Money Funds Meet Zero Yields by Breaking Buck Taboo: Euro Credit
Investors in Europe risk losing a haven as Goldman Sachs Group Inc. (GS), JPMorgan Chase & Co. (JPM) and Morgan Stanley break a taboo that’s stopped 88 billion euros ($113 billion) of money-market funds from ever losing principal.
The banks are preparing to abandon the policy that investors get one euro back for every one they put in as government bond yields near record lows make it harder for the funds to generate returns.
A money-market fund failing to repay investors in full is said to “break the buck” and is forced to shut down. To avoid this, banks propose to change rules governing the investment vehicles so they can pass on losses to investors by reducing the number of shares outstanding in a fund, without closing.
“The jury is out on this,” said Bruce Campbell, head of liquidity sales at Glasgow-based Ignis Asset Management, which manages about $25 billion of money funds and is weighing options to cope with negative yields. “Managers’ decisions are being made to look after the majority of clients, but they’re not always going to suit them all. Some clients are not happy with the cancelation mechanism.”
Banks and institutions such as BlackRock Inc. (BLK) and Northern Trust Corp. are making the changes to so-called constant net- asset value funds, which operate by maintaining a value of one euro per share. The changes will kick in when the European Central Bank cuts its deposit rate to below zero or yields on the safest government bonds turn negative for a prolonged period.
Benchmark German bond yields are close to record lows, with the rate on Germany’s two-year bond at minus 0.001 percent, up from minus 0.023 on March 28, data compiled by Bloomberg show. France’s two-year security is yielding 0.145 percent, up from a record-low 0.03 percent in December.
Since the ECB cut the deposit rate to zero in July, money- market funds that are restricted to buying short-term debt generated almost no extra cash, putting pressure on their goal to provide a sanctuary for investors. The seven-day yield on funds that buy euro government securities was zero percent for the week ended March 22, according to research firm iMoneyNet Inc.
Prime funds, which take more risk and can also invest in bonds issued by the highest-rated banks and companies, made 0.02 percent. Since Jan. 4, euro money funds have seen assets under management fall by 7.1 billion euros to 87.9 billion euros, Westborough, Massachusetts-based iMoneyNet data show.
JPMorgan, the largest U.S. bank by assets, said in October it was replacing two constant NAV euro money-market funds, with about 16.2 billion euros under management, with new structures which have shares that can be canceled. All investors will have their holdings cut if total assets drop, an action that isn’t allowed under current fund rules.
JPMorgan is the second-biggest provider of money funds with $241 billion in assets worldwide as of Feb. 28, according to Crane Data LLC in Westborough, Massachusetts. Sarah Godfrey, a spokeswoman for JPMorgan Asset Management in London, declined to comment.
Goldman Sachs Asset Management followed suit in December, changing the share class of three of its funds, with about $13.7 billion under management in total, denominated in euros and yen.
‘Flight to Quality’
“A very high flight to quality in Europe could cause yields to fall below zero,” said David Fishman, managing director and co-head of global liquidity management at Goldman Sachs in New York. “If that happened on a persistent basis, you could see a situation where you would need to implement this. We’ve seen crisis-type situations periodically, when short-term French and German government paper yield below zero, when there’s a lot of panic.”
BlackRock, the world’s biggest money manager, Morgan Stanley (MS), Royal Bank of Scotland Group Plc (RBS) and HSBC Holdings Plc are also preparing their constant NAV euro funds to pass on losses by canceling investors’ shares while keeping the net- asset value at one euro a share, Moody’s Investors Service said in a March 13 report. While the funds act like bank deposits in allowing companies, government authorities and pension funds quick access to cash rather than high returns, they can lose money.
“We are now in a position where we can manage through potential negative yields,” Jonathan Curry, global chief investment officer of liquidity at HSBC Global Asset Management with more than $428 billion under management, said in an e- mailed statement. The changes were put in place on Feb. 22, an HSBC (HSBA) spokesman said.
Stephen White, a London-based spokesman for BlackRock, declined to comment. Tom Walton, a spokesman for Morgan Stanley and Aoife Reynolds, a spokeswoman for RBS, also declined to comment.
The managers are trying to avoid the fate of the $62.5 billion Reserve Primary Fund, which was the first fund in 14 years to break the buck when its net-asset value fell below $1 a share in September 2008 because of its holdings of Lehman Brothers Holdings Inc. debt. Shareholders couldn’t access their cash for months as the New York-based fund was unwound and the collapse triggered a run on money-market funds that worsened the global financial crisis.
While the changes may mean losses for investors, the funds would be saved from having to close and will operate without the stigma of breaking the buck. Still, clients may choose to redeem their shares from the adjusted funds and invest in variable net- asset value vehicles that operate with a flexible price while guaranteeing investors will keep all their shares.
Northern Trust (NTRS), the third-largest U.S. independent custody bank, has prepared to change its 1.2 billion-euro constant NAV prime fund to variable, allowing investors to know how many shares they hold while the price can fluctuate, said David Blake, head of international fixed income at the firm’s asset management unit. Chicago-based Northern Trust’s euro government fund has been closed to new subscriptions since the ECB’s rate cut in July.
“The delivery mechanism for money-market funds in a negative rate environment would be unfit for purpose,” said Blake in a phone interview. “If the fund’s overall yield falls below zero, then the constant NAV structure won’t work, it’s broken.”
About 51 percent of European funds use variable asset values, according to the European Fund and Asset Management Association in Brussels. Europe’s money market fund industry had 1.02 trillion euros under management in December, according to EFAMA data in euros, pounds and dollars.
Funds in the U.S. aren’t adopting the changes even as the Federal Reserve has held its main rate at an all-time low 0.25 percent since December 2008. Two-year U.S. treasuries yield 0.24 percent, up from 0.21 in July and compared with a record-low 0.15 percent in September 2011, data compiled by Bloomberg show.
“We haven’t seen these changes implemented anywhere outside Europe,” said Yaron Ernst, managing director of the managed investments group at Moody’s in Paris. “Yields moved lower in Europe after the ECB’s decision in July. Since U.S. cash yields are slightly higher, the need for such change is not as critical.”
The changes are being adopted by more than half the euro funds represented by the Institutional Money Market Funds Association in London, with almost 50 billion euros of assets, Fitch Ratings reported Jan. 28. Half of the 68 European treasurers Fitch surveyed said the false perception their investment is guaranteed is a drawback of the funds and 35 percent said they disliked the lack of transparency due to the accounting method, the rating firm reported Feb. 26.
“Investors like the clear risk profile of constant NAV funds; that you get one euro in, one euro out,” said Alastair Sewell, an analyst at Fitch in London. “Without that certainty, they may consider moving to deposits. Losing a lot of assets to bank deposits would be a concern for the industry.”
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