Given a choice between tweaking a money market investment strategy and playing Scrabble with a compliance officer, a surprising number of advisors would choose the board game. Money market funds are that dull, that uninviting.
This doesn't need to be the case. In fact, as I'll demonstrate later in this article, a little rate shopping can make money markets almost interesting, doubling or even quadrupling a client's yields without significantly increasing risk exposure.
But first let's get everything in its proper perspective: Money markets are a yawn to most advisors because their yields are so low. In the wake of the Federal Reserve Board's thirteenth consecutive rate cut on June 25, yields on retail money market funds dropped to an average 0.38 percent by the end of July and have hovered around that number ever since. (Since such a return does not even keep pace with the rate of inflation, currently running just above 1 percent, the average investment in such a fund is actually losing value.)
However, given that most advisors use money markets as short-term holding pens for unreinvested dividends and other soon-to-be-redirected funds, it only makes sense to maximize their returns, if possible. The simplest way to do this is to shop around for the highest rates.
Unlike other areas of investment, higher rates of return in the money market world do not correlate with higher risk. This greatly simplifies the effort of shopping for a better deal. True, keeping money market investments within the same fund families might be more convenient. But with rates at five-decade lows, putting forth a little effort to acquire some risk-free gains seems like a no-brainer. Higher yields are of particular concern to those clients who consistently allocate a portion of their assets to money market funds as part of a diversification effort. Another reason to seek out the best rates now is that an overall jump in money market rates seems unlikely any time soon.
Following the Fed
Money market funds generally follow the Federal Funds rate and are less influenced by movements in the bond market. For example, after the Fed's 0.25-percentage-point easing in June, the rate on the 10-year Treasury bond rose from 3.4 percent to 4.47 percent by July 31. Over the same period, the rate on the average retail money market fund fell from 0.48 to 0.38 percent.
But that doesn't mean all money market funds hug the Fed rate equally. Even after the Fed's most recent rate cut, some are returning close to 1 percent (with at least one above 1 percent), whereas others sit as low as 0.1 percent.
A major reason for the wide variation is the expenses that companies build into the funds. If expenses were equal at all funds, yields would vary by only 0.20 percentage points. But, as it is, the range is much higher — 0.95 percentage points. The expense rate has a direct impact on a money market fund's net yield. If a fund earns a gross yield of 1.05 percent, but has expenses of 1 percent, it would pay investors only 0.05 percent. If the same fund has expenses of only 0.10 percent, it would pay investors 0.95 percent.
Many companies are able to pare expenses through efficiencies of scale — by combining some aspects of their money market operations with those of their other funds, for instance. For others, such synergies don't exist.
But cutting expenses is not the only way to boost yields. Some managers have found that actively managing their accounts can also have a positive effect on yields. This is essentially a market-timing play: Managers invest in securities with different maturity dates and try to time the maturity by being aware of market trends, monthly patterns and trends in the movement of money in the banking system. Managers also try to add value by actively investing across a variety of security types, such as highly rated corporate bonds, which can help boost the yield.
Consequently, some companies are able to boost yields by judicious management. Because money market expenses, whether high or low, are generally consistent and predictable, a money market fund that has relatively low expenses and a comparatively high yield today is likely to have a similar profile tomorrow.
So it pays to search around for the companies that offer above-average rates. After all, doing so is better than settling for a return that amounts to little more than suggesting your clients put their money under the mattress.
Writer's BIO:
Mark Amberson is director of short-term investments and head of the in-house money market portfolio management team for Russell Investment Group.