Q&A Time: Bond Ratings Affecting Money Market Funds

Question:

If the ratings on government bonds fall below AAA, I’m concerned that money market funds will have to sell the bonds because the prospectus may state they can only own AAA rated bonds.  Money markets will then fall below the $1 per share. I have funds in money markets with Schwab. What is your opinion?

Answer:

We have not looked over all the money market funds used in client accounts, but Schwab Value Advantage (SWVXX) is among the most commonly used money markets. In looking through the prospectus of SWVXX, we note the language is vague enough that it should not cause the fund to sell U.S. Treasuries on a downgrade. In fact, the fund holds many short-term corporate bonds that are not rated AAA.  Money market funds only invest in instruments with 270-day or less maturity. Generally, these are high quality bonds that pay interest.  Sometimes you may find a little bit riskier investment, but these are usually such a small percentage, that a default on a single issue should not hurt the fund significantly.

In the strategy language, it is stated that the fund seeks the “highest current income consistent with stability of capital and liquidity.” Again, this falls short of specific language that would force the manager’s hand to sell treasury bonds at a discount.

As for the concern of falling asset value to force the money market below $1, the only “government” bonds held in SWVXX, as of June 30, 2011, were Fannie Mae and Freddie Mac bonds. Although they were both bailed out in 2008, neither Fannie Mae nor Freddie Mac is officially backed by the full faith and credit of the U.S. government. These bonds made up approximately 9% of the total holdings, as of June 30, 2011. We should not expect them to suffer significantly. Based on this information and our belief that the United States will not fail to pay its debts, we do not recommend removing your assets from the money market at this time.

Overall, the bond market has been unfazed by the threat of default. The 10-year U.S. Treasury has ticked down only 0.01% during the week. Sovereign bonds of countries with AA ratings are trading at higher interest rates than ours.

If you have questions regarding the Treasuries or money market funds you use, the experts at Henssler Financial will be glad to help. You may call our experts at 770-429-9166 or e-mail at experts@henssler.com.

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