BOSTON Aug 5 Money market funds run by Fidelity
and American Beacon are relying on an unlikely source to juice
up their returns: beat-up bonds issued by cash-strapped Puerto
The funds have accepted the U.S. territory's debt as
collateral on their short-term loans to Wall Street banks, and
in exchange for that added risk are receiving a higher interest
rate, according to public filings.
As a result, American Beacon's $767 million fund has one of
the best one-year returns in the industry, while Fidelity this
year used at least one loan backed by Puerto Rico bonds to
generate a yield about 20 basis points higher than U.S.
Treasuries or bank certificates of deposit.
The strategy comes as the money market fund industry seeks
to retain investors spooked by new U.S. regulations, and could
stir up worries about market risk that emerged after the 2008
financial meltdown, according to analysts.
So far, repurchase agreements backed by some of the riskiest
collateral make up just 3 percent of the $2.4 trillion in
taxable money market fund assets, according to research firm
Crane Data LLC. But that could grow if the improved returns
among those using riskier collateral prove to be a draw for
The American Beacon Money Market Select Fund, for
example, has nearly a third of its repurchase agreements backed
by riskier collateral. As payoff, the fund's one-year total
return of 0.08 percent through the end of July is better than 91
percent of peers, according to data from Lipper Inc, a unit of
Thomson Reuters. The fund's five-year annualized total return of
0.21 percent, as of Dec. 31, also beat nearly 90 percent of
In recent months, the American Beacon fund has used a $39
million repurchase agreement with RBC Capital Markets LLC to
generate a yield of 18 basis points. In April, the collateral in
the deal contained about $6 million worth of Puerto Rico bonds,
including ones issued by the island's electric authority.
Standard & Poor's said last month the Puerto Rico Electric
Power Authority is likely to default on its credit lines and
file for protection under a new restructuring law. PREPA bonds
were not listed as collateral in the fund's end-of-May report,
The fund is a survivor of the financial crisis, but heavy
redemptions left it with just $708 million in assets at the end
of 2008, down from $11 billion at the beginning of that
tumultuous year, according to Lipper.
American Beacon declined to comment for this story.
'BREAK THE BUCK'
Money market fund sponsors downplay the collateral risk
associated with repurchase agreements, saying their ultimate
backstop is the bank on the other side of each transaction.
"Prime money market mutual funds only enter into repurchase
agreements with counterparties that represent 'minimal credit
risk,'" Fidelity Investments, the largest U.S. money market fund
sponsor, said in a statement.
The $13 billion Fidelity Retirement Money Market Fund
recently reported a $126 million repurchase agreement
with Merrill Lynch, which had a yield of 0.38 percent and
featured Puerto Rico bonds as most of the deal's collateral,
according to fund disclosures.
About 10 percent of the fund's repurchase agreements are
backed by collateral considered more risky, according to
Fidelity disclosures. Fidelity's fund returned one basis point
for investors over the past year, a typical performance in the
The risk around counterparty banks is partly why U.S.
regulators have had concerns about repurchase agreement
collateral since the financial crisis. The possibility of
collateral fire sales still poses "significant risks" for the
U.S. financial system, according to the Financial Stability
Oversight Council's 2014 annual report released in May.
A redemption run on the Reserve Primary Fund in 2008 has
been a rallying cry for reform after its exposure to Lehman
Brothers debt prompted panicked investors to withdraw their
money in droves. That run led the fund to "break the buck," a
rare event in the money market fund industry that refers to a
fund's net asset value falling below $1 per share.
New rules passed last month by the U.S. Securities and
Exchange Commission are designed to limit redemption runs, but
they could make life harder for money market funds. A floating
net asset value for some funds could make them less appealing to
investors who prefer the stable $1 share price.
That could push money market fund assets into customized
separately-managed accounts, for example, which contend with
less regulatory oversight, said Josh Galper, managing principal
at Finadium LLC.
That competition might encourage more money market funds to
enter into more repurchase agreements with riskier collateral. A
repurchase agreement with municipal bonds as collateral can
generate a yield premium that is 30 basis points to 40 basis
points better than a deal with U.S. Treasuries, Galper said.
"This can make muni repo an attractive short-term cash
investment especially when a U.S. treasury repo is running at 8
or 9 basis points," he added.
(Reporting by Tim McLaughlin; Editing by Richard Valdmanis and