Disclosure won't help money fund investors

CHICAGO Tue Jan 22, 2013 1:30pm EST

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CHICAGO (Reuters) - The $2.7 trillion money market funds market is in line for new regulations as the Securities and Exchange Commission ponders new rule changes that would give investors a better idea of how much risk they're taking.

But no matter what happens, the funds will still be relatively safe baskets for short-term cash, though afflicted by paltry yields for the near term.

The biggest change that might come about is increased transparency. The SEC tabled a proposal late last year on a set of rules and now the matter is being reconsidered, although it may not be acted upon until a new, permanent chairman is appointed and one of the empty commissioner's seats is filled. Another proposal before the Financial Stability Oversight Council may require that managers set aside capital against losses or price funds at the actual net asset value.

Already, in advance of possible regulations, some of the biggest fund groups are taking their own steps in that direction. On January 11, a group of them, led by BlackRock Inc, Fidelity, Federated Investors Inc, Goldman Sachs Group Inc and Charles Schwab Corp, said they would agree to post "shadow" daily fund asset values. The companies are hoping to head off the rules being considered by the SEC because they would be more costly to implement.

The concern of regulators and investors is that a money fund's net asset value - perceived to be locked at $1 per share -- actually may vary a few hundredths of a percent every day. The fear is that investors will perceive money funds as unstable if the NAV doesn't always equal the cash value of $1.

Only one fund has "broke the buck" in recent memory -- when the Reserve fund dipped below the $1 NAV in September, 2008, after the failure of Lehman Brothers. When that happened, it triggered a run on money funds, which was only halted by government intervention.

While most variations will mean little or nothing to most investors, no one in the industry wants to fuel that fear again.

In fact, many fund companies seem like they'd rather just run away from money market funds altogether. As a result of a combination of tougher rules, which the SEC imposed in 2010, and a low-yield environment, 14 fund companies have either shuttered or merged them into other funds. The overall number of funds sank from 1,569 in December 2011 to 1,470 as of December 31, the lowest total since December 2000, according to Mike Krasner, managing editor for iMoneyNet, a financial information service.

LOOKING FOR YIELD

If you are also concerned about low fund yields -- and who isn't? -- there are some alternatives, although few will impress you.

At around a 0.02 percent average seven-day yield, taxable money funds, which pool short-term corporate and government debt securities, are still relatively safe buckets to keep cash in, yet they're also a little leaky. They are losers on net return when you subtract taxes and inflation.

If you wanted to lock your money into a one-year, federally insured certificate of deposit, you could find a CD around 1 percent in yield, compounded daily, according to BankRate.com. The national average for that maturity of certificate is 0.27 percent. You could nearly double the yield if you wanted to lock up your money for five years.

Outside of CDs, you'd have to consider taking some credit-market risk and enter the uninsured world of short-term bond funds.

The Vanguard Short-Term Investment Grade fund offers slightly more than a 2 percent yield and has more than half of its holdings in corporate bonds, most of which mature in under three years. The USAA Short-term bond fund offers a somewhat higher yield, but takes roughly the same approach, but with about one-third of its portfolio in corporate bonds.

Unlike money funds or CDs, you need to be concerned with a measure of risk called duration in short-term bond funds. This is a measure of how much the fund would lose value if interest rates rise 1 percentage point. The Vanguard fund's average effective duration is 2.3 years; it's 1.26 years for the USAA fund.

How much risk you take depends upon how you plan to use the cash in question. Short-term bond funds may be suitable for funds you won't need for a few years, while CDs or money funds are fine for cash you'll need within the year. It all depends on how much risk you want to take over time.

(The author is a Reuters columnist and the opinions expressed are his own.)

(Follow us @ReutersMoney or here; Editing by Beth Pinsker and Dan Grebler)

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