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Profit From The Growing Wave Of Money Market Fund Closures

This article is more than 10 years old.

A lot of investors have noticed that money market funds have paid out a big fat zero, goose-egg, nada, so far this year. But, it’s easy to miss the fact that the sponsors of money market funds have had to subsidize these funds in order to keep their returns from turning negative. This can’t go on forever and when the subsidies do stop, those who have waited until the last minute, will find that the best income oriented investments will have already been bid up by those who had the foresight to take action now.

How big are these subsidies?

Four of JP Morgan’s money market funds recently reported an average 7 day yield of 0.02% and an average unsubsidized 7 day yield of -0.33%. This means that JP Morgan provided a subsidy of 0.35%.

These four funds have total assets of $8.7 billion, so over a year the subsidy comes to about $28 million. But it doesn’t end there. These four funds are part of a family of JP Morgan money market funds with total assets of $114 billion.  If the subsidies on these 4 funds are representative of the whole family, then JP Morgan's money market funds are costing them about $365 million a year in subsidies. And, that’s just JP Morgan (NYSE:JPM). Goldman Sachs (NYSE:GS), Charles Schwab (NYSE:SCHW), Bank of America (NYSE:BAC), Morgan Stanley (NYSE:MS) and all the other money market fund sponsors are dealing with the same issue.

The money market fund industry has a total of $2.5 trillion under management. If the average money market fund is being subsidized at the same rate, the industry tab comes to $8.8 billion a year.

After all these subsidies, what does the investor get in return? With many funds currently yielding between 0.00% - 0.02%, a million dollar investment will return maybe $200 in a year. In addition, there are now active discussions by the powers that be to let money market funds trade at Net Asset Value (NAV), which would mean that the value of your money market fund could go down, just like most other mutual funds. At the end of the day, money market funds aren't what they used to be and there is very little upside for investors to remain in them.

How long can this go on?

First, it’s important to realize that these subsidies have already been going on for the past 3 years. Last week, Goldman Sachs and JP Morgan both announced they were closing their European money market funds to new investors after the ECB reduced interest rates on deposits to zero.

In the U.S. the Federal Reserve has said that short term rates will remain steady at 0.25% until at least 2014. But the reality is that the Fed is under a lot of pressure to reduce rates because of the high unemployment rate.

If the Fed drops interest rates from these historically low levels, it would increase the subsidy that JP Morgan, Goldman Sachs, and all other fund sponsors, must make to keep their funds from turning negative.  As U.S. fund sponsors evaluate their options, we are likely to see some decide to follow JP Morgan’s and Goldman Sach’s lead and try to limit their losses by closing their funds to new investors. Some will go farther and close down funds entirely.

If short-term rates stay at these levels (or lower) for the next 2 or 3 years, we are likely to see the wholesale closure of the money market mutual fund industry.

What happens when money market funds close?

Investors in funds that close down will get their money back and have to decide what to do with it. My guess is that these investors will be looking for safety and yield, so investments that offer these characteristics are going to see a big surge in investor interest which is likely to move their prices up. The opportunity is to anticipate where this pool of capital of as much as $2.5 trillion is likely to flow and start buying these names before everyone wants to own them.

What are some of those names?

Click here to read about the stocks Eugene Groysman and I discussed on Saturday’s Investment Masters Roundtable.

Reserve a seat at the next Investment Masters Roundtable on Saturday, July 14.  Click here for links to previous roundtable discussions.

For additional investment insight and to converse directly with the Marketocracy Masters and the Warren Buffets Next Door, join Ken Kam's group on LinkedIn or sign up for our free e-mail list.

Disclosure: I am the portfolio manager for mutual and hedge funds advised by Marketocracy Capital Management, an SEC registered investment advisor. Before relying on the opinions expressed in this article, you should assume that Marketocracy, its affiliates, clients, and I have material financial interests in these stocks and may hold or trade them contrary to these opinions when, in our view, market conditions change.