Is your money fund safe?
The short answer is yes. But there are risky securities lurking in some portfolios.
(Fortune Magazine) -- Money market mutual funds are known for being both liquid and solid. Liquid because you can get your money out of them at any time; solid because they maintain a steady value of $1 per share. And they're popular because they tend to pay slightly higher rates than Treasury bills or bank savings accounts. Individuals and institutions alike use them to park cash they are waiting to deploy and to ride out market storms. Amid the turmoil of the past year, assets have soared 45%, to $3.5 trillion. But with the credit crunch casting doubt on many formerly safe-seeming securities, the big question for many investors has become, Is my money fund safe?
The short answer is yes, with some caveats: Money market funds have been around since the mid-1970s, and since then no retail investors have lost a cent in one. "Money market funds have endured crises in the past and are still safe," says Alyce Zollman, a financial consultant at Charles Schwab. But investors are right to be concerned. "There is so much less risk with money market funds relative to other funds that people view them as risk-free," says Robert Plaze, an associate director in the Securities and Exchange Commission's division of investment management. "But they're not insured by the government. Saying there's no chance for problems is not accurate." The danger: A fund could suffer losses on its holdings and "break the buck" - see the value of a share fall below $1.
Money market funds typically hold a mix of short-term corporate bonds, Treasury bills, and other high-quality debt. But in recent years they also bought more exotic stuff: specifically, paper issued by structured investment vehicles (SIVs) - entities set up by banks to hold debt off their own balance sheets. "Last August, over half of money fund managers were buying SIV-related debt, which amounted to about 5% of money market fund holdings," says Peter Crane, whose firm, Crane Data, tracks money market funds. Crane goes on to explain that when the market for a security dries up, as it did for SIV debt, the value drops, even if the risk of default hasn't increased. And in a fund where even 1% of the assets have no buyers, says Crane, "the fund could break the buck."
Since last summer Crane has seen 13 asset-management companies buy securities from their portfolios or take other actions to prevent a share-price decline. Crane estimates that SIV-related paper now makes up less than 2% of money market fund holdings.
How can you protect yourself from dubious money fund holdings? The first thing to do is to make sure that you're invested in a true money market mutual fund and not some look-alike investment, such as a floating-rate bank loan fund or seven-day-paper fund. If you're in doubt, ask your broker or the fund sponsor whether the fund is registered with the SEC under the Investment Company Act's Rule 2a-7. "Only funds that are 2a-7 compliant have to follow provisions put in place to keep a fund from breaking the buck," says Brian Reid, chief economist at the Investment Company Institute. The rules require funds to buy high-quality securities - and to ascertain that quality through their own due diligence, rather than relying only on credit ratings. Also, the funds are not allowed to invest more than 5% of their assets in the securities of any one issuer (unless that issuer is the federal government), and the weighted average maturity of all securities in the portfolio can be no longer than 90 days.
Once you've established that what you have is a true money market fund, it's not realistic to think you can comb through the portfolio and detect dubious securities. So your best protection is to stick with funds operated by major companies such as Fidelity, Merrill Lynch (MER, Fortune 500), T. Rowe Price (TROW), and Vanguard. Although they are not compelled to do so, those companies are almost certain to step in to prevent any losses in their money market funds. It is not merely a matter of good citizenship, says Crane. The companies are much better off absorbing a small loss to avoid breaking the buck than suffering permanent harm to their credibility. Says Crane: "If a run started, that would do more damage than that small loss, and the damage to reputation would be huge." .