Even before the financial crisis, the dangers of “reachign for yield” have been well known and warned about. So this WSJ cautionary tale about Bruce Bent, the father of of the money market industry, whose own fund “broke the buck” when Lehman collapsed, reads like heartbreaking tragedy.
The basic plot goes like this: Act I: Conservative investment manager offers savers slightly higher yields on cash by investing their savings in the most conservative investments imaginable — mainly Treasuries. The money market industry booms. Act II: Other firms enter the space, but buy riskier assets like corporate paper. The original industry father scolds them for risk. Act III: After falling behind its competitors because it couldn’t compete on yield, they can’t take it anymore. fund loads up the boat on risky stuff, including nearly $800 million worth of Lehman paper. Lehman collapses almost overnight and the fund breaks the buck.
Reserve had told the Securities and Exchange Commission in September 2005 that “to further minimize investment risk, the Funds do not invest in commercial paper.” In another federal filing on March 15, 2006, Reserve said its funds had “slightly underperformed” rivals, owing to a “more conservative and risk averse manner” of investing, and noted: “For example, the Funds do not invest in commercial paper….”
A week later, Reserve amended its prospectus, deleting a line that said the Primary Fund couldn’t buy commercial paper.
Within two months, such paper made up 5.7% of the fund’s assets. The percentage soared tenfold in two years. The result was that by this September, the Primary Fund’s 12-month yield was the highest among more than 2,100 money funds tracked, according to Morningstar — 4.04%, versus an average of 2.75%. With this stellar yield, the fund’s assets tripled in two years to $62.6 billion.
Mr. Bent didn’t stop talking about investment caution. On Sept. 5, in commenting to the SEC on a regulatory proposal, he wrote: “When I first created the money market fund back in 1970, it was designed with the tenets of safety, liquidity and a reasonable rate of return. What the past year has demonstrated is that these have fallen to the wayside as portfolio managers chased the highest yield and compromised the integrity of the money fund.”
It was other portfolio managers that made Bent do it. By compromising the integrity of the money market fund, he had no choice but to do it himself.