FUND TRACK Fidelity May Be the Real Winner In Money-Market Insurance Plan
May 01, 2011
Who is the real winner when the wealthiest mutual-fund company in the world says it wants to protect mutual-fund investors by setting up a new insurance company for its money-market funds? Oddly enough, giant Fidelity Investments itself may be the biggest winner from its marketing coup -- not the small investors who lose sleep worrying about the safety of their money funds. That's what fund-industry veterans and nervous rivals are saying now that Fidelity has filed with the Securities and Exchange Commission a plan to set up an affiliated mutual insurance business just for its $80 billion of money-market funds. There is more to the Fidelity plan than just investor protection, fund industry experts say. There's a cost-saving aspect for Fidelity, too. Big fund companies have a tradition of reaching into their own pockets to prevent money-market funds from ``breaking the buck,'' or dropping below the $1-a-share that these popular pools of short-term investments strive to maintain. A couple of years ago dozens of fund advisers infused their own money into money funds hurt by the financial meltdown of Orange County, Calif., and its investment pool. By contrast, under Fidelity's plan it would be the fund investors who would pay, through the mutual insurance company, to keep fund prices stable. ``From an investor's point of view, insurance is really unnecessary'' in a well-run money fund from a big fund group, says Sherman Reinaldo, editor of the No-Load Fund Investor, a newsletter in Irvington, N.Y. Fidelity is ``probably looking to get off the hook in case they buy some bad paper.'' Michaele Montanez, a bond-market strategist for Corby North Bridge Securities who has advised certain money funds during past travails, sees little chance that most money funds -- especially Fidelity's -- would ever incur a loss calling for insurance. ``So the question becomes, why would an investor need this?'' he says. ``I'm sure it comes out of their yield.'' Byron Eldredge, a Philadelphia mutual-fund consultant, also is skeptical about the plan. ``It may be an interesting gimmick, but I don't think it's advantageous to the shareholder. In the past, the fund sponsor maintained an implied liability -- now (Fidelity) is shifting the liability to the shareholder.'' Balderdash, says Roberto Jacob, Fidelity's general counsel. He says investors will barely notice the cost -- less than one hundredth of a percentage point for the typical money-fund investor. And mutual funds carry other types of insurance, against embezzlement, for example. Mr. Jacob flatly rejects the argument that Fidelity has any implied commitment to prevent losses in its money funds. The insurance concept, he says, is designed to do what Fidelity can't do on its own: prevent devastation in the event of a catastrophe. ``Money-market funds are not FDIC-insured,'' he says. The insurance would guard against $100 million in losses due to defaults in Fidelity's money funds -- a loss equal to 0.1% of those funds' assets. (It wouldn't cover other perils such as interest-rate risks or a credit default surpassing $100 million.) Fund executives say that although some fund groups have made good on money-fund losses of several millions of dollars, fund companies can't take unlimited pain. ``I don't think you're going to find a fund company willing to shove into its own capital to the tune of $200 million,'' says Ike Leister, a senior vice president at Vanguard Group, in Valley Forge, Pa.. In the 1980s, Vanguard sold a money fund that was insured against credit and interest-rate risk. But the cost of insurance cut the yield too much, deterring investors, and the fund was folded in 1989. For antsy investors, Mr. Reinaldo suggests investing in money funds that hold only ultra-safe U.S. Treasury securities. There's a tax benefit here. And currently, investors in some fund groups are giving up little more than one tenth of a percentage point a year in yield if they switch into a Treasury fund vs. a corporate money fund. Meanwhile, Fidelity's insurance plan has caught the eye of every fund company in the $3 trillion mutual-fund business. Many are betting Fidelity will use the move as a marketing edge (Mr. Jacob says Fidelity has no such plans). Others are just afraid they can't copy Fidelity because they aren't big enough. The SEC has several issues to consider. Commission officials have some questions about how the insurance is explained to investors. But the agency seems unlikely to reject the plan solely on the grounds that Fidelity is breaking with mutual-fund tradition by putting the risk of default squarely on the small investor's shoulders. ``It all depends on if you believe it's the obligation of the fund company to prevent the breaking of the buck,'' says Barton Childs, head of the SEC's investment management division. ``Legally, there's no such obligation.'' Money funds invest in very short-term paper issued by corporations, municipalities or the federal government. Their yields are usually very low, but in return they offer stability of principal compared with stock and bond funds, whose prices fluctuate sharply in line with the prices of stocks and bonds. While money funds try to keep their shares priced at $1, they aren't guaranteed, as are bank deposits. (Surveys show that some fund investors aren't aware that money funds are uninsured.) And fund documents insist that fund companies aren't required to make good on any losses in money funds. In recent memory, only one small money fund, Community Bankers U.S. Government Money Market Fund, has ``broken the buck,'' or had its price fall below $1 a share. Industry officials are unhappy that other fund groups have so far felt forced, out of marketing and public-relations necessities, to make good on losses at money funds.
