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Mutual fund sector owes National Bank big time for intervention

The mutual fund industry and its customers can watch the mayhem in financial markets a little more comfortably now thanks to National Bank of Canada.

If conditions in the markets get a lot worse, it may even turn out that National Bank saved the fund industry from a public relations disaster. That's how important the bank's move yesterday to protect clients of its money market funds was.

Money market funds offered by National Bank's own fund arm and subsidiary Altamira Investment Services are exposed to asset-backed commercial paper, a type of security that has been dragged into the mess created by defaults in the U.S. subprime mortgage market.

Asset-backed commercial paper offers an opportunity to buy into a package of credit card debt, mortgages or car loans, and money market fund managers are avid users because the returns are better than standard fare like Treasury bills. Much of the asset-backed paper owned by money market funds is backed by big banks, and there doesn't seem to be much concern about this end of things right now.

The problem is in paper issued by non-bank financial firms. There's more trepidation about these securities and it has trickled down to the money market funds that own them, including those run by National Bank. In a worst case, declining values in asset-backed paper might require these funds to freeze redemptions or slash their unit price, which is traditionally pegged at $10.

National Bank's move to buy the asset-backed paper held by its own funds and Altamira products removes this risk. Now, National takes the pain if there's a wipeout in the asset-backed paper market, not small investors who would be staggered by the prospect of losing money.

That's the thing about money market funds - they're widely considered a safe investment, and they're typically held by people who never read, much less understood, any fund company boilerplate describing a trace level of risk in these products. Just imagine what would happen if clients of even a single significant fund family lost money in a money market fund. The result would be a worse scandal for the mutual fund industry than the market-timing scandal of a few years ago.

For the most part, fund companies understand the bond of trust between it and the people who buy money market funds. While many of these funds have dipped into asset-backed paper to enhance returns, they've stuck to bank-issued products and thus held the line on risk.

National is among the fund companies that was less picky in the asset-backed paper it bought, but that's not a point worth belabouring here. What matters is that the bank recognized the potential danger to its clients, and its own reputation, and acted.

The fund industry, particularly the big banks, owes National a big thank-you. The explanation here begins with the fact that there's almost $49-billion sitting in money market funds, about two-thirds of it controlled by the Big Six banks, including National.

It's a highly lucrative line of business, as you might expect given the heavy involvement by the banks, and revenues run in the hundreds of millions of dollars each year. Security is the key here. If any money market fund of even modest size were to run into trouble, all investors would have good reason to move their cash into high-interest savings accounts and, for larger accounts, T-bills and banker's acceptances.

As of yesterday, most of the major banks had announced that their money market funds had no exposure to non-bank asset-backed paper. They went on to say they expected no changes to the asset values of their funds, which means investors should continue to receive monthly interest from these funds without fear of losing money.

National Bank's news release on behalf of Altamira funds may have been most educational from the investor's perspective. The bank noted that Altamira money market funds offer no assurances they can maintain their net asset value and protect against losses. It also pointed out that money market funds are not insured by Canada Deposit Insurance Corp., as are high-interest savings accounts and guaranteed investment certificates.

In shoring up the money market franchise for the mutual fund industry, National Bank has also highlighted the fact that these funds are not risk-free. This brings us back to high-interest accounts, a corner of the financial marketplace where there happens to be some stiff competition these days. The rates are higher than money market funds, fees are non-existent and federal or provincial deposit insurance offers a safety net. What a deal.


By the numbers


total held in money market funds as of July 31


total assets held by the fund industry


percentage of total fund industry assets in money market funds


number of the Top 10 Canadian money market funds as ranked by assets that are owned by the big banks


assets in RBC Premium Money Market, the largest Canadian money market fund


minimum upfront investment for RBC Premium Money Market


Average one-year return from Canadian money market funds


Average yield on federal government T-Bills for terms of one month to one year

source: Investment Funds Institute of Canada,, Bank of Canada

© 2007 The Globe and Mail. All rights reserved.

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