July 17, 2018. By John Wolfsberg:
It wasn’t too long ago that yields on most money market funds were essentially zero. In fact, had most mutual funds levied their full management fee on these types of funds the yield would have been negative!
When the financial crisis hit in 2008 the Federal Reserve responded by drastically reducing interest rates and embarking on an extensive bond buying program. Their goal was to drive interest rates so low across the entire yield curve as to make it extremely attractive to borrow money and therefore stimulate economic growth. Unfortunately, one of the victims of this process was the money market fund industry. Managers of these funds were forced to purchase fixed income securities yielding virtually zero which meant that the funds themselves were also paying close to zero. Since most investors were more concerned with market risk after the crisis, the amount of funds that moved into short-term instruments and money market funds in particular ballooned…which exacerbated demand and kept yields at historic lows.
However, as economic growth has continued to improve, the Federal Reserve has begun to remove its accommodative stance to interest rates and raised the Federal Funds Rate with the goal of controlling inflation. As a result of these rate increases yields on short-term instruments purchased by money market funds – US Treasury Bills, Commercial Paper, etc. – have risen. In fact, yields in many U.S. Government money market funds have moved from a low of just .01% (1 basis point; a basis point is 1/100 of 1%) in February 2016 to over 1.60% (160 basis points) as of this writing. While 1.60% may not seem like a lot of yield (especially for those who rely on income generated from their portfolio) it is significant when you consider it provides more than half the current yield of the 30-year US Treasury. In addition, accounts holding large cash balances can access institutional U.S. Government money market share classes, which now boast yields that approach 1.80%.
Buyers of money market funds do need to be aware that some of the rules in this area have changed over the past few years. In an effort to improve how money market funds react during times of stress, the SEC in 2016 adopted rules that require certain types of money market funds to treat their Net Asset Value (NAV) as floating rather than fixed at $1.00 per share. In addition, the SEC rules were altered to permit these funds (those with floating NAVs) as well as certain other funds to impose liquidity fees and redemption gates (i.e. the fund may impose a fee upon the sale of your shares or may temporarily suspend your ability to sell shares). As a result of these rule changes, both prime and municipal money market funds now carry a small degree of additional risk. We would note that none of these rules (floating NAV, liquidity fees or redemption gates) apply to U.S. Government money market funds. While these funds typically offer slightly lower yields they do so with lower risk.
We would highlight that despite all of their differences, perhaps even more important for investors is what money market funds have experienced in common: their yields have risen. Investors are finally able to generate a reasonable amount of interest on their idle cash after earning next-to-nothing for an extended period prior. And with the Federal Reserve likely to continue hiking interest rates, money market yields should remain on the rise, making cash a much more attractive asset class for investors.