Investors have largely cheered the Federal Reserve’s openness toward cutting interest rates beyond their 41-year low, believing lower rates will promote economic growth. But the prospect of additional cuts is stirring concern in the money-market fund business.
Taxable money-market yields average 0.70 percent after expenses are subtracted from portfolio earnings. If the Fed reduces the federal funds rate when it meets June 24-25, as some analysts believe it will, money fund yields could fall close to zero or lower for some funds.
That could create turmoil for financial services companies with the highest expense charges, since they will have to cut costs to pay their bills without dipping into principal. Investors also must be vigilant about the risk to their principal if firms aren’t willing to sacrifice profits, although analysts believe that is unlikely.
“At this point with rates and yields where they are, depending on the extent of the rate cut, some funds will have to consider waiving fees. That could adversely affect their bottom line,” said Peter Rizzo, director of money fund ratings at Standard & Poor’s.
“The smaller companies who only have a few funds will probably look to merge with other funds,” he added. “There’s only so much unprofitability they can withstand during these times.”
A quarter-point rate cut, for example, would knock average money-market yields down to 0.45 percent, putting 142 funds in danger of posting negative returns if they don’t cut fees. Still, those funds would only represent 2.1 percent of total money-market assets, according to money fund tracker iMoneyNet.
But if the Fed were to cut rates by a half-point, 424 funds could fall in the red, while a three-quarters point cut would threaten a vast majority of the total 1,747 money funds offered, said Peter G. Crane, managing editor of the Westborough, Mass., firm.
“The longer we’re down here the more of a problem this will become,” he said, predicting a wave of fund closings or consolidations. “It could be quite ugly.”
Among the firms that could feel the pinch are Munder, BlackRock and Franklin Templeton whose money fund yields were hovering at 0.04 percent or lower. Pimco, known for its bond funds, has a 0.05 percent yield, according to iMoneyNet.
Rachel Barnard, a stock analyst who follows asset managers for Morningstar Inc., added that firms that specialize in money-market funds such as Federated Investors could be hurt the most, since other companies might have mortgage businesses that would benefit from a rate cut.
“I don’t think anybody stands to lose a lot except Federated, since 70 percent of their business is in money markets,” she said. “For Federated, a half-point cut is where they’re going to start taking it on the chin.”
Officials for Federated declined to comment. They have said in the past that because the company caters mostly to institutional clients, its expenses have been lower and yields higher, giving it a greater cushion against rate cuts before profits dramatically suffer.
BlackRock, which also serves mostly institutional clients, echoed that view.
“While the absolute level of interest rates is an issue for money market funds and their providers, the issue is significantly less for institutional funds vs. retail products as the fees are much lower,” the company said in a statement.
Financial planners advise investors to be aware of money-market yields and consider short-term bonds if they don’t mind taking on more risk in exchange for a potentially higher return. Those who hold shares of financial services firms with substantial money-market businesses also should be wary particularly if the Fed cuts rates by a half-point or more, they said.
Percy E. Bolton, a certified financial planner in Pasadena, Calif., also cautions against investors pouring their cash into stocks, betting on a better return, if they are using money funds for their intended purpose — to protect the principal before major purchases within a year.
Mr. Crane agreed. “Investors really should ignore what the market is doing.” he said. “If the money’s intended use is for a down payment on a house or a college tuition bill, you’d be crazy to move it into a bond fund.”