.1 trillion, according to a September report by the International Monetary Fund. Much of the reduction has come in segments that gave money funds their highest-yielding holdings.
Banks and other companies have reduced their reliance on short-term securities for financing as they build cash. Issuance of commercial paper fell to $1 trillion as of Sept. 28 from $1.8 trillion in August 2008, before the bankruptcy of Lehman Brothers Holdings Inc. paralyzed credit markets, according to Fed data.
Where supply has fallen or funds have pulled back, managers have turned to Treasuries or other U.S. government-backed securities. David Glocke, head of money funds at Vanguard Group Inc. in Valley Forge, Pennsylvania, said the portion of his funds in Treasury and agency paper has risen to about 50 percent from about 10 percent in 2008.
The U.S. Securities and Exchange Commission’s staff is expected to propose changes by early 2012 that providers say will increase costs and may spoil the appeal of money funds.
The agency favors a plan that would force funds to create capital buffers equaling 1 percent to 3 percent of assets to protect against losses, three people familiar with the regulator’s deliberations said in July. The extra expense would be borne by fund companies or passed on to investors.
Staff may also propose that funds abandon their fixed share price in favor of one that fluctuates with the daily market value of holdings, a move industry leaders have said would destroy the appeal of money funds. Any proposal would be followed by a public comment period and then require approval by SEC commissioners.
The regulatory environment has been overhauled since the collapse of Reserve Primary, which owned $785 million in debt issued by Lehman Brothers.
The fund wrote down its holding a day after the bank declared bankruptcy, pushing its net assets per share below $1, a rare event known as breaking the buck. Worse than losses that ultimately amounted to about 1 cent on the dollar, clients lost access to most of their cash for months as the fund was unwound.
Investors, concerned that other firms might hold Lehman debt, fled prime funds, forcing them to sell assets and helping to freeze global credit markets. The run abated only after the U.S. Treasury guaranteed money-fund holdings against default and the Fed began financing purchases of asset-backed commercial paper from funds at full value.
Eager to prevent another exodus, the SEC approved new rules in January 2010. Funds were forced to shorten their maximum average maturity to 60 days from 90 days, and to keep 30 percent of assets in securities convertible to cash within seven days, with 10 percent convertible in one day. The SEC also lowered to 3 percent from 5 percent the portion of assets that could be invested in lower-rated, or tier 2, securities.
Declining yields and falling revenue won’t deter investment firms focused on staying in the business long-term, said Joseph Lynagh, head of retail money funds at Baltimore’s T. Rowe Price Group Inc.
“It’s a troubled product at this point, and we’re not making much money on it,” Lynagh said. “But if you take a longer-term perspective, this, like all cycles, will change.”
Yield of 0.01%
“It is an impediment to revenues, but for us, principal preservation is the most important thing,” Brown said. “We’re not going to reach for yield.”
The annualized seven-day net yield for the $119 billion Fidelity Cash Reserves, the firm’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 SEC show.
Industry assets are down almost a third from a peak of about $3.9 trillion in 2009, when investors sought the safety of cash as stocks fell to a 12-year low. A decision by the Federal Deposit Insurance Corp. in 2008 to increase its insured limit for bank customers to $250,000 from the $100,000 helped funnel assets from money funds into bank accounts.
Assets ballooned in the financial crisis “because investors were using money-market funds as a flight-to-quality vehicle,” said Deborah Cunningham, head of money-market funds for Federated. Assets are “fairly steady” again, with the funds serving investors looking to park their money in a liquid asset class, Cunningham said.
Federated, the third-largest U.S. provider, has been waiving some of its fees since the fourth quarter of 2008, including $143 million in the first half of this year, according to regulatory filings. The company generated $460 million in revenue in that period, Bloomberg data show.
Schwab, the sixth-biggest provider, waived $240 million in fees in this year’s first half and said, in a July presentation to investors, waivers may reach $150 million a quarter later this year. Schwab reported revenue of $2.4 billion in the first half.
Fund providers are bracing for the next round of regulation. Clients who rely on a stable net asset value when they invest in cash products could be driven away, according to Cunningham.
“The next phase of regulatory change weighs heavily on the industry,” she said. “The disruption would be bigger than what is trying to be prevented.”