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Fee reductions and market conditions put future of money market funds into question

By Al Emid | March 12 2009 09:41PM

Some fund companies have begun reducing fees on money market funds in an effort to avoid negative returns for clients in the current low interest environment. This low-rate environment, combined with competition from high interest savings accounts, is even leading some industry observers to question the future of this fund category.

In mid February, CI Investments reduced management expense fees from 1% to 0.80% on Class A versions of its Canadian money market and short-term corporate class funds, regardless of whether sold on a front-end load or deferred sales charge basis, and reduced trailer fees from 0.25% to zero, the rate applied to units sold on a front-end load basis, but not to units sold on a deferred sales charge basis.

CI's move suggests serious concerns, says Robert Frances, president of Montreal-based Peak Financial Group. "That's a very drastic measure. It only indicates to me that CI is undergoing some serious questions."

The move also disrupts what Mr. Frances terms "an unwritten rule" in the fund industry. "Traditionally the mutual fund companies have been the collection agency for revenues for the advisors," he says. "Essentially they're just collecting what has already been discussed with the client," he says, referring to trailer fees.

Paradoxical

"It's rather paradoxical. Advisors bring that money to CI and then when times get tough, CI reduces its income by 20% and the advisor by 100%."

The continued low interest rate environment leaves this fund category open to questions about its future, Mr. Frances says. "Every advisor understands that if a money market fund will earn zero, nobody can earn anything, including the fund company."

CI may have disrupted its advisor relationships by handling the need for cost-cutting unfairly, Mr. Frances suggests, pointing to the fact that while the company completely eliminated trailer fees on these funds, it only reduced management fees. "They are reducing their income by 20% and they are reducing the advisors' income by 100%. Many advisors find that questionable behavior," he says. "I think they would understand if there was a reduction in revenue that was identical, [meaning that] the advisor will go from 25 basis points to 20 basis points."

Company executives from CI refused to comment directly despite repeated requests from The Insurance Journal and confined comment to three e-mail responses. Denied access to CI executives, The Insurance Journal asked via email whether and how CI could expect continued sales of its money market funds since it had removed the service fees?
CI responded that it does in fact expect continued sales because its funds "...continue to meet the needs of investors who require capital preservation and liquidity." In its communications, CI did not directly address advisor concerns over the removal of service fees.

Mackenzie Financial Corporation, meanwhile, has spread the pain of reduced fees on its money market funds between company and advisor. Mackenzie decided on a pro rata strategy, explains David Feather, president of Mackenzie Financial Services Inc. and has decided to reduce management fees and trailers in proportion to their relationship.

"As an example, if our management fee [on one of the funds] is 50-basis points and the trailer fee was 25 basis points or half the management fee, then for every two points off the management fee, one would come off the trailer, so it's pro rata," he says. This decision applies to numerous funds including the Mackenzie Sentinel Cash Management Fund, the Mackenzie Sentinel Cash Management GIF and the Mackenzie Sentinel Money Market Fund.

Flexibility

The actual reduction is flexible and the goal is to ensure that investors do not end up with negative returns. "It will vary depending on the different yields on any day, but we will take our fee down to whatever extent we have to, to make sure that the fund never goes negative."

Like CI, Mackenzie has not set any termination date for the changes, according to Mr. Feather. He explains that the changes will apply for as long as the low interest rate environment continues. "That could be two months. It could be years," he says. "At some point, a more a typical environment will prevail and we'll back to normal. We just don't know how far off that is."

Invesco Trimark recently decided to leave trailer fees untouched and to confine reductions to management expense charges on its money market funds. It plans to vary the reductions in order to keep the fund yields above zero, explains Aysha Mawani, the company's vice president, Corporate Affairs. "We're definitely committed to ensuring that our money market yields stay positive in this market environment," she says. "We are definitely continuing to support the yields on the funds to ensure that the net asset values do not dip below the $10 amount (which is standard on these funds)."

Trailer fees

Like CI and Mackenzie, Invesco Trimark has no timeline for ending the changes.

While the Invesco Trimark approach may appeal to advisors, it may become unsustainable over time for the company to absorb all of the reduction without touching the trailer fees, suggests Jay Nash, associate portfolio manager at the London, Ontario branch of Wellington West Capital Inc. He argues that if the current low interest rate environment continues for a long period, the company may have to re-examine the decision.

Fee reductions by other companies appear inevitable, according to Mr. Nash. "Generally speaking, once this has started they're all going to have to address it in some way," he says, adding that he believes other companies will eventually adopt the CI, Mackenzie or Invesco Trimark approach.

The decisions of these companies, with others rumoured to be about to follow suit, could signal a trend, says Dan Hallett, president of Windsor-based Hallett & Associates. "It might be too soon to call it a trend yet, but I think it's certain it will become one," he says, adding that the trend will be driven by the outlook for continued low rates.

Furthermore, the trend can be expected to continue for as long as the current economic climate remains uncertain and rates remain low, an equation that suggests it will last at least until the end of this year, he says.

A broader question is the future of money market funds as a category, according to Mr. Nash. As well as the current low rates, they face obstacles from competing products like high interest accounts, such as those offered by B2B Trust. These accounts pay higher interest rates than money market funds and also provide advisors with trailers, typically at 0.25%. "Traditional money market funds no longer have a place in portfolio management," he suggests, although they may continue serving as temporary parking place for dollars between fund transfers. "This category may see large reductions in the capital or may cease to have an importance to the investor."

Competition from banks

Moreover, Canadian banks' requirements for Tier 1 capital indirectly ensure that they will continue providing these accounts at rates more attractive than available through money market funds, Mr. Nash believes. "The banks are competing against the fund companies for the safe cash and they'll pay for it," he says.

Further, those looking for a safe harbour for their investment dollars have other options that are essentially safe although with a measure of risk, Mr. Nash argues, pointing to Bank of Montreal common shares as an example. At time of writing, BMO shares are selling for $27.64 and offer an annual dividend of $2.80 for a yield of about 10.13%. Even if returns dropped 25%, an investor would do better than in a money market fund, assuming no reductions in dividends, or changes in current interest rates and before factoring in the dividend tax credit, he points out.

Meanwhile, in January Questrade Inc. a direct trading brokerage, launched its Mutual Fund Maximizer offering that provides rebates on trailers for all funds to the extent that they exceed a monthly service fee of $29.95.

Questrade does not style the move as a reaction to low yields but an extension of its value proposition, explains Edward Kholodenko, the company's president. "Part of the value proposition that we offer to the self directed independent investor is lower fees and more transparency," he says. "We're not providing advice to the customer so it seemed like a natural thing to offer, whereby we would rebate the trailer fee but charge a monthly fee."

According to data from the Investment Funds Institute of Canada, funds in the Canadian money market category posted positive sales numbers in January hitting just over one billion. This is down, however, from January 2008, when sales hit $4.16 billion.

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