For Money Fund Investors, Yields, Safety Are Improving

Money market mutual funds are getting safer--and more lucrative for investors--thanks to a confluence of factors that range from the derivatives scare to continuing stiff competition.

The rise in short-term rates has helped push average yields over 4% for the first time since January, 1992, and so far this year the money funds have been about the best place to put your cash.

But the biggest buoy to yields is that fund managers continue to waive their fees in an effort to boost investor returns, says Walter Frank, chief economist at Money Fund Report, an Ashland, Mass.-based industry newsletter.

Overall, the average general-purpose money fund is now returning 4.16%, compared to an average yield of just 2.7% for all of 1993, according to IBC/Donoghue Inc.

Ironically, just as things have begun to look up for money fund investors, some investors have bailed out, citing concerns about complicated hybrid securities generically referred to as derivatives.

To maintain confidence despite derivative-spurred losses, some money funds have poured millions of dollars into their funds in recent months to keep net asset values consistent--in effect bailing out investors.

Nonetheless, the losses have undermined confidence in the industry, convincing many individuals that money funds are not as safe as they used to be.

“There is a fair amount of fear about this industry,” says Don Phillips, publisher of Morningstar Mutual Funds Report in Chicago. “Money funds were sold as an alternative to cash. But (because of derivatives), investors are no longer convinced that the funds are as safe as cash.”

Yet in the last several months, there has been something of a “safety backlash” that has prompted many of the big money funds to clean up their acts like never before, Frank says. By and large, money funds are replacing derivatives with super-safe government securities, he says.

The latest to fall to the trend is Kidder, Peabody Group, which announced last week that it would eviscerate derivative securities from its five money market offerings at the urging of the Securities and Exchange Commission. The SEC cracked down earlier this year, informing fund managers that certain high-risk securities were “not appropriate” and should be eliminated.

Whereas derivatives caused losses this year, in 1993 they were the darlings that boosted money fund returns.

Even with the higher rates and greater security, does it still make sense to keep money in cash equivalents, such as money funds, when the stock and bond markets do so much better over time?

The answer is that as long as you’re parking your cash for only a short period, money funds can give you the opportunity to sidestep market corrections and earn far more on your money in the long run, experts say.

While market direction is always hard to call, there is a lot of talk of the long stock bull market being at a high point, given traditional measurements such as price-earnings ratios and dividend yields. Bond prices, meanwhile, get hit whenever interest rates rise. If the economy picks up steam this year or next, some bond investors are concerned that the Federal Reserve Board will again raise interest rates, which would send their asset values south.

Additionally, this is a tenuous time of year for investors because market pressures that involve the business inventory cycle tend to push interest rates up somewhat during the fall, says William E. Rhodes, vice president of Merrill Lynch in New York. That can prove unsettling for both stock and bond markets.

“September is the dreaded month because October tends to be where market bottoms occur,” Rhodes says. “There’s an old market adage that you buy stocks on Rosh Hashanah and sell on Yom Kippur. It seems to work.”

But the Rosh Hashanah Jewish holiday falls on Sept. 6 this year. Yom Kippur is Sept. 15.

Still, those who invest in money funds this fall ought to be aware that the way you use your fund will have an effect on your total return.

For instance, many people buy a fund based on its performance and its promise to waive fees to maintain a higher-than-average return, Frank notes. However, some of the funds that aggressively waive fees also restrict services, such as check writing. You can generally still write checks against your assets in the fund, but you may have to pay a hefty fee each time you do.

Consumers who use their money fund as an alternative to a bank account will find that the cost of these per-check fees can more than outweigh the benefits of a higher interest rate. If you require check-writing services, pay less attention to yield and more attention to who can provide the services you need at a low cost, Frank says.