April 22, 2010

Yield stopped being a real incentive for investors to flock to money market funds a while ago, and for a number of fund firms that is just fine.

While attractive, yield isn’t the primary reason money funds will continue to garner investor dollars and remain a viable competitor, say top fund executives. Money market funds’ ability to sell themselves based on other factors besides yield has gained prominence since the Reserve Primary Fund broke the buck in September 2008 — and since yields sank in a low-interest rate environment.

“Yield was never a driving factor; daily liquidity at par and cash management services were,” says Chris Donahue, Federated president and CEO, who also notes the firm’s own credit analysis of commercial paper and its understanding of customer needs as factors that are more important to investors than yields. “You package these things going on for 35 years… and that is why people have $3 trillion in money market funds even though yield is larger in other places.”

Total money market fund assets stood at $2.9 trillion as of April 14, but reached as high as $3.9 trillion in March 2009, according to Investment Company Institute data. Retail money fund assets dropped from $1.4 trillion to $1 trillion during that same time period.

Despite Donahue and other fund executives' downplaying the importance of yield, the reality is that money market funds have always been seen as a commodity-type product, making them a tough sell based on quality and safety, says Peter Crane, CEO and publisher of Crane Data. The Securities and Exchange Commission’s new money fund rule imposing stricter liquidity requirements makes it even tougher to manage the funds, he says.

“It’s tough to differentiate yourself from the competition in the money market space because expenses are the dominant contributor to yield and the yields, in general, are so tightly clustered,” Crane says. “[Funds] all fish from the same pond, and the pond is getting a lot smaller.”

Joan Ohlbaum Swirsky, of counsel at Stradley Ronon, agrees that it is harder for funds to distinguish themselves on performance. But safety also has gained prominence in investors’ eyes, and this affords funds an opportunity to market themselves in other ways, she says.

Money funds can distinguish themselves on the “expertise necessary to comply with complex compliance demands, on reputation and on the variety of money market funds offered so shareholders have a choice,” says Swirsky, who authored The Guide to Rule 2a-7: A Map Through the Maze for the Money Market Professional.

Funds can also tout other aspects of the service they provide, such as how late in the day they will accept orders, offering pricing two times a day and check-writing services, she says.

“As soon as rates go up enough and yields start to increase, that of course will be important,” she says. “But you have to think of something to say when you have zero yield.”

But Donahue contends that if low-yield money market funds are less attractive, you would not know it from his firm’s investors.

“Our clients are so focused on cash management services that even if the yield was zero, they wanted that service to be maintained and did not want to disrupt their systems for what they viewed as a temporary situation,” he says.

Indeed, Bob Deutsch, head of global liquidity for JPMorgan Asset Management, says money market funds saw a similar period of low yields in 2004 when they bottomed out to 1%. Deutsch, who runs global cash that includes money market funds, says the low-yield environment is pushing smaller funds out of an already crowded space and reinforcing for investors which firms are committed to the market.

“Part of me loves this because some of the smaller [funds] are out or will get out,” Deutsch says. “The bigger picture is that there are still close to 100 different managers of money market funds and the market probably doesn’t need that many.”

In fact, Eagle Asset Management noted in a March regulatory filing that Eagle, a subsidiary of Raymond James Financial, planned to liquidate the Eagle Cash Trust, which includes two money funds. Eagle announced that starting May 1 it would replace its existing money funds with two JPMorgan money funds. Eagle had cited thinner margins and greater regulatory scrutiny for its exit from the money fund market.

JPMorgan’s strong brand actually helped it gain market share in the money fund market, from 12% in the first half of 2007 to 17% now, Deutsch says. Although about 80% of its money market fund assets are from institutional clients, it manages more than $25 billion in retail assets, he says.

Money managers who lack size and scale are not as capable of weathering the tough environment and are asking whether the risk inherent in running money market funds is worth it, Deutsch adds. Large-scale managers with more resources will be good for money fund investors, he says.

“We put ourselves in a stronger competitive position in these markets from our commitment and don’t see as many of our peers staying committed when things get difficult,” he says. “We think assets will continue to consolidate to large-scale, high-quality management.”

Laurie Brignac, senior portfolio manager and managing director with Invesco Fixed Income, says over the past two years the competitive environment for money funds has remained relatively stable.

“We have witnessed eight money fund advisors exit the business and industry assets have become more consolidated with the largest advisors,” she writes in an e-mail response to questions. “In our experience, investors have an increased focus on credit and risk management controls.”

Brignac downplays the importance of yield and instead writes that investors should be reviewing experience, expertise in various markets and risk management controls. She also says investors need to vet the firm’s investment teams and processes and that the investment process at her own firm “was designed to completely separate the portfolio management function from the credit process[,] allowing the two teams to make separate and distinct investment decisions.”

“[W]e have been managing money market funds for the past 30 years using the same investment philosophy — safety and liquidity as the primary focus with yield as a product of the first two components,” she writes. “When investment managers buy based on yield, the risks outweigh the benefits, which are generally short-lived.”

Simon Mendelson, chief operating officer and head of the global client group for BlackRock's global cash management business, acknowledges in a statement that “in a low-yield environment it is hard for money funds to differentiate themselves based on yield.” But, like Donahue, Deutsch and Brignac, he writes that BlackRock has “never attempted to differentiate ourselves through yield.”

“Rather, we focus on safety and liquidity as our primary objectives,” he writes. “We believe clients choose us for the quality of our credit team, our track record of delivering safety and liquidity through market cycles, and the expertise of our sales team.”