The Derivative Project

Money Markets: Suspend, File and Charge the Investor for Low Interest Rates

Money Markets:  Suspend, File and Charge the Investor for Low Interest Rates

Money Markets: Suspend, File and Charge the Investor for Low Interest Rates

Moody’s actually did the unthinkable this week, with hardly a whisper.  They downgraded the money market mutual fund industry to negative.  Reuters covered it, hardly anyone else did – “Moody’s slaps negative outlook on U.S. Money Sector.”  Can’t have too much transparency for the retail investor.  They still think money market funds are no different than bank accounts, as Wall Street advertising has convinced them over the decades.

As Reuters also wrote on November 28th: ” In a near-zero interest rate environment, the funds are not in position to recapture previously waived fees just yet. But as one industry executive put it, funds are drawing a line in the sand to let investors know that fee recapture is coming.”

Guess the industry’s go to most influential bloggers in and around the “advice industry” do not want to provide too much information to the little retirement investor.  These vociferous Tweeters on all the latest news for investors, seemed to have lost their Twitter handles on this industry-changing down grade by Moody’s.

Multiple Reasons for the Downgrade by Moody’s

Moody’s rationale for the downgrade was actually quite cryptic, “The unstable market environment will limit fund managers’ ability to offset rising risk through active management, thus making it more challenging to maintain the highest quality profiles,” Vanessa Robert, Moody’s senior credit officer said in a statement.”

There are multiple issues here with the money market fund industry in this economic environment, that do require full transparency, particularly for retirement investors and those without a lot of slack in their monthly budget:

  • The product is not viable in an extended low interest rate environment, since expenses exceed returns.  Most of the industry has had to waive fees so investors do not experience negative returns.  A few unsuspecting investors are actually losing money at some money market mutual funds, who are not waiving their fees.
  • If interest rates rise quickly, there are so many interlocking guarantees and poor credits in the funds, with managers already searching for yield, that a dramatic rise in interest rates, could cause a domino wave of credit defaults, which the Financial Stability Oversight Council (FSOC) and SEC locked horns on, until the issue of who bears the losses was quasi-resolved with the SEC ruling last summer on NAV.  Remember money market mutual funds were developed in a period of relatively high interest rates and investors always assumed they pretty much just held  A-1 P-1 commercial paper, not VIE’s and SUV’s that went belly up during the 2008 financial crisis and non-transparent asset backed securities.
  • If interest rates rise and money market funds exercise their right to voluntary recapture and recoup fees that they have waived, investors may all run for the exits at once or… start their departure now.

Retirement investors are starting to pay attention to fees.  They have to in this low interest rate environment and stagnant wages.  For background purposes, The Derivative Project wrote in 2012 on this non-transparent “voluntary recapture” policy of certain money market funds:

Voluntary Recapture from Your Money Market Fund

Well, two years later and the money market funds have had to revised their prospectuses to get set again to recoup all the fees they waived from the unsuspecting investor, who may think if interest rates rise they might get ahead…not so fast.

It is time to double down on those voluntary recapture fees, as Tim McLaughlin of Reuters writes on November 28,  “US Cash Funds Primed to Recover Fees.”

Reuters quotes Schwab:  “This recapture could negatively affect the funds’ future yield,” Schwab said in the recent SEC filing. A Schwab spokeswoman declined to provide further comment. Schwab’s U.S. Treasury Money Fund, for example, reported nearly $168 million in “recoupable expenses” over a three-year period.

If you are a brokerage firm with a product that is costing investors money, the responsible thing to do is to offer an alternative, until the economic scenario changes.  Most firms are simply hiding the “voluntary recapture” clause in their SEC filings in size 2 font.

What should retirement investors do to avoid voluntary recapture?

Accept brokerage firms operate in their interest not yours.  Money market funds are not valid in this interest rate environment.  Their risks are greater and their returns typically less than US Treasuries and commercial bank certificates of deposit (CD’s).

If you care about the fees and the additional risk:

  • Take the time to invest your cash direct at Treasury Direct, where you can buy US government bills, notes and bonds directly.
  • Invest your cash in certificates of deposit, FDIC insured at a US Bank
  • For small sweep amounts, reinvest dividends into existing investments.

For small amounts, it is probably not worth the hassle, but the fact that the firms that package money market funds have not been proactive in helping the retirement investor with their cash needs is cause enough to look at other options than the conflicted money market industry, and their product sales force (“Advisors”) that clearly put their interests over yours.

Additional Reading on Money Markets, History and the Unprecedented Scenario Today

Lamenting for the markets of the past, we recommend  Marcia Stigum’s 1978 The Money Market as a must   The Money Market, Marcia Stigum 1978

read in understanding how far we have strayed in the integrity of our capital markets.

Here is an updated 2007 version:  Stigum’s Money Market 4E

“Attention Retirement Savers: Time for Immediate Demand for Alternative to Money Market Funds and Your “Voluntary Recapture” from Wall Street”   September 3, 2012

Wall Street’s “Investor Advocate” Misrepresents Money Market Reform October 3, 2012