INVESTMENT OUTLOOK : ASSESSING THE MAJOR MARKETS : Momentum Is on the Side of Money Funds : Stability, Attractive Interest Rates Have Lured Conservative Investors
After languishing somewhat in the mid-1980s, money market mutual funds are booming again.
Since 1988, money has been pouring in, inflating assets of taxable money market funds to more than $350 billion. They have now had 18 consecutive months of growth, the longest uninterrupted stretch since 1981, when exceptionally high interest rates led to the discovery of the funds by legions of small investors.
Money managers say the renewed attraction is a result of a new conservatism by investors scared by the volatility of the stock market, better interest rates than those offered by banks, and general wariness of savings and loans because of failures and scandals. Investment experts say the funds also have established an impressive record of safety and stability, even though they aren’t insured like bank deposits.
“People are just afraid of another crash” says Neal Litvack, vice president for marketing at Fidelity Investments, the nation’s largest mutual fund company. He adds that the 190-point plunge in the Dow Jones industrial index this October sharply boosted the already strong growth of money fund assets.
Fund executives say they expect the boom to continue well into the 1990s, although the growth rate may be erratic as interest rates fluctuate. Over the next several months, if the trend toward lower interest rates continues, the funds will remain attractive because their rates generally lag current interest rates. And innovations by some fund managers are expected to continue drawing additional customers.
Walter S. Frank, chief economist at the Donoghue Organization, which tracks money market funds, said they “are gradually displacing certificates of deposit” as the favored way of holding cash.
The funds were invented in the mid-1970s as a way for a broad range of investors to benefit from investments in short-term debt securities such as commercial paper, Treasury bills, jumbo CDs and bankers’ acceptances. These offered significantly higher interest rates than those paid by banks and savings and loans, with relatively slight additional risk. In addition to allowing investors to withdraw funds without penalty, the funds offered such convenient features as check writing, wire transfers and, often, easy switching of money to other types of mutual funds offered by the same company.
Money market funds initially were used mainly by institutional investors. But they became a vehicle for the masses at the beginning of this decade when the Federal Reserve made its stand against inflation and drove interest rates to record heights. Small investors discovered that through the funds, they, too, could benefit from the high, short-term interest rates.
The number of money funds has grown from 77 in 1979 to 588 this year, including both taxable and tax-exempt funds.
Once interest rates began to go down, the growth of money market fund assets slowed, and total assets actually decreased in 1983 and 1985. They were also temporarily hurt by bank deregulation, which allowed these institutions to offer federally insured, money market deposit accounts.
But today money market funds offer significantly higher yields than the bank money market accounts. In mid-October, the average annualized yield of money market funds was 8.14%, compared to 6.22% on the bank money market accounts, according to the Donoghue Organization. In addition to concern about the stock market, money funds in the past couple of months have been helped by the flight from junk bond mutual funds.
Because the average maturity of securities held by money funds is more than a month, interest rates that they offer generally lag market rates. If rates are falling, the money funds will offer a higher rate for an interval of several weeks. Of course, the funds also lag current rates when they are moving up. In that case, investors temporarily get a lower return.
In spite of the fluctuations of interest rates, innovations such as a “no-frills” fund by Fidelity are luring into money funds the type of people who generally dealt only with banks. Fidelity has had spectacular success with its Spartan Money Market Fund, established in January. It offers a significantly higher yield by keeping the fund’s administrative costs down, in part by having customers pay costs normally absorbed by the funds for such services as check writing and wire transfers. The fund, still growing, already has $4.9 billion in assets.
Fidelity’s Litvack said the new fund tapped a new source of customers: the people who do little if any investing but let relatively large amounts of cash sit in banks. These “savers,” as Fidelity refers to them (as opposed to “investors”) generally were conscious of yields but not interested in frequent transactions. The high yield and low administrative cost of the Spartan fund have begun to lure these savers from banks. One way the fund has kept its costs down has been to require an extremely high initial investment--$20,000, compared to $500 to $2,000 for most money funds. The big investment requirement means that the proportional costs of servicing each account are lower, Litvack said.
Spartan has had a number of imitators, including Dreyfus’ Worldwide Dollar Money Market Fund, that for the moment are offering higher yields by temporarily shifting the burden of administrative costs to the company rather than the fund itself. Another marketing tool that Dreyfus has used for its Worldwide Dollar fund has been to look abroad for the best return on securities. But some fund experts say this is a marketing ploy, and that many other money funds have been buying such securities for some time.
Another innovation that so far hasn’t really taken off is a modified version of money funds, in which the fund invests in slightly longer-term securities for correspondingly higher yields. For ordinary money funds, the maximum maturity for the securities that they buy is 120 days. But Neuberger Berman Management Inc. in New York offers a fund called Money Market Plus, which invests in Treasury securities and commercial paper with an average maturity of about one year. The fund has marginally higher risk than regular money market funds, and its net asset value varies slightly from the $1 a share of ordinary funds.
But Stanley Egener, president of Neuberger Berman’s mutual funds unit, said “a one-year Treasury bill is not that much riskier than a three-month bill.” He added that the fund normally offers a yield that is about a full percentage point higher than ordinary money market funds; at the end of October, the Money Market Plus fund’s yield was 9.7%.
The fund is tiny now, with only $102 million in assets, most of it from institutional investors. Egener said one problem that the fund has had in attracting investors is that newspapers and other services that run columns of figures on the yields of individual money market funds refuse to list Money Market Plus because it is not a standard money market fund.
MONEY MARKET FUNDS (Assets of taxable funds)
1989 (Through Nov. 1): 4359.7 billion
Source: Investment Company Institute
