Issue 17 • March 26, 2009

How to Cope in a World with ZERO Money Market Yields ...

Sharon Daniels here with this week’s issue of Weiss Advice. I asked Mike to let me take this week to write to you about a topic that many investors are concerned about today  ... very low money market fund yields.

No question, the current economic and investment climate has presented a new set of challenges to investors seeking income and security and it’s important that you fully understand what’s happening and what choices are available today for protecting your “keep-safe” money.

The following Q & A should help inform you about why money fund yields are at such low levels today and to arm you with some suggestions on how you can potentially earn higher yields with relative safety.

Why have yields on Treasury money market funds
dropped to such low levels?

Simply put, as this credit crisis and market volatility intensified, investors flocked to the safety of treasury securities — especially those with short-term maturities. This mad scramble pushed yields on government debt down to historic lows, resulting in the outright closing of some mutual funds — just at a time when many savers and investors needed these vehicles as a haven of safety and liquidity.

Unfortunately, while low interest rates may be good to help stimulate our economy, by helping borrowers and debtors lower their borrowing costs, low rates also come at a cost to investors on fixed incomes or those savers who need interest income to cover their living expenses.

What you have is a combination of two powerful factors at work right now:

1. A record-low interest rate target of 0–0.25% set by the Federal Reserve in an effort to help jump start our economy again and support the ailing financial sector. But with 30-day Treasury bills yielding practically ZERO, the result is extremely low money market yields.
2. A massive “flight-to-quality” by investors last year, in search of the highest-quality and most liquid securities. In times of crisis, investors across the globe typically race to what they perceive to be the safest investments available ... namely U.S. Treasury and other government securities ... which benefit from the full faith and credit backing of Uncle Sam. As demand for U.S. government securities rises, so does the price, which, in turn pushes yields lowers.

The pressure has been intense and doesn’t show any signs of abating either. Indeed, many providers of Treasury money market funds have closed outright, or are limiting investors and temporarily waiving fees and covering expenses in an effort to remain open as a benefit to their shareholders.

What can money funds do to improve their yields?

Unfortunately, because of the short-term nature of these funds, and their requirement to buy only securities with short-term maturities, the fund manager does not have many options to improve yields without taking unacceptable risks.

The total operating expenses and management fees charged to funds are a critical component in determining the relative yield of the money market fund. You can find out about these fees in each fund’s prospectus, typically disclosed in the “expense ratio” section. The bottom line: the higher the fund expense ratio, the lower its yield will tend to be.

So while Treasury-bill yields have hovered near zero, an increasing number of money fund advisors are waiving their management fees and/or reducing expenses where possible to remain competitive. And today, “competitive” in the treasury money fund space translates to yields at 0% or just slightly above.

When will this low-yield situation end?

Sadly, it may persist for some time yet. That’s because our country is still in the throes of a severe economic downturn brought on from the credit crisis, a housing bust and the ensuing financial market decline. The Fed’s recent statement from its March 18, 2009 policy meeting says in part: “economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.”¹ In other words, we expect the Fed will maintain its current target range of 0-0.25% for the fed  funds rate.  Given this stance, low yields may persist through 2009 and perhaps even into 2010, barring any sudden and dramatic improvement in the economy, which is not likely.

What options are there for higher income without adding much risk?

First, you need to determine your personal tolerance for risk and your income needs. Ask yourself, what your time horizon is and whether you can handle fluctuations in the value of your fixed income investments. Depending on the answer, then consider the following …

#1: If you don’t want any fluctuation of your principal, and preservation of your capital is a primary goal, then a Treasury money fund where the duration must remain under 90 days may be the most appropriate choice for you. These money funds typically manage to remain at a stable $1.00 net asset value per share. Another alternative: buy individual T-bills through your broker or Treasury Direct.

#2: If your time horizon is longer and you can handle some fluctuation in the value of your fixed income portfolio, you can buy short- or medium-term government securities or mutual funds invested in these securities. With this option, you should pick up a higher yield than in option #1, above, however the trade-off may be greater volatility in the price of your securities. The Weiss Managed Treasury program is a separately managed account strategy we offer that invests this way at present — mostly in short-term Treasury bills, with some longer-term holdings in Treasury Inflation Protected securities, or TIPS.

#3: If you must have more income than a Treasury money fund or T-bills can provide, but your primary goal is preservation of capital, then another option may be high-quality corporate money market funds or CDs.  In this case, you’ll need to carefully assess the financial stability and credit worthiness of the bank you’re doing business with.  

Still another option, in my opinion, would be to invest in a government agency money fund or mutual fund with very short maturities.  Here’s why:  a fund that invests in government agencies may not carry the full, explicit guarantee and backing of the Federal government like Treasuries do, but the safety is pretty close, plus yields are higher.

In summary, we’ve already seen historically low yields push investors into higher-risk securities, which may not be suitable for everyone. And while zero interest rates are quite unattractive to investors, at least one can sleep at night knowing that the trade-off is liquidity and relative safety of principle. To learn more about your fixed-income investment options, please visit our Web site at: www.WeissCM.com. Or, contact a Weiss Capital Management financial advisor right away at: 1-800-814-3045.

Safe investing,

Sharon A. Daniels
President
Weiss Capital Management, Inc

¹ Federal Reserve Press Release, March 18, 2009