On Friday November 6, 2009 the unemployment rate was reported at 10.2%. The markets were expecting double-digit unemployment, but not till sometime in the first quarter 2010. The result of the unemployment number may well be the demise of the money market mutual fund industry. TD Holdings, the third largest retail brokerage by client assets, reported last week that the fee waiver for their money market mutual funds impacted the earnings results in perhaps the biggest bull market in 80 years. Can other brokerages like Charles Schwab be far behind in reporting similar results impact on earnings through fee waivers?
Charles Schwab reported in its third quarter earnings report that money market fund fee waivers increased to $78 million through the end of the quarter resulting in a 24% decline in overall revenue. Randy Merk, CIO of Schwab expects that there will be $200 million in fee waivers for 2009. He further said that if interest rates stay low in 2010 he expects that Schwab will report $100 million in fee waivers per quarter next year.
On Wednesday November 5, the Fed Open Market Committee reaffirmed its position when it said that it would hold interest rates low for the dreaded “Extended Period of Time”. The market was hoping for a better unemployment number on Friday and because we are now at 10.2% and probably moving higher the likelihood that the Fed will be tightening next year went out the window and the possibility of return for both managers and investors alike. The estimates for the peak in unemployment will have to go up as economists were looking for a peak in second quarter 2010 at around 10.5%. Some are predicting that we may go above the post World War II record that was 10.8 in 1982.
For most of this year money market mutual funds managers have been under pressure by outside directors to do whatever was possible to hold the net asset value (NAV) of money funds at $1.00. The vast majorities of both US Government and General money market funds have waived most of their management fees and managers are now paying some if not all of the other operating expenses to hold NAV at $1.00 even if the return is near zero.
If near zero return is not bad enough for regular money market mutual funds, according to the Investment Company Institute (ICI) in a recent report there is also over $1 trillion dollars in separate account variable annuity and variable life products that are losing money. The ICI reports that approximately one third of the separate account assets are in money market accounts. If you look at the Wall Street Journal report on separate account performance (http://online.wsj.com/mdc/public/page/2_3059-qtrlyann_A-qtrlyann.html) you will find, net of mortality and expense fees, all these accounts are losing money. Some separate accounts cash accounts are showing losses as much as 1.60% on a seven-day yield basis. If you look at cash account values in separate accounts you will see that they are declining. People are loosing money on cash investments.
Because of the employment data the short end of the bond market saw the yield on 90-Day T-Bills fell to 3 basis points. All of the money funds are trying to shorten their duration and therefore they are becoming the victims of their inability to accept that the money market mutual fund business model is broken. Time is wearing them down along with the loss of income.
Many of the US Government money funds are closed to new and sometimes existing investors can’t add money. I have noticed that some general money funds are beginning to close so no new money can be added to existing accounts. The enormous stock market rally has taken the spotlight away from the problem of no return on cash. When the stock market has a serious correction and investors want out of equities, where will they go? Those investors in separate account investments will see their losses continue when they get out of stocks and go to cash. Cash at zero return will not be acceptable; cash at negative returns is even less acceptable.
I think return of invested capital is in the offing for many money market mutual fund holders especially the smaller funds. The asset management companies will have to come to grips that after the first of the year they could be looking at perhaps two more years or more of no fee income from whatever is left in the money market accounts. The idea of no income will not be acceptable and they will want to find ways to get out of the business. Closing funds and distributing assets is the quickest way out of the business. It is possible that some management companies will break the buck and use the cover of the prospectus language of potentially loosing money and look to keep whatever money they can on their terms.
If you think about the customer earning zero percent on money market funds when they could earn at least 3 to 4 basis points on a direct purchase of T-Bills the fund industry has to ask if they are doing the best thing for the clients. As advocates for the client investment advisors have to help clients get the most on their money with the least amount of risk.
The problems of making little or no income on market mutual funds and separate account cash investments require both industries to rethink their business model. I believe that the new model will see the NAV of $1.00 disappear and people will be exposed to the potential of losing money. I think both the managers and the investors will continue to loose money until reality sets in and true business decisions are made.