The death of money market funds

In October, Canadians redeemed more than $355 million worth of money market fund units. That brought the total redemptions since the beginning of 2010 to more than $20 billion.

As of Oct. 31, we had only $34.6 billion invested in money market funds, representing just 4.5 per cent of the total fund assets reported by members of the Investment Funds Institute of Canada (IFIC). That’s down from $58.8 billion (10.8 per cent of assets) just two years ago. What’s going on?

Nothing, that’s what — as in zero returns, or close to it. Over the 12 months to the end of November, the average Canadian money market fund returned only 0.46 per cent and a few earned nothing at all. The Brandes Canadian Money Market Fund was one of that undistinguished group; in fact over the past three years it has produced an average annual compound rate of return of only 0.6 per cent. The shocker is that it still has almost $40 million in assets under management. You have to wonder why anyone would keep their money in a fund that earns almost nothing and has a management expense ratio of 1.33 per cent.

This isn’t to say that all money market funds are dreadful. A few continue to produce half-decent results although there is a little cheating going on in some cases. For example, the APEX Money Market Fund gained 3.61 per cent in the year to Nov. 30 but one-quarter of its assets are invested in 4 per cent Government of Canada bonds that mature in June 2017. Normally, money funds restrict their holdings to notes with maturities of one year or less.

Among conventional mutual funds that play by the rules and have an affordable cost of entry ($1,000 or less) the Manulife Money Fund stands out. It gained 0.96 per cent over the past year, thanks to a low MER of 0.5 per cent. You only need $500 to get in. The Matrix Money Market Fund is also strong (in relative terms) with a gain of 0.84 per cent for the year to Nov. 30 and a very low 0.32 per cent MER. It also requires a $500 minimum. Almost in the same league is the Stone & Co. Flagship Money Market Fund (0.82 per cent, $1,000).

But except for the APEX fund, those returns are piddling compared to the rates being offered by high interest savings accounts. That’s where a lot of the cash is migrating to and there is no reason to believe the trend will be reversed in future.

Several companies are competing aggressively for cash deposits and financial advisors, who used to favour money market funds, are increasingly on board since some companies began offering trailer fees of 0.25 per cent on their high interest accounts.

The top choices among brokers right now are Manulife Bank, which is paying 1.75 per cent on high-interest accounts, National Bank’s Altamira High Interest Cash Performer (1.20 per cent), and Laurentian Bank’s B2B Trust (1.25 per cent). Some small financial institutions pay even more (in a few cases 2 per cent +) but they aren’t promoting aggressively through the brokerage community.

You should insist on the highest possible return on your cash holdings, especially if the amount involved is significant. That means asking your advisor to find out which company is offering the best rate on a high interest savings account that is eligible for your portfolio and switching all your money market fund assets into it.

I doubt you will ever go back to a money fund once you’ve made the move, for these reasons.

Financial protection. High-interest savings accounts are protected by the Canada Deposit Insurance Corporation (CDIC) up to $100,000. There is no such coverage for money market funds. Many investors assume money funds can never suffer losses but that’s not correct. Although their net asset value is pegged at $10, in extreme situations it is feasible that a fund could hit a financial wall, creating a loss for unitholders.

During the 2008 financial crisis, the U.S. Congress had to pass emergency legislation to bail out a widely-held fund that was in exactly that situation. Here in Canada, National Bank had to inject about $2 billion to protect some of its funds that were caught holding suddenly illiquid asset-backed commercial paper.

Superior returns. Almost all high-interest savings accounts offer better returns than money market funds can generate right now. But will that always be the case? Probably. When interest rates start to rise, returns on money market funds will improve. But the sponsors of the savings accounts will likely hike their rates to stay one jump ahead. The last thing they want is to see all those billions of dollars flow out now that they’ve captured them.

No management fees. Far too many money market funds have management fees of over 1 per cent. That’s much too high for the current environment. Even when interest rates move up, sensible investors are going to ask themselves why they should pay any fees at all when they can keep their cash in a transparent and liquid high interest savings account.

All this suggests that money market funds are about to go the way of the dodo. There appears to be no logical reason for choosing them over a high interest savings account. It’s only a matter of time before the folks who still have almost $35 billion in these funds figure that out.

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