Money Funds - the mythical damn weakens Friday, September 19, 2008
I've written a number of times over the last year about money market funds [here, here, and here] and the myth surrounding "breaking the buck" i.e. the notion that they always return the capital invested and hence are safe. On a number of occasions during the last 12 months, Managers of money funds have been required to financially support them in order to preserve this fallacy i.e. directly top-up funds to maintain investors capital.
Money market funds invest in short-term money market instruments such as Govt Treasury Bills, Certificates of Deposit, and Repos. Such short-term horizons should minimise the likelihood of capital losses arising but cannot eliminate it and any losses directly impact the value of the fund.
As an industry, Money Market Fund Managers are very aware that if confidence in these funds were to be damaged and the illusion of safety to be impaired, the impact would manifest itself in huge withdrawals from a sector with trillions under management.
In 2008, the top ten Managers by funds under management were:
JP Morgan $267.9bn
Goldman Sachs $183.5bn
Morgan Stanley $112.6bn
However, the fallacy was exposed this week when Reserve Primary's Money Market Fund was forced to announce that it had "broken the buck" - the fund was priced at 97cent following losses on Lehman short term debt. This is the first fund to actually price a fund at below $1 in 14 years, all other losses having been funded by the managers.
As I stated in past posts, most fund managers aren't capitalised sufficiently to provide such guarantees other than for small losses. It was for this reason that BNY Mellon and State Street both saw sharp falls in their share price, amidst concerns about potential money fund losses, with the former having admitted capital losses on one of its institutional money funds but confirming it would be supporting their net asset values.
At the same time, Putnam Investment decided to close it's money fund and return $12bn of funds to the investors. It did so not because of losses experienced, but because of the potential for losses especially after a period of heavy redemptions, when some assets may not have realised their value due to the need to sell them quickly to fund the said redemptions.
Given clear examples of implicit support by Managers, you would expect the regulator to either require these off-balance vehicles to be brought on balances or ensure risk warnings are given plenty of airing. Fund managers want neither of these, but unless something is done soon we may face a "mis-selling" scandal when a large fund encounters losses too great to be compensated by its' manager. Despite this, I doubt regulators will want to introduce any measures that could affect confidence in fund managers or the funds at present.