Money market crunch

Short-term interest rates are now so low that some money market funds (MMFs) showed zero return for the 30 days to May 15. The danger now is that, once fees and expenses are taken into account, a few of these funds could fall into negative territory.

That would be a disaster for the fund industry. MMFs are regarded as safe havens by investors, places where they can park their cash without risk while waiting out stock market downturns. Unit values are fixed at $10 and no Canadian money fund has ever broken that, to the best of my knowledge.

According to the Investment Funds Institute of Canada (IFIC), investors held $74.4 billion in these funds as of the end of April. That represents about 15 per cent of the total amount invested in mutual funds offered by IFIC members.

However, new inflows have slowed dramatically this year as short-term rates keep dropping. In January, MMFs recorded almost $2.5 billion in new net sales and reinvested distributions. The February number dropped to about $1.7 billion and in March it was down to $520 million. The April figures showed that investors took out more cash than they put in during the month to the tune of $276.1 million.

It should not come as a surprise that MMFs would lose ground at a time when rates are low and stocks are on the rise. But think of what would happen if money funds started to report negative returns. There would be a huge run on them, which could be highly disruptive to the industry. That explains why we’re starting to see announcements about MMF fees being cut in an effort to keep returns in the black.

One of the first out of the gate was Fidelity Investments which has announced it is waiving a portion of the management fees it charges to MMFs and short-term fixed income funds so as “to maintain a positive yield for investors”. The company has also served notice it will reduce the trailer fees paid to financial advisors on these funds if necessary.

No specifics were given for the amount of the fee reduction. The company simply says the cuts ” will be implemented gradually as required”. The affected funds include Fidelity Canadian Money Market Fund, Fidelity Canadian Short Term Income Class, Fidelity Premium Money Market Private Pool, and Fidelity U.S. Money Market Fund. However, not all classes of units will immediately benefit; the initial reductions will be made to units with the highest management expense ratios, which are the A and C units. Fidelity says it will not change the way in which it manages the funds in an effort to enhance yields.

In a Q&A accompanying the announcement, Fidelity says that its managers expect that “rates will continue to fall to levels that will be lower than the fees we assess on some series of our money market funds” and that the steps it is taking are required to maintain a positive return.

“We can state unequivocally that Fidelity’s money market funds continue to provide security and safety for our customers’ cash investments,” the company said. “Our funds continue to invest in money market securities of high quality, and our customers continue to have full access to their investments any time they wish. Protecting the $10 net asset value has always been our #1 objective in managing these funds”.

This is all fine and I expect we’ll see other fund companies taking similar action going forward. However, don’t lose sight of the fact that the only commitment being made is to maintain a positive return. That could conceivably be as little as 0.1 per cent over the next 12 months. It’s time to look at other alternatives.

Photo © Ahmad Hamoudah

Adapted from an article that originally appeared in Mutual Funds Update, a monthly newsletter that provides advice on fund selection and strategies. For subscription information, click here.