Money Market Mutual Funds Try To Avoid Breaking the Buck
Kurt Brouwer November 13th, 2007
The fallout from the subprime lending mess continues to ripple through the financial markets. Today, we have a report on concerns about money market funds that invested in structured investment vehicles (SIVs). SIVs are among the most complex investments ever devised on Wall Street, a place that loves complexity. Essentially, SIVs are pooled investment funds typically issued by banks and sold to investors. An SIV has a tiered structure in which it issues short-term notes backed by assets such as credit card debt and then invests the proceeds from the notes in long-term securities.
Now, due to the credit crunch that was initiated by subprime lending woes, SIVs are also hurting. As a number of money market mutual funds have invested in short-term securities issued by SIVs, problems have ensued. From the Wall Street Journal [emphasis added]:
SEI, Rival Money Market Funds Go On Offense To Avoid ‘Breaking the Buck’ (Wall Street Journal, November 13, 2007, Diya Gullipalli & Tom Lauricella)
The crisis of confidence rattling credit markets is putting new pressure on money-market mutual funds, traditionally some of the safest investments around.
Money-market funds aim to maintain a $1-per-share price and losses on any investments that drive their share price below that mark — known as “breaking the buck” — could send investors running for the door. That’s a possibility facing a number of money-market funds that hold troubled investments called structured investment vehicles — or SIVs, complex investments that have come under selling pressure amid bond-market turmoil…’
‘…Just a few months ago most SIVs had been viewed as a high-quality holding. Now a number of fund companies are scrambling to find ways to shore up their funds and reassure investors…
…Triggering the latest concern are securities from a SIV named Cheyne Finance LLC, which were downgraded to default status last month by Standard & Poor’s Corp. after going into receivership. While it is highly unlikely that such mutual funds are at risk of significant losses, their rapid response to one troubled SIV signals the level of concern over holdings like these.
One reason money-market funds are scrambling: S&P has said in recent weeks that such exposure to Cheyne isn’t consistent with its criteria for receiving its highest ratings for money-market funds. Money-market funds are restricted from investing in low-grade securities. So, when any of their holdings become ineligible for purchase, it raises concerns among investors and regulators that any losses on those riskier holdings could cause money-market funds’ net asset value to fall below the $1-a-share level they seek to maintain…
…About 5% of prime money-market mutual-fund assets have SIV-related investments, according to estimates last week from Bank of America analyst Michael Hecht. A key challenge for the funds in recent months has been pricing SIV-issued commercial paper, given tight trading conditions and diminished demand in such markets in recent weeks…’
In all likelihood, investors in money market funds will not even notice this event because fund companies are moving quickly to deal with this issue. The fund companies themselves will probably take the hit, if indeed there is one. Assuming that happens, one question remains: Why did mutual fund sponsors invest in SIVs in the first place? Answer: to get higher yields. And a significant part of the responsibility for that can be properly laid at the feet of investors themselves.
Many money market funds compete on having the highest possible yield because they know that is what drives investors. However, I think shopping for the highest possible yield in a money market fund is a mistake. The point of a money market fund is safety, liquidity and yield — in that order. If you want your money safe and liquid, then you should be willing to give up a small amount of yield in return for safety and liquidity.
Hat tip: Steve Janachowski
- Hedge Funds , Investing , Money , Mutual Funds , Personal Finance
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