European money market funds–charging to hold your money?

That’s what the Financial Times suggests is about to happen, based on what the largest European money market fund managers have told them.

money market funds

Money market funds are a kind of mutual fund that specializes in holding very short-term government and corporate debt.  They became popular as a much higher-yielding, but safe alternative to bank deposits well over a quarter-century ago.  Although not insured by governments in the way bank deposits are, their investing operations are designed to preserve net asset value at a constant level.  That’s usually $1 or €1.  Interest is paid in new shares.

defending net asset value

Over their entire lifespan, there have been only a small number of incidents, involving a small minority of funds, where investors have received less than their initial purchase price when redeeming shares.  There have been cases–only a few–where funds have made imprudent investments stretching for yield.  But the financial conglomerates sponsoring the wayward managers have invariably made investors whole, typically by buying the dud paper at the initial purchase price.

today’s situation in the EU

Why is today any different in Europe?  Two reasons:

–the European Central Bank has recently reduced the interest rate it pays on overnight deposits from 0.25% to plain old zero.  And it says it might reduce rates further, meaning it will begin to charge banks for holding their money.

–the long-running EU debt crisis has created a two-tier structure of sovereign borrowers, haves and have nots.  Interest rates on short-term French and German notes are already negative (meaning you lend €1 to either country and get €0.995 or so back when the note comes due).  Yes, a money market fund can get a positive yield by lending to Spain or Greece, but only by taking on extra risk.  Also, once your clients learn what you’re doing, they’ll probably move their funds elsewhere.

A manager can, of course, think about buying longer-dated securities that do pay interest.  But he takes on interest rate risk by doing so.  Just as important, the fund’s charter will doubtless bar, or at least limit, such investments.

To sum the situation up, money market funds promise safety + a better yield than bank deposits.  In today’s EU, they can’t deliver both.

plans being considered

According to the FT, some fund sponsors are toying with the idea of keeping the net asset value constant, but charging the negative interest rate to accounts by decreasing the number of shares an investor holds.  Others appear to be considering levying charges in some form, but outside the fund, so that neither the asset value nor the number of fund shares will be affected.

bank accounts must be in the same situation

Given that money market fund managers are usually much more efficient than their bank counterparts, the banks themselves are likely beginning to lose money on savings accounts.  So it’s possible that in the stronger EU nations, banks will begin to charge customers a monthly fee to safeguard their money.

more than an oddity

I think the most important information to take from this discussion is that the money market fund sponsors don’t expect the situation to change any time soon.  If they thought that negative returns on government notes were a three- to six-month aberration, they might quietly suffer through the losses.

But they’re not.  They’re planning on the current situation being around for a long time.