ONE SHARE class of the ProFunds Money Market Fund was earning 0.01 percent when the Federal Reserve Board cut interest rates Nov. 6.
Now, 0.01 percent can hardly be classified as a "return." At that rate, it would take about 7,200 years for a shareholder's money to double. But it's still better than a loss.
And with the Fed cutting short-term rates by 0.5 percentage points, ProFunds executives - and those at about 70 other money funds that were earning less than 0.5 percent - were sent scrambling to make sure that their safest issues didn't lose money.
When the average money market fund is yielding less than 1 percent and dozens of funds are in danger of becoming money losers, it's time for investors to reconsider whether this is where they want to stash their cash.
Money market mutual funds are the fund world's safe haven. Their share value is designed to stay at a constant $1, with interest being paid out in the form of new shares. Of course, to make that payout, a fund must have positive earnings after expenses.
In general, money funds invest in ultra-safe securities such as Treasuries and high-grade corporate bonds, siphon off a sliver for expenses, and then pay the rest back to shareholders.
But when the investments a fund buys are paying pennies, expenses and other costs can overwhelm the fund's ability to generate income. That's what the Fed's rate cut basically ensured would happen in the case of ProFunds and other small earners. Without waiving expenses or eliminating fees, those funds were in danger of "breaking the buck," moving their share price below $1 and creating losses for investors.
"We're pretty confident that everyone who was in danger of breaking the buck will waive fees to avoid a zero or negative yield," says Peter Crane, managing editor at imoneynet.com, which tracks money fund returns. "Any fund that goes negative won't stay there long, because either the Securities and Exchange Commission will shut them down or the investors will all take their money elsewhere."
Before the Fed's rate move, according to imoneynet.com, the average money market mutual fund was earning 1.21 percent. In the first week after the rate cut, money fund yields dropped to an average of 1.05 percent. By the end of next week, the average money fund will be earning in the neighborhood of 0.75 percent.
"It's not much better than having your cash in an ordinary checking account," says Crane.
Clearly, investors have taken notice. Where money funds were once a safe haven for those fleeing the stock market, they now face investors ready to run from their unattractive yields. But rather than put that money back into stock and bond funds, there is some indication - most notably a recent study by Strategic Insight, a New York data firm - that the money is actually moving into bank deposits.
Bankrate.com shows the average return nationwide on money market accounts beating the yields on certificates of deposit that are shorter than 6 months. That means bank deposits outperform money funds only if you lock up your money for at least a half-year. Of course, bank deposits do have the benefit of federal insurance against the failure of the institution. There is no such insurance for money market funds.
What the trend means for investors, however, is that money fund holdings need to be reviewed.
For shareholders, this starts with scrutinizing a fund's current cost structure. Many money market funds attract investors by waiving fees to increase their yield; over time, however, the expenses sneak back into the picture, turning the fund into an average performer, or worse.
Moreover, some money funds sold by advisers come with sales charges or 12b-1 marketing costs. This is how ProFunds ate away so much of their shareholders' returns.
Money funds can also come in expensive clothing. If you own a money fund in a retirement account, a variable annuity or a wrap account with a brokerage, for example, you are paying additional administrative costs. The fund might look positive, but the costs can effectively swallow all of your gains.
Check-writing fees and other costs also can turn performance negative.
That's not a suggestion to run from money funds, but rather to invest in them carefully so that you squeeze as much yield as possible from them.
"If this continues for another month or two, I'd expect to see a lot of funds closing or merging," says Crane. "But then again, if this continues for another month or two, people might start thinking that the potential of the stock market looks a lot better than the potential of a money market fund."
Charles A. Jaffe is mutual funds columnist at The Boston Globe. He can be reached by e-mail at jaffe@globe.com or at The Boston Globe, Box 2378, Boston, Mass. 02107-2378.