Eulogy for the Money Fund?

December 24, 1969

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We confess reports of the demise of the money market mutual fund are premature. But, we cannot help but wonder if another nail in its coffin was not added last week when the Federal Reserve Board (FRB) released its Summary of Economic Projections (SEP). The January 25th forecast included, for the first time, Federal Open Market Committee (FOMC) members’ assessment of when monetary policy may change.

It is no surprise the majority (14 of 17) felt there was little chance that the present trading range (0 to 0.25 percent) for Federal Funds would rise in 2012. Likewise, the majority (11 of 17) believe at the present that current policy is unlikely to be reversed in 2013. Looking ahead, it is only in 2014 that the majority of FOMC members see any possibility of a significant increase in the targeted Federal Funds rate.

We doubt the latest non-farm payrolls report (+243,000 jobs) fundamentally changes the equation. Chairman Bernanke in recent testimony before the House Budget Committee expressed disappointment in the recovery’s pace. So we question whether there is much resolve to reverse course and raise short-term interest rates.

Short-term interest rates, at a whisper above zero, may be a boon for banks, but they certainly have not been for money market mutual funds (MMMFs). MMMF assets continued to slide lower as investors ? both institutional and retail ? seeking higher yields, yanked more deposits from taxable and tax-exempt money funds. The Federal Reserve, in its Flow of Funds Accounts compilation, reported total assets fell by $59.4 Billion in the 3rd Quarter; and, year-over-year (through the 3rd Quarter), assets are off by $168.0 Billion.

Where is money going? For the most part, probably into bank CDs and savings accounts. Year-over-year through the 3rd Quarter, bank deposits grew by $348.7 Billion.

In the tussle for deposits, banks have the overwhelming advantage in a persistent low interest rate environment. Specifically, there are relatively few constraints on a bank’s ability to borrow short and lend long. In other words, banks can take advantage of the steep yield curve by paying next to nothing (for short maturity CDs or savings accounts) to depositors while buying long-term government bonds or extending credit and loans to businesses and households. Money funds are not so blessed. Security and Exchange Commission Rule 2a-7 places a number of limitations which hinder a money fund in a persistent low rate environment. The most restrictive is the requirement that money funds maintain a weighted average maturity of less than 60 days. This effectively precludes money funds from using the steepness of the yield curve to their investor’s advantage.

As the U.S. enters the fourth year since the 2008 mortgage debacle, it is not just investors who are siphoning off deposits from money funds. Many fund families are also shuddering money funds or consolidating offerings. We estimate over 180 money funds have either been liquidated or merged away since the financial crisis commenced.

An irony is money funds first came into existence because of government inaction. Regulation Q (before its repeal in 1980) limited the yields banks could pay on savings deposits. In the late 1970s, as short-term market interest rates rose the ceiling of 4? percent fostered the money fund’s introduction ? a development which caused the disintermediation of banks and thrifts. Thirty years later government policy is forcing (for the second time in a decade) a reversal of this secular trend. As long as interest rates remain low, money funds will remain vulnerable. And, as long as monetary policy remains the sole policy option, money fund flows are at its mercy.

Notes:

Money market mutual fund assets sourced from the L.121 Table for Money Market Mutual Funds, line 1.

Time and savings deposit levels sourced from Table L.205.

Both tables can be found in the Federal Reserve Board’s Flow of Funds Accounts of the United States release.

Fund returns are for money market mutual funds classified by Lipper in their Money Market Funds category. This universe is composed of taxable funds permitted to invest in a wide variety of money market instruments including Treasury Bills, commercial paper and negotiable CDs.

(Sources: Federal Reserve Board, Z.1 Flow of Funds Accounts of the United States, December 8, 2011; Lipper; AIFS estimates.)

About American Independence Financial Services, LLC

American Independence Financial Services, LLC (“AIFS”) is the investment adviser and administrator for the American Independence Funds and the NestEgg Target Date Funds. The firm is a limited liability company founded in 2004.

Important Disclosures

The views expressed in this document are based on political, market, economic and other conditions subject to change at any time. Data are acquired from sources believed to be reliable. But no warranties are made to the accuracy, completeness or timeliness of the data and information presented. Opinions expressed are those of the author unless indicated to the contrary. Nothing in this document should be construed or taken as financial or investment advice. Please consult with your financial advisor to discuss how the subject of this research report may impact your unique, individual circumstances.

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