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Portfolio > ETFs > Broad Market

Money Funds Wounded, But for How Long?

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Sept. 11, 2003 — Money market funds, regarded as one of the safest and most liquid of investments, are swooning in this low interest-rate environment.

The average government money market fund rose a scant 0.45% year to date through August, little more than the average municipal money market fund (0.37%), and the average taxable money market portfolio (0.43%), according to Standard & Poor’s data.

Indeed, the average seven-day simple yield on taxable money market funds, which approximately tracks the Federal Reserve’s federal funds rate, plunged to 0.50% a few weeks back — a 45-year record low.

Yields on money market funds, which translate into performance, are low right now because short-term interest rates are at historically low levels. Money market funds typically invest in very short-term bank, corporate and government debt securities. As a result, long-term interest rates have minimal impact on money market funds.

Indeed, the Federal Reserve’s Open Market Committee (FOMC) is widely expected to keep short-term interest rates low for an extended period, dashing any hopes for money market rates to rebound any time soon.

“The consensus from the portfolio managers that we speak to is that the Fed will hold rates steady through the end of this year, and likely for the beginning of 2004,” said Peter Rizzo, director of fund research at Standard & Poor’s. “Money market fund returns are highly correlated to short-term rates. For instance, when the Fed Fund rate is 5%, money market fund returns would likely be in that neighborhood.”

As equity markets rebound and returns for money market funds drop, investors are bailing out: Money market funds have suffered $132 billion in outflows this year through July, according to the Investment Company Institute (ICI). This compares with a net outflow of $46.7 billion in 2002, and a net inflow of $375.6 billion in 2001.

Most of the outflow this year, however, has been from institutional funds, ICI noted. But overall, money market fund assets, particularly those held by institutional investors, have grown dramatically over the past few years. Money market funds currently have about $2.2 trillion in assets, up from $1.6 trillion at the end of 2000. Of that $2.2 trillion, $983.1 billion is held by retail investors, and $1.2 trillion by institutions.

Why would a retail investor put cash into money markets? Although they generally don’t provide high returns, “they serve as a substitute for checking accounts and routinely offer check-writing privileges,” noted Louis Harvey, president of Dalbar Inc., a Boston-based mutual fund consulting firm. “They’re a very convenient ‘parking place’ for cash.”

“For people who need safe, very secure, short-term, immediately available cash, it makes sense to keep money in money market funds,” said Michael Vogelzang, president and chief investment officer of Boston Advisors, which manages about $1.7 billion in money-market assets.

Returns data reveal that while money markets won’t make anyone rich, they tend to never lose money over the long term. For the ten years ended August 2003, government and taxable money market funds returned an average annualized 4.1%, versus 2.5% for municipal money market funds.


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