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Why Fidelity dumped short-term Treasurys
A guide to understanding how money-market funds work

When word got out last week that Fidelity Investments, the nation’s largest manager of money-market mutual funds, had dumped all of its short-term U.S. government debt, the pundits, talking heads and political partisans all started spinning the story to their advantage.

It was positioned as a statement on the safety of government bonds in light of the federal shutdown and the looming debt-ceiling issue, it was discussed as a step that shows the country could soon see a cut in its credit rating, and it was labeled as the next step in a downward spiral with politicians fiddling while Washington (and the rest of the country) burns.

In reality, however, it was business as usual, a step that has much more to do with the world of money-market funds than the realm of politics and public policy. It was also a predictable, necessary move from a company that controls more than 15% of the $2.67 trillion currently held in money funds.

To see why investors should ignore the political spin and not read anything but “business decision” into this, you need to know a bit about how money funds work, especially in light of the financial crisis of 2008, where the collapse of the Reserve Primary Fund – the world’s oldest money fund – was directly responsible for much of the misery that infected every market around the globe.

Money-market funds are the ultra-safe parking spot for cash in the mutual fund world. Priced at a constant $1 per share, they invest in short-term securities; while there have been times, historically, when yields have reached the double-digit realm, in recent years money funds have earned next to nothing. Currently, according to Crane Data, the average money-market fund nationally yields 0.02%, a rate so low that it would take a deposit made today some 3,600 years to double.

With rates that low, some fund firms have been closing their money-market funds because there’s no profit in them. The big, brand-name companies like Fidelity, offer them almost as a professional courtesy to investors; they keep the business around not because it is adding anything to the corporate bottom line, but because there will be profits there again someday when interest rates rise.

The last thing the big boys can afford, however, is any sort of problem that might force a money fund to “break the buck,” where a decline in the value of the fund’s holdings drops the price below the constant $1 level. That’s precisely what happened to Reserve Primary Fund at the center of the 2008 financial crisis, when the fund held some Lehman Brothers paper that lost value as the big brokerage firm sought bankruptcy.

Generally speaking, retail investment firms buy troubled paper back from their money funds whenever there is an incident that even raises the specter of breaking the buck. The fund firm can then hold the assets through any temporary decline or eat a small loss, but protecting the fund avoids the embarrassment and subsequent investor panic that comes from allowing a money fund to post a loss.

Fidelity, with such a large share of the market, can’t just self-insure against the prospect that the U.S. government may not be able to re-pay bondholders for a short period, while politicians wrestle over the debt ceiling.

A single day of uncertainty on short-term bonds could amount to hundreds of millions of dollars for the parent company to buy the paper from its own funds to avoid breaking the buck.

Thus, Fidelity has quietly backed away from short-term U.S. government debt, anything that matures in October and November, the most vulnerable time frame if politicians can’t figure out a way to stop the government from running out of money.

“We expect Congress will take the steps necessary to avoid default but, in our position as money market managers, we have to take precautionary measures,” Nancy Prior, president of Fidelity’s Money Market Group told the Associated Press on Wednesday.

It’s not the first time Fidelity has done this, most recently jettisoning short-term government securities when Standard & Poor’s downgraded the nation’s credit rating in the summer of 2011 as the government was, again, coming close to a default.

“When you’re that big, you have to move first and move quickly,” said Peter Crane of Crane Data, which tracks the money-fund business. “Nobody wants to be the tip of the spear on those game-of-chicken dates we keep hearing about, and the big guys have to act first or they might not get the chance.”

Added Geoff Bobroff, an industry consultant in East Greenwich, R.I.: “It looks bad when you have a headline saying Fidelity is dumping its Treasurys, but that’s not the real story here; it’s business as usual in the unusual circumstances we’re living in.”

In the end, Fidelity’s move isn’t the spooky Halloween story that the media, pundits and talking heads wanted it to be.

Said Crane: “If you want something scary about money funds, something to worry about, it’s not what Fidelity is selling or buying. It’s that scary 0.02% yield you’re getting from your money funds; that’s something for money-fund investors to worry about.”


http://www.marketwatch.com/story/why-fidelity-dumped-short-term-treasurys-2013-10-12?siteid=YAHOOB