The Meaning of Zero, Part 2

In an earlier post, I discussed the possible reasons behind the zero-interest rate t-bill auction.    There’s an interesting flip side to this story — the implications for asset management companies and money market investors.  Earlier this week, the Financial Times ran a story discussing the challenges that asset management companies will have offering positive, let alone, attractive yields on money market funds.  For asset management companies, already reeling from the blow of downsized investment assets, this is another challenge, as money market funds have been both good profit centers and stabilizers of business (assets may leave a fund company’s equity funds, but continue to earn a management fee in their money market funds).  The choices for asset managers are limited — cut fees drastically or potentially charge customers more than the underlying assets can produce, i.e., a negative yield.   So far, this is most pronounced in U.S. government securities money markets since these yields are lowest.  However, as credit spreads continue to decline, this could have broader impact.

A possible third route, at least for a time, is to close funds to new investors to prevent yield dilution.  Today, for example, Fidelity closed several of their government money market funds to new investors.

A zero or negative yield in U.S. government securities money market mutual funds, if it persists, should have 2 consequences: 1) it will push investors out of government money market mutual funds and into bank products, whether CDs or deposit accounts, and 2) it will push investors into riskier alternatives, either conventional (corporate securities) money markets, bond funds, or the equity market.  Either way, while troubling for savers, this is not necessarily a bad thing for the economy — rising demand for bank deposits will lower the cost of funds for those institutions, helping repair the balance sheet damage of the past year; the availability of low cost deposits and the associated profitability improvement enhance the chance that the banks will lend more freely.  Obviously, if some of this cash returns to other items on the capital market menu (bonds, stocks), we’ll also see some benefit.

It will be interesting to see how the asset management industry deals with this challenge.  There was a time (I believe 2003) that, after deducting M&E expenses, variable annuities effectively carried a negative yield on money market balances, but this was fairly short-lived.  However, those were generally small balances within a complex “wrapper.”  This time around, affecting millions of savers and investors, the impact will be far more noticeable.

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