November 25, 2007

In the investment world, money-market mutual funds are supposed to be safe and secure—the equivalent of Fort Knox. But the recent credit crunch has raised the possibility that the $3trillion in money-fund assets may not be as well protected as we thought. Personal Business Editor Lauren Young spoke with Peter Crane, president of Crane Data and publisher of the Money Fund Intelligence newsletter, about the health of money-market funds.

Are money-market funds getting dragged down by the subprime crisis?

The funds can invest only in the highest-quality securities, so they can’t buy subprime debt. Some funds have bought commercial paper [short-term debt] from structured investment vehicles [SIVs] that hold subprime mortgages. What is making people jittery is that another batch of SIVs is on watch for a credit downgrade. So, while a money fund can’t buy lower-quality debt, what it has can deteriorate.

How can I tell if a fund holds any of these investments?

It’s hard to figure out, but the chances your money-market fund owns any of these securities is minimal. The subprime crisis has been going on for three months, while a money fund portfolio turns over, on average, every 30 days. The vast majority of securities that held any kind of threat are long gone. And we’ve seen some fund advisers purchase troubled securities from funds or say they will back them up.

Are money funds rated?

All of the underlying securities these funds invest in are rated by credit-rating agencies, but only institutional portfolios tend to be rated.

Are they guaranteed by any agency?

No. Unlike bank money-market funds, which tend to have lower yields, money-market mutual funds do not carry FDIC insurance.

Why are money-market funds always priced at $1 per share?

It’s an accounting fiction. Money-market funds are just short-term bond funds. Although the target price for each share is $1, a bond might be at 0.998 cents on the dollar while another is at 1.00123 cents, and it all balances out to $1 per share.

Have funds ever fallen below $1?

There have been about 30 incidents this year in which a manager bought securities to prevent a fund from possibly breaking the buck. The only example where a fund’s net asset value fell below $1 was in 1994 when the $82million Community Bankers U.S. Government Money Market Fund was liquidated and investors got 96 cents on the dollar. It was an institutional fund, so no individual investors lost money.

There has been all of this Sturm und Drang over the possibility of losing a penny on the dollar. Everything the fund industry has done to date shows it will protect a fund’s net asset value come hell or high water.