Academic journal article Journal of Economics and Finance

Fee Waivers for Tax-Exempt Money Market Mutual Funds

Academic journal article Journal of Economics and Finance

Fee Waivers for Tax-Exempt Money Market Mutual Funds

Article excerpt

Abstract

In this study we investigate why tax-exempt money market mutual funds often waive fees. Contrary to statements in the popular press, our results provide weak evidence that fee waivers lead to asset growth. We find strong evidence, however, that fee waivers are used to keep the fund's reported yield in line with competitors. We find that funds have comparable before-expense yields and that smaller funds generally have higher expenses. If all expenses were charged to investors, then smaller funds would significantly underperform larger funds. Thus, in order to keep reported yields in line with competitors, smaller funds must waive a significant portion of fees. (JEL G20, G21)

Introduction

According to a recent Wall Street Journal (WSJ) article (Damato 1999), money market mutual funds (MMFs) often waive management fees at various times during the fund's existence in order to attract investors. This is not a recent phenomenon, however, as funds have been following this practice for years. Retail and institution-only tax-exempt MMFs waived an average of $550,243 in fees each year from 1994 to 1999.

The publicly stated motivations for waiving management fees vary from fund to fund. In many cases, the fee waivers are undertaken to enhance yields and achieve a high ranking in the regular weekly/monthly/annual ranking of MMFs by yield. By paying a higher yield, the fund expects to attract investment dollars in order to grow to some critical mass in terms of asset size. Since the MMF market is highly competitive and since the types of assets MMFs can invest in are limited, waiving fees is often the most significant way to boost yield and attract attention. In other cases, funds that have stopped waiving fees at some point begin to waive fees once again, presumably to attract attention and investment dollars.

Taken together, the public motivations for waiving fees are essentially growth related. That is, fees are waived to get investors' attention, attract dollars, and grow the fund. Anecdotal evidence provided in the WSJ suggests this is a very effective method of luring new investment dollars into the fund. Since management fees typically run at about 0 to 1.66 percent of fund assets, waiving such fees automatically boosts the reported yield on the funds by this same amount.

One of the problems faced by the managers of tax-exempt MMFs is the relatively limited type of investments that can be undertaken by the fund. According to a typical prospectus, managers of tax-exempt MWs attempt to predict movements in interest rates and select investments based on the disparities in the yield relationships between different money market instruments. This suggests that fund managers believe they are able to outmaneuver the market. However, the existing literature relating to MFs concludes that they can't or, if they can, transaction costs make it too costly to frequently shift assets. Given the limited investment vehicles available, it may be true that managers compete more by minimizing costs charged to investors than by actively managing their portfolios. In addition, recent rule changes instituted by the SEC effectively limit the amount of risks managers can take in the assets they buy for a tax-exempt MMF. The combination of these two factors makes it difficult for the fund manager to differentiate the fund from others. One clear way to do so is to waive management fees in order to boost yields.

In this paper we examine fee waivers by tax-exempt MFs and make two contributions to the literature. First, we directly test several popular notions that are associated with money market funds: (a) the larger a fund is, the higher the yield; (b) small funds waive expenses in order to grow the fund; (c) fee waivers are temporary and disappear once a fund reaches some critical size; and (d) some funds are better managed than others and provide higher yields for investors. Second, we develop an alternative theory concerning why MMFs waive fees. …

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