Money Funds Buck Euro-Zone Retreat

By KIRSTEN GRIND

At a time when many money-market mutual funds are piling out of Europe, some are looking for more of it in their quest for higher returns.

Eight of the 20 money funds with the most exposure to Europe, as measured by total assets at the end of May, increased their euro-zone holdings between last August and May 31, according to iMoneyNet, a research firm in Westborough, Mass. Managers of the eight money-market mutual funds that ramped up their European holdings include BlackRock Inc. and Goldman Sachs Group Inc.

Officials at such funds insist they aren't taking bigger risks, noting their heightened exposure to Europe is coming through short-term "repurchase agreements" issued by European banks.

A repurchase agreement is a short-term loan in which the investor acts as a lender to the bank issuing securities. The bank offers collateral, usually in the form of U.S. Treasurys and other government securities.

The repos "are an incredibly low-risk exposure," says Dave Robertson, a partner at Treasury Strategies Inc., a consulting firm in Chicago. The reason: If a bank were to default on its loan, the money-market fund would be made whole by the government-issued securities backing the agreement.

Joseph D'Angelo, head of money funds for Prudential Fixed Income, a unit of Prudential Financial Inc., boosted the euro-zone exposure of the asset manager's Prudential Core Taxable Money Market Fund by 11% in the nine months ended in May, according to iMoneyNet.

Mr. D'Angelo says the rise came from repos, largely with BNP Paribas SA of France and Deutsche Bank AG of Germany. The fund's returns of 0.22% through May 31 were sharply higher than the 0.06% for the Crane 100 Money Fund Index, an average return of the 100 largest money funds.

"You're trying to find a risk-free way to find yield, and given the way the curve is in the market, I'll take a bigger bet on overnight repos," he says.

Yields on repos backed by Treasurys have jumped to an annualized 0.17%, up from 0.11% in August, according to the Depository Trust & Clearing Corp., a securities clearinghouse. In contrast, the average annualized yield on money funds has shriveled to 0.06%, down from 5% in mid-2007, says researcher Crane Data LLC.

Investors long have worried that the European crisis could trigger a wave of losses for money funds. Such funds generally have reined in their exposure to Europe in the past few years. None of the 20 funds with the most exposure hold investments from Greece, Spain or Portugal, according to iMoneyNet, a unit of Informa PLC. Total assets of the 20 money-market funds represent about one-third of the $2.5 trillion U.S. money-market fund industry.

Money-market funds aim to be as safe and liquid as cash. But during the financial crisis, money fund Reserve Primary "broke the buck" by falling below the $1-a-share value that funds seek to maintain. Investors fled, and the U.S. government backstopped the industry to prevent damage from spreading.

The push toward repos is a big switch from the past few years, when money funds were buying debt securities outright from European banks. Holdings since May 31 aren't publicly available, and firms that manage the funds analyzed by iMoneyNet declined to disclose current figures.

Goldman's FS Government Fund/Institutional increased its exposure to France, Germany and the Netherlands by 64% to $12.7 billion through the end of May. That level represents about 40% of the fund's total holdings. All the growth came through repos, which make up 74% of the fund's portfolio, according to the company. Through May, the Goldman fund had a return of 0.04%.

James McCarthy, co-head of global liquidity management at Goldman Sachs Asset Management, says the fund classifies the repos as U.S. exposure because the collateral is guaranteed by the U.S. government. "We think of this fund as having no exposure to the euro zone," he adds.

Fimalac SA's Fitch Ratings and iMoneyNet consider the holdings euro-zone exposures because European banks are the funds' trading partners. The Securities and Exchange Commission also classifies repos with European banks as exposure to the euro zone, but distinguishes between repos and direct lending for its own internal analysis, according to the agency. By federal regulation, funds must disclose the nature of the collateral backing the securities they purchase as well as the counterparty, but they are not forced to categorize the type of exposure in a particular way.

Overall, money-market funds have been shrinking their euro-zone exposure. Of the 20 funds with the most exposure to Europe, their combined exposure fell 20% to $162.6 billion in the nine months ended May 31.

For example, Fidelity Investments had $6.9 billion in euro-zone holdings in its Fidelity Cash Reserves fund at the end of May, down 73% from $25.3 billion in August. The fund's exposure fell 34% in May alone, and it had no exposure to government agency-backed repos.

"Because there's been a high degree of volatility and uncertainty, we positioned our funds conservatively," says Nancy Prior, president of Fidelity's money-market fund group. The fund returned 0.03% through May, according to iMoneyNet.

Write to Kirsten Grind at kirsten.grind@wsj.com

A version of this article appeared July 2, 2012, on page C1 in the U.S. edition of The Wall Street Journal, with the headline: Money Funds Buck Euro-Zone Retreat.