Money Funds Taking on Risk Again

Representing Investors Nationwide

According to a Wall Street Journal article (Sept 16, 2010), some money-market funds are once again venturing into riskier investments, a strategy that led to massive investor withdrawals and the collapse of one fund during the recent credit crisis. The Reserve Primary Fund “broke the buck” due to a large exposure to Lehman Brothers debt which became worthless when the company filed for bankruptcy protection on September 15, 2008.

In the wake of the near-collapse of the financial system, the Securities & Exchange Commission enacted new rules limiting the types of investments money funds could hold. Those rules include a requirement the funds hold at least 30% of their assets in securities with maturities of seven days or less and to post their holdings each month online. The goal of the 30% requirement was to ensure the funds could convert securities to cash to meet investor redemption requests on short notice.

However, an unintended result of the new rules was issuers are now turning to longer-term financing thus reducing the available short-term instruments available for money-fund investment. In response, the funds are turning to repurchase agreements (REPOS) to make up for the shortfall and to get better yield. REPOS are often backed by government securities but more and more the funds are purchasing REPOS backed by corporate debt and stock. Obviously these are more risky securities then government-backed investments.

These revelations have spooked some institutional investors and many remain unconvinced the new rules have made the money-fund market any safer.