Money-market funds 'break the buck'

Last week the oldest money-market fund in the US 'broke the buck' – i.e. it returned less than investors had put in. Similar funds operate in the UK. So are they really the place to be putting your cash?

With all the talk this week surrounding the "mother of all bailouts", an equally worrying rescue package went almost overlooked. As Hank Paulson was campaigning for $700bn to save Wall Street, President Bush announced that money-market funds would be allowed to tap up to $50bn from an emergency fund set up during the Great Depression.

Why the worry? Money-market funds invest in Treasury bills, short-term debt issued by banks (commercial paper) and other low-risk securities. They are not backed by a Federal guarantee (until now, at least), and thus typically pay a higher interest rate then savings accounts. But because they "have almost always produced positive returns", they've been seen by investors as being as safe as bank accounts, says the Washington Post. That faith proved misguided when last week the oldest money-market fund in the US, the $60bn Reserve Primary Fund, 'broke the buck'. That's industry jargon meaning that it would return less than investors had put in (97 cents in the dollar, in this case) only the second time in history this has happened. It turned out Reserve Primary was holding $785m of Lehman Brothers debt, which had to be written down to zero after the bank went bust.

Investors should have been aware of the risks the Reserve Primary Fund's average 12-month yield of 4.04% was the highest of the 2,100 funds in the money market sector, says Karen Dolan at Morningstar. But in the end the US government had to act to prevent a stampede out of the $3.5trn sector, saying it would reimburse investors for losses for a year on funds invested before 19 September. Over the week, worried investors pulled $197bn out of funds, but the exodus slowed to $5.2bn by last Friday. A mass run on the funds could have seen many others 'break the buck', as they were forced to sell assets at a loss into an already panicky market. This would also have caused more upheaval in the commercial paper market, cutting off a key avenue for banks to raise short-term money for day-to-day operations. The government may have seen off trouble for now, but it seems likely US money market funds will move towards being more conservative.

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Money-market funds are also available in Britain. But as the American experience shows, if you want your cash to be safe, a better bet is to put your money into a good savings account, particularly as the sector has only returned an average 3.4% this year, reports the Investment Management Association.

Jody Clarke

Jody studied at the University of Limerick and she has been a senior writer for MoneyWeek for more than 15 years. Jody is experienced in interviewing, for example in her time she has dug into the lives of an ex-M15 agent and quirky business owners who have made millions. Jody’s other areas of expertise include advice on funds, stocks and house prices.