Investment Insights

Jeff Benjamin

Sleeping giant: Investors' $3.5 trillion in cash ready for a wake-up call

Aug 28, 2009 @ 11:34 am

By Jeff Benjamin

Cash management should get a lot more interesting over the next few weeks as government protections for money market funds expire and new rules are considered.

Cash remains the sleeping giant. Despite the Standard & Poor's 500 stock index having rallied more than 50% from its March low — and being up more than 14% so far this year — about $3.5 trillion in cash still sits on the sidelines in money market mutual funds.

Given the size of that cash stockpile, which may reflect everything from a skittish institutional investor base to the gummed-up credit markets, the future of money market funds affects most investors.

The first big change comes Sept. 19, when the Department of the Treasury's 12-month money market fund guarantee program expires. The program has been insuring money fund assets since the Reserve Primary Fund, advised by Reserve Management Co. Inc. of New York, broke the buck last fall.

After that date, other safeguards will remain in place, including a program that allows money market fund advisers to borrow from the Federal Reserve against asset-backed commercial paper in the portfolios.

Another program, which is also designed to ensure investor liquidity, allows the issuers of commercial paper to issue debt and to borrow from the Fed against that debt to support liquidity in the commercial paper market.

Commercial paper — promissory notes issued by banks and corporations to meet short-term debt obligations — is second only to government agency securities in terms of money market fund holdings.

“The chances of any kind of a run on money funds that would force them to sell is still remote, but the die is cast and the new playbook has been written,” said Peter Crane, president of Crane Data LLC, a Westborough, Mass.-based money fund tracking firm.

Mr. Crane is among those who believe the raft of swift new government support programs, combined with proposals still on the table, will continue to eliminate many of the risks associated with money market funds.

Last week's report that Reserve Fund investors could end up getting back as much as 99 cents per share, plus a return in the 4% range, “will help shift the perception of risk in the money market space,” he said.

But the debate over the future shape of money funds continues.

Sept. 8 marks the end of the public comment period regarding money market reforms proposed by the Securities and Exchange Commission.

Some of the changes being discussed include requiring funds to set at least 5% aside for overnight liquidity demands, and have 15% of the fund available for weekly liquidity. The average weighted maturity of portfolio holdings is also being evaluated, and maximum maturity could be reduced to 75 days from 90.Most of the proposals could reduce money fund yields.

On Sept. 15 we'll likely see a report from the President's Working Group on Financial Markets that considers regulatory changes for money funds.

Such proposals, subtle as they might appear, introduce new wrinkles and challenges for money fund advisers, and potentially open the door for cash management alternatives. Most of the proposals could reduce yield.

One new program avoids money market fund risks altogether by offering Federal Deposit Insurance Corp. protection on investments of up to $10 million.

At USA Mutuals Partners Inc. in Dallas, the idea is to leverage FDIC protection by linking up with an institutional banking platform that allocates investments, in $250,000 increments, among more than 100 banks.

With most money market funds yielding less than one-tenth of 1%, the FDIC insurance of up to $250,000 ($500,000 for joint accounts) has become an attractive alternative that is being leveraged by a growing number of brokerage firms with bank affiliations.

USA Mutuals Partners program, launched a month ago, is yielding about one-half of 1%, plus paying advisers a trail equal to a quarter of 1%.

The program is similar to one offered by Promontory Interfinancial Network LLC, an Arlington, Va.-based firm that allocates investments across multiple certificates of deposits.

“I wanted to offer something with greater liquidity, and I'm fearful that this money fund issue is going to hit financial advisers like a brick wall,” said Eric Lansky, president and chief executive of USA Mutuals Partners, which also manages $100 million in two mutual funds.

Without a doubt, a program such as Mr. Lansky's is banking on rough waters ahead for the money fund industry, which may face a more skeptical market of investors and advisers.

“A lot of people still think money funds are guaranteed investments,” he said. “And nobody likes uncertainty when it comes to cash.”

A new Investment Insights column appears every Monday on InvestmentNews.com.

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