Relatively low interest rates and high management expenses have combined to punish returns of some money market funds. Advisors can still find good yields, but it takes quite a bit of shopping around.

Most funds with minimum investments of $10,000 have pretty solid returns, according to Morningstar Canada data. Six of 20 exceeded the 2.4% that ING Direct pays on its competitive no-fee, no-minimum investment savings account, and 10 more earned an annual average compound return for three years of more than 2%

It’s when you get to the funds with minimums of $5,000 or less that returns tend to be considerably lower, averaging 1.62% for 80 funds.

Two firms that stand out in terms of low returns and high MERs are AGF Funds Inc.
and AIM Funds Management Inc. , but management of neither company is concerned.

AGF views its Canadian Money Market Fund — which, at 1.06%, has the sixth lowest average annual compound return for three years and, at 1.58%, the sixth-highest MER — as a temporary parking spot and a convenience for investors, not a savings vehicle.
Investors who want a better return can invest in AGF Short-Term Income Fund, which has a lower MER of 1.29% and an even better return at 1.51%. Morningstar considers this a specialty fund, so it isn’t included in this analysis.

AIM has three of the lowest-returning funds, all generating less than 1% and all with very high MERs of 1.86% or more. In the case of Trimark Interest DSC Fund, the
MER is 88 basis point higher to pay for the DSC. But no reason is given for the very high fees for AIM Short-Term Income Class A and Class B funds. However, investors have choices at AIM. They can invest in Trimark Interest, which had a return of 1.68% or AIM Money Market, with a 1.35% return.

Paltry returns

Despite the paltry returns on some funds, this type of investments is still well-used. As of Aug. 31, a total of $48.9 billion was invested in money market funds. Almost a third, $16.4 billion, was in 14 funds with minimum investments of $10,000, while the six
funds with minimums of $10,000-$50,000 have $1.3 billion in assets. That leaves $32.5 billion in funds with minimums of $5,000 or less.

There is about $1.6 billion in 66 segregated money market funds, all with minimums of $5,000 or less. The range of returns was 0.48%-2.21%, with an average of 1.33% — lower than the 1.62% for the comparable mutual funds.

That’s because the cost of the insurance element in seg funds pushes up the MERs, which average 1.44%, vs 1.04%.

Those who invest in money market funds tend to use them as short-term parking spots for money they have withdrawn from one fund that they plan to invest in another fund soon.

But some investors use Canadian money market funds as part of the cash portion of their portfolios, says Simon Hitzig, executive vice president of marketing at Dynamic Mutual Funds Ltd. in Toronto.

For those who use one of these funds as a short-term parking spot for a relatively small amount of money, the returns don’t vary much. On a $5,000 investment, they can expect to see monthly returns of $11 from funds with highest returns and only $1 from those with the lowest.

However, on large amounts of money, returns can vary significantly. The range of interest received for one month would be $20-$223 on $100,000, $100-$1,117 on $500,000 and $200-$2,233 on $1 million. Financial institutions recognize this and generally offer high net-worth investors funds with attractive returns and low fees. It is here that it pays to shop around, even for short stays.

Altamira T-Bill Fund is one of the best bargains around, with a three-year average annual compound return of 2.3%. and an MER 0.39%.

This fund was launched in 1998 along with Altamira Short-Term Canadian Income Fund, whose MER is only 0.57% and three-year average annual return is 2.3%, as low-cost company-subsidized alternatives. According to the prospectus, the MERs would have been higher (0.65% for the T-bill fund and 0.83% for the short-term fund in 2004) if the company did not waive the management fee and some of the administration costs. Morningstar considers the short-term income fund as fixed-income, so it is not included in this analysis of money market funds.

@page_break@Apart from Altamira T-Bill, there were nine other funds in the $5,000-or-less minimum investment category with three-year returns of 2% or better. At the other end, there were 12 funds with returns of 1.34% or less.

In most cases, the differences in return is determined by the MERs. But there are exceptions, which is an indication that a good manager can add value.

Take Montrusco Bolton T-Max. Its manager had to produce a gross return of 4.15% to
pay the 1.48% MER, which resulted in the highest average annual compound three-year return of 2.68%. However, this fund doesn’t appear in the table because it requires a minimum investment of $150,000. Then there’s Stone & Co. Flagship Money Market Fund. Its managers eked out only a 2.22% gross return, the lowest of 100 funds, while investors paid an above-average MER of 1.12%, resulting in a average annual compound return for the three years of just 1.1% The average MER was 0.95% for all the funds and 1.04% for funds with minimum investments of $5,000 or less.

There are a lot of different strategies that can be used to enhance returns, says Richard Levesque, manager of money market funds for National Bank Securities Inc.

Fund managers can play the yield curve. Money market funds can’t invest in instruments with durations of more than a year and must keep the average duration to no more than 90 days. But that still leaves a lot of scope because managers can go as short as one day with overnight paper. They also have to guess which way interest rates are going — and when — and then construct an appropriate yield curve, says Levesque.

They can also buy U.S. instruments, if they have greater returns, and turn them into Canadian dollars. In addition, they can negotiate discounts with the seller. Even 10 basis points can make a difference, considering that some of the funds have significant assets. Three National Bank money market funds each contain more than $700 million.

As for Dynamic, Hitzig says, the company’s management fee of 1% is similar to the average of its major competitors, the big six independent mutual fund companies.
Dynamic’s expenses tend to be a little higher, although the company is working on lowering them, which will result in lower fees.

Corporate class

Dynamic offers five money market funds: two under the Dynamic name, one Cartier,
one Hathaway and one Radiant. All are managed in the same way. Four have the the same MER of 1.38%, but Dynamic Money Market Class charges only 0.67%. This fund is part of the corporate class of funds that investors can move to without triggering capital gains. For these investors, the advisor’s trailer fee is dropped. Hitzig says advisors have not complained.

Like other companies, Dynamic also offers a dollar-cost averaging fund. For this, Dynamic has waived its management fee, resulting in an MER of 1.12%. This is done as a courtesy to investors who have already decided to invest in Dynamic funds.
IE