November 23, 2011
Dear Client,
We recently changed your account’s core money market (i.e. “cash”) fund to a US Treasury money market (symbol FDUXX).[1] Our reason for doing so is rooted in safety and prudence but also in the belief that when we do take risk, we must be adequately compensated.
Money market funds’ exposure to short-term European debt is significant. The Wall Street Journal reported in June the largest US money market funds held roughly $1 trillion of debt issued by European banks. The low interest rate environment has squeezed money market funds’ ability to cover their management fees and expenses, encouraging them to “reach for yield.” Unfortunately, this reach for yield has not accrued to investors as evidenced by the uniform yield profiles across money market funds regardless of composition. This results in an asymmetric distribution of risk and reward for investors.
ZIRP[2] has artificially depressed interest rates and changed the economics of operating money market funds. While these instruments have never been large profit centers for the companies that offer them, they were largely self-sustained. With yields at record lows however, they have instead become a cost center as funds are unable to cover their expenses and fees. Funds are mitigating this, albeit marginally, by seeking higher returns while not passing through the incremental yield to investors. To illustrate this, below we provide information as of 10/31/11 for the Fidelity US Treasury Fund and the Fidelity Cash Reserves Fund. The latter is Fidelity’s largest money market fund.
| Fund Name (Symbol) | 7 Day SEC Yield (%) With Subsidy[3] | 7 Day SEC Yield (%) Without Subsidy |
| Fidelity Cash Reserves (FDRXX) | .01 | -0.03 |
| Fidelity US Treasury Fund (FDUXX) | .01 | -0.61 |
Source: Fidelity Investments
The second column shows both funds offer the same return: 0.01%. The holdings of the funds however, are different. FDUXX is invested, as of 10/31/11, entirely in US Treasury securities or repurchase agreements for those securities. FDRXX on the other hand holds a variety of non-US Treasury securities including certificates of deposit and commercial paper issued by European banks, among others. Given the current environment, we believe that US Treasury securities are “safer” than European debt, be it sovereign or corporate.[4] The question then becomes, why would FDRXX, which invests in higher yielding debt, offer the same return as FDUXX which invests entirely in US government debt? The third column shows the yield that investors would have obtained in the absence of subsidies. The lower the value, the more money the fund company has to spend in order to make investors whole.[5] By investing in higher yielding paper, FDRXX lowers the cost to the fund sponsor to preserve $1 NAV per share. This works out for the fund sponsor but not for the investor who still receives the same paltry yield the US Treasury fund offers although with higher risk.
To be clear, we are not sounding the alarm bells and calling for financial Armageddon. However, a fundamental cornerstone of our investment process is taking calculated risks that we are compensated for. This is simply not the case here, where investors are undertaking greater risk yet receiving the same return offered by a US Treasury money market.
As always, if you have any thoughts regarding the above ideas or your specific portfolio that you would like to discuss, please feel free to call us at 1-888-GREY-OWL.
Sincerely,
GREY OWL CAPITAL MANAGEMENT, LLC
[1] The symbol for the Treasury fund is FDUXX.
[2] Zero Interest Rate Policy
[3] SEC 7 Day Yield is the average income return over the previous seven days, assuming the rate stays the same for one year and that dividends are reinvested. It is the Fund’s total income net of expenses, divided by the total number of outstanding shares. This yield does not include capital gains or losses. Yield without Subsidy is the Class’s SEC 7 Day Yield without applicable waivers or reimbursements, stated as of month-end. Waivers and/or reimbursements may be discontinued any time. All yields are historical and will fluctuate.
[4] “Safer” in this context means lower credit risk. Because these funds hold very short maturity paper, there is al very little “interest rate” risk should US interest rates normalize.
[5] A negative yield would result in the fund’s NAV dipping below $1/share causing it to “break the buck.”