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Rate Cuts Weighing on Money Funds

As yields decline, some experts say the Federal Reserve is punishing savers too much.

June 26, 2003|Josh Friedman | Times Staff Writer

Wednesday's interest rate cut by the Federal Reserve spells more bad news for shareholders of money market mutual funds, whose record-low yields are sure to fall further.

It's also another blow to the money fund industry, which increasingly will have to waive management fees to keep funds from "breaking the buck," or losing investors' principal by letting share values slip below $1.

Some 209 money funds may be forced to eliminate or reduce expenses at least temporarily, according to IMoneyNet Inc.'s Money Fund Report in Westborough, Mass.

However, those funds represent only 3% of industry assets, because they tend to be smaller portfolios that already have scared off investors because of rock-bottom yields.

"We expect all money fund providers to maintain positive returns, at least in the near term," said Peter Crane, Money Fund Report's managing editor. "The interesting thing is, nobody is leaving the business -- at least not yet."

Money funds, created in the early 1970s, invest in short-term IOUs of companies and government units. They have grown dramatically as an alternative to bank accounts, and now hold more than $2.1 trillion in assets.

But as the Fed has slashed interest rates since 2000, money fund returns have been crushed. The average fund's annualized yield sank to a record low of 0.64% in the week ended Wednesday from 0.67% the week before, Money Fund Report said.

Once the latest quarter-point Fed cut is fully felt during the next five weeks, the average fund yield should fall to about 0.44%, Crane predicted. After management fees are deducted, the average money fund yield usually is about half a point below the federal funds rate, the overnight bank lending rate set by the Fed. That rate was cut to 1% on Wednesday from 1.25%.

Yields on certificates of deposit and other bank accounts also have plunged since 2000. In recent months, however, average CD yields have held up better than Treasury bill yields, a sign that banks may be holding the line on deposit rates.

Some experts complain that the Fed is punishing savers.

"It looks like the Fed is joining Wall Street in seeking to support the stock market," said Martin Weiss, head of Palm Beach Gardens, Fla.-based Weiss Ratings Inc. "I question it. There are millions of people living on fixed incomes in this country."

For savers and for the money fund industry, it could have been worse: Crane said 565 funds, with $309 billion, or 15% of industry assets, yield 0.50% or less, meaning a half-point rate cut by the Fed might have forced many more funds to waive fees.

A half-point cut would have cost the industry $1 billion in fees, Crane estimated, versus an expected $100-million cost with the quarter-point cut.

Money funds generate about $9.3 billion a year in revenue for fund companies, he said.

If rates remain depressed, some money funds may soon charge investors fees for check writing, account maintenance or other services, Crane said.

But he and others said they expect fund firms to do whatever it takes to keep any money fund's share price from falling below $1. That barrier has been broken once, when a fund was liquidated by federal regulators in 1994.

"Any provider of money market funds worth their salt would not break the buck," said Chad Peterson, spokesman for Evergreen Investments in Charlotte, N.C., whose Evergreen Money Market B, C and S shares are yielding 0.07%.

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