December 10, 2008 / 5:59 PM / 11 years ago

UPDATE 2-Historic low US T-bill rates hammer money funds

(Recasts lead, adds quotes)

By Richard Leong

NEW YORK, Dec 10 (Reuters) - Historic low rates on U.S. Treasury bill rates hammered the $3.7 trillion money market fund industry with nearly half of the funds currently earning nothing, according to fund tracker Lipper.

A money market fund is expected to secure an income each day like a bank saving account, but low U.S. Treasury debt rates, a result of the current financial crisis, have diminished those expectations.

“At the very least, you hope to beat inflation, which they are not keeping up with. Their returns when you factor in inflation have been negative,” said Jeff Tjornehoj, Lipper’s senior research analyst in Denver.

The money fund industry, which is still recovering from the upheaval caused by the collapse of Lehman Brothers in mid-September, is poised for its fourth worst year in the past three decades, Tjornehoj said. “2009 could shape up to be a terrible year,” he added.

Based on preliminary data, 838 or 46 percent of the 1,810 classes of money market funds Lipper tracks earned no return on Tuesday when benchmark three-month T-bill rates slipping into negative territory to their lowest level since the early 1940s. This compares with 112 classes that posted zero return on Monday, according to Lipper.

In September, Reserve Primary Fund, which had been one of the oldest U.S. money funds, saw its net asset value fall below $1.00 a share amid losses on issues by now-defunct Lehman Brothers. The news unleashed a flood of withdrawals from money funds, causing further disruption of the credit markets and leaving some money funds earning nearly nothing.

In response to industry turmoil, the Treasury Department created a program to support the value of money market funds, in which fund operators pay a premium to insure their shares. The program is due to expire on April 30, 2009.

LOW T-BILL RATES

In the wake of this year’s severe losses in stocks and other investments, anxious investors have been flocking into the safety of Treasury bills to park their money, driving rates down to levels not seen since the early 1940s.

Some 44 percent of the 1,283 classes of taxable money funds tracked earned no return on Tuesday, according to Lipper, while 53 percent of the 525 classes of tax-exempt or municipal money funds posted no return.

Money market fund yields dropped this year. On a year-to-date basis, the average yield on taxable funds was running at 1.95 percent, down from 4.41 percent in the same span a year ago, Tjornehoj said.

Despite historic low yields on T-bills and other short-term debt securities, investors have poured cash into money funds.

Last week, U.S. money market fund assets rose by $23 billion to a record $3.657 billion, according to the Money Fund Report. For details, see [ID:nN03452204]

This surge in assets has also intensified pressure on fund managers to deliver some modicum of return in this precariously low-rate climate, said Tjornehoj.

It is tough for small- and mid-tier providers to stay competitive,” he said.

Some fund operators will be forced to cut operating costs and/or subsidize the funds to prevent their shares from falling below $1 or “breaking the buck,” which is not expected to occur, analysts said.

“Funds can waive fees for some time, and can waive a substantial amount,” said Peter Crane, president and publisher of Westboro, Massachusetts-based research firm Crane Data LLC. “You are not anywhere near the point where funds have nothing left to waive.”

Additional reporting by Muralikumar Anantharaman in Boston

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