T-bill yield challenge

BOSTON – Three months after the government stepped in to prop up reeling money-market funds, the $3.8 trillion industry is largely healthy again, with money flowing back to the safe-harbor investments at a steady clip.

But there’s one problem: Yields for the safest category of money funds, those that invest in Treasury bills, have sunk to near zero. That means fund companies’ returns are barely enough to offset expenses to run the funds unless yields creep back up again soon – a prospect considered unlikely given the Federal Reserve will need more time to give its rate-cutting campaign time to take hold.

Dropping yields at Treasury-only money-market funds aren’t expected to trigger investor losses, and money-market funds – including higher-yielding prime funds that invest in corporate debt – remain safe places to park cash after the hit stocks have taken this year.

“If Treasury funds yielding zero is your biggest problem in these markets, congratulations,” said Peter Crane of Crane Data, publisher of the newsletter Money Fund Intelligence.

But declining yields are eating away at the already slim returns clients expect from money funds. The average yield for funds investing exclusively in T-bills now stands at 0.20 percent, according to iMoneyNet, another money fund research firm. That means an investor plowing $1,000 into a Treasury-only fund would see a return of $20 after a year.

With the realistic possibility that fund companies may temporarily start to suffer losses at their lowest-yielding funds, some providers are responding by closing Treasury-only funds to new investors, or limiting new investments by existing clients. For example, Vanguard recently imposed new restrictions at a couple of its Treasury money-market funds.

Still, times are better for money funds than three months ago, when a large fund called the Reserve Primary Fund exposed investors to losses because of a soured investment in Lehman Brothers. That episode of a fund “breaking the buck” – in which the value of the fund’s assets fell below $1 for each investor dollar put in – triggered a rush out of prime funds investing in corporate debt until the federal government offered guarantees to back money funds.

Now, with guarantees in place, total money-market mutual fund assets are up nearly 12 percent to a record $3.8 trillion, from a recent low of $3.4 trillion in late September.

But prospects are grim for the 20 percent of the money fund industry’s total assets in the lowest-yielding and safest category: funds that invest exclusively in virtually risk-free T-bills.

Crane, of Crane Data, said even if some of those funds aren’t able to maintain yields big enough to offset expenses, they’ll have enough financial cushion to ride things out until yields rebound.

“This is a gradual problem that fund companies will have plenty of time to deal with,” Crane said.