The Reserve Primary Fund broke the buck in September, but despite fears to the contrary, it has not broken the back of the money market fund industry.
Assets held in money funds rose 28.2% from a year earlier, to $3.4 trillion as of March 31, according to Morningstar Inc. — hardly the result observers expected after panicked investors responded to the Reserve Management Co. fund's incident by withdrawing $144.5 billion from money funds in the third week of September.
Observers expect still more growth, especially at the industry's biggest firms.
"A lot of people thought money funds as we knew them were in trouble — maybe not dead, but definitely troubled," as a result of what happened to the Reserve fund, according to Lloyd Wennlund, an executive vice president at Northern Trust Global Investments. "But ultimately, I think it allowed the substantial players in the money market fund space to rise to the top of a crowded field."
Industry executives attribute the asset growth to declining interest rates and the difficult economic conditions that have forced investors out of equity funds — and into a product that could generate a higher return than a savings account while offering a reputation for safety, the Reserve fund aside.
(As of April 30 the average money fund was generating an annual return of 0.53%, according to Lipper, while the average savings account was generating a return of 0.26%.)
"The Reserve Fund changed this industry forever," said David Fishman, a managing director at Goldman Sachs Asset Management and its co-head of global liquidity management. "People now realize that there is no such thing as free yields. Now when it comes to money funds, investors are choosing safety and liquidity over larger yields."
Steven R. Meier, an executive vice president at State Street Global Advisors and its global cash chief investment officer, put it this way: "Investors have realized in the past year that the core objective of money funds is capital preservation."
At Northern Trust, Wennlund said, institutional and individual investors have moved assets from general-purpose money market funds to still-safer money funds, including government and government select funds.
Fishman said he expects fund managers in charge of more than $100 billion of money market fund assets to continue to generate above-average growth.
That's because "investors are just going to be more comfortable working with companies that have more resources around them," he said. "This really bodes well for larger managers. Larger companies will attract a lion's share of the business, and smaller companies may exit or get smaller."
According to Morningstar, money fund assets held by the 10 largest providers, which all have more than $100 billion of assets, increased 32.7% from a year earlier, to $2.3 trillion as of March 31.
Consolidation and a potential increase in regulation are also likely to benefit large, conservative money fund companies, executives say.
Both the Securities and Exchange Commission and the Investment Company Institute are considering new rules for the money fund industry to keep other funds from breaking the buck.
Meier said that before the Reserve fund's troubles, too many managers had been running their money funds with a "bond manager's mentality," allowing unacceptable levels of risk to creep into their portfolios. This practice "got a lot of smaller competitors into trouble."
Fishman said it will become more difficult for a fund manager with $3 billion to $5 billion of money fund assets to be profitable, and this could lead to industry consolidation.
"There is going to be a lot more scrutiny on money market funds, and these products are going to become more expensive to run," he said. "I think the bar is being raised for what it will take to be a scale player."
Meier called consolidation inevitable. He said about 26 money fund providers needed capital to sure up operations over the past 21 months; these companies will need to "sell or outsource."
State Street is talking with a few of these firms about a possible deal, he said. "After everything that happened with the Reserve, investors are astute enough to realize that these products aren't about yields," Meier said. "Investors want to go to a company with critical mass and the resources to withstand the next panic."
Charlie Morrison, a senior vice president for Fidelity Investments and the leader of its money market group, said the industry has already seen some consolidation, and more is possible. "To manage assets, you need a critical mass of resources to manage through the most volatile periods," he said. "Not everyone in the market today has the resources necessary."
Fishman said he does not think Goldman Sachs will look to buy small money fund managers. He also said the company does not plan any major changes to its money fund strategy in the next year. "We have always been a conservative player. We have never chased yields, and sometimes that has cost our business when customers went to someone with a higher yield," he said.
Observers expect the large industry players to emerge from the crisis in better shape than before, though the same will not be true for the Reserve Fund.
On Tuesday the SEC filed a complaint in the U.S. District Court for the Southern District of New York saying the fund's managers committed fraud by failing to provide material facts to investors and trustees.
The complaint named Reserve Management, along with Bruce R. Bent, its founder, chairman and chief executive, and his son, Bruce R. Bent 2nd, the president. The complaint, filed, seeks to expedite the distribution to shareholders of the fund's remaining $4.8 billion of assets.
In the same court Tuesday, Visa Inc. filed a $98 million breach-of-contract suit against Reserve Management, saying it is wrongly withholding a portion of a $982 million redemption request tendered Sept. 15. The elder Bruce Bent said in an e-mail: "The Lehman Brothers bankruptcy filing created an unforeseeable and out-of-control condition for many parties, and the results were serious. Our management worked extremely hard throughout the chaotic and fast-moving events of September 15 and 16, and we remain confident that we acted in the best interest of our shareholders. We are hopeful that this matter can be resolved quickly."
Bloomberg News contributed to this story.