How safe are money market mutual funds?
The question is posed frequently by potential investors who know the funds are not insured by the U.S. government and by current investors concerned about losing their money in the event of a money market fund failure or the collapse of the economy.
Now the money market fund newsletter claiming the largest circulation (6,600) in its field--Money Fund Safety Ratings--would like to become to money market funds what Standard & Poor's is to bonds or Value Line to stocks. But complaints from the fund industry about the publication's tactics in collecting its data has raised eyebrows at the Securities and Exchange Commission, which is questioning the service.
Published in this seaside resort by The Institute for Econometric Research, the monthly publication ($49 a year for charter members) matches relative risk with expected yields and makes recommendations. Chairman Glen King Parker said in an interview that the catalyst for the newsletter, which made its debut last August, was the demise of First Multifund for Daily Income of New York. First Multifund was reprimanded by the SEC two years ago for falsely claiming it offered "maximum safety" when it had exposed investors to significant capital losses in 1977 by extending its portfolio to 825 days. After interest rates went up the next year the value of the assets it held fell.
Institutional Liquid Assets of Chicago was another fund that got caught short by lengthening the maturity of its portfolio. It was bailed out by the First National Bank of Chicago and Salomon Bros. in October 1980. The brokerage house, which administered and sold the fund, assumed $700,000 in losses to protect its clients, so none of the institutions investing in the fund lost any money. Dreyfus Liquid Assets got caught holding paper from Franklin National Bank when it collapsed in 1974, but it was also bailed out by its sponsor.
Such disastrous miscalculations have been rare in the history of money market funds, which have enjoyed an excellent safety record to date. The average portfolio maturity is now just 31 days. (A doubling of the average portfolio maturity doubles the risk; it rises steeply over 60 days' maturity, according to Parker.) Yet, though the funds have learned their lesson, it could happen again, Parker says. As the number of money funds and competition among them increases, he said, "some small fund might try to go out long on its portfolio maturity to be a hero."
Should a small fund get in trouble and have to suspend redemptions, news reports could trigger a panic, much as unfavorable news caused a run on a Connecticut savings and loan recently. Because the funds are not insured, it is widely feared a run on one could have grave consequences for the industry and possibly for the economy.
Parker calculates that money market funds have a daily cash flow of $10 billion. Were the funds, instead of rolling over their securities, to become net sellers and flood the secondary market, the commercial paper market (corporate IOUs) could become illiquid and the economy would suffer. Parker calls such a doomsday scenario possible, though not probable, and feels it is important for investors to know the quantity and quality of commercial paper held in their money market funds' portfolios.
The institute's safety rating, ranging from AAA (virtually riskless) to D (grievous risks), is based primarily on the quality of 20 different types of assets found in portfolios. But average portfolio maturity, diversification, volatility and disclosure policies are also counted. Another criterion is how fast a customer can get funds in or out of an account.
Triple A assets are U.S. Treasury securities and securities of U.S. government agencies backed by the full faith and credit of the United States. Triple B securities are deposits in home offices and non-U.S. branches of foreign banks and thrift institutions; and most other instruments, including most commercial paper (rated below A-2/P-2).
The distinction between U.S. Treasury securities and other government securities, like Small Business Administration guarantees (rated upper AA), becomes evident only in times of financial crisis; the Treasury would likely pay off faster. As for Eurodollar deposits, they could be subject to seizure by the country in which the bank is located.
"The genuine risk distinction between assets in the AAA and AA categories is quite small, and AA assets are often more attractive because they usually provide a more generous yield," says the publication.
The other component of the publication's recommendations is the yield forecast, based on past performance data of each fund calculated on a comparable basis. The range is from +2 to -2. The top 10 percent of the funds can expect the highest yield (+2 rating), the next 15 percent (+1) the next highest yield. Half of the funds have a 0 or average yield rating.
The difference in actual yield between a +2 and a -2 rated fund is about one percentage point. Last month, for example, actual yields ranged from 13.5 percent to 12.7 percent.
Combining safety and yield, the institute makes up a list of recommended buys. AAA rated funds must have a yield forecast of at least -1; AA funds must have a yield of 0 or better; and A funds, +1 or more. Those funds with the institute's highest recommendation in February were Government Investors Trust (AAA/0 rating); Dollar Reserves (AA/+2); and Kemper Money Market (A/+2). Others on the list are Daily Cash Accumulation, Cash Reserve Management, DBL Cash Fund, Franklin Money Fund, First Investors Cash and Vanguard MMT-Prime (all rated AA/+1).
The institute also has a category called "Avoid" which has been the source of controversy. At least one fund contended to the SEC that it was rated BBB because it had not supplied the institute with information on the makeup of its portfolio. Parker says those funds on the "Avoid" list would be there anyway because of the poor quality of their portfolios (which are periodically reported to the SEC). Moreover, he said, some funds that had not furnished the data would get an AAA for the opposite reason.
Parker has been warned that the SEC may try to suspend his registration as an investment adviser, but a spokesman said the agency has not decided whether to act.
The Investment Company Institute, the trade organization for mutual funds, has also complained to the SEC. The ICI, strongly opposed to any type of safety rating for money market funds as "unnecessary," contends the type of ratings given out by the institute make it seem there is a big difference between AAA and BBB rated funds when there is not.
William Donoghue of Holliston, Mass., who pioneered money fund ratings, would appear to agree. Industry sources say he abandoned a plan to rate funds 0 to 100 when several low-rated funds objected; he now gives only their past performance.
However, Parker believes there is sufficient difference between the funds to warrant such ratings. So does Harvey Baskin of Washington, whose company, Liquid Assets Information Service, plans to start a rating service similar to Parker's next month.
"It is meaningless to compare yields of one money market fund to another without considering the safety aspect," he said. "Ratings are more necessary today than ever before."