Embrace of Money Funds More Than a Safety Maneuver

A security sporting the lowest return in more than four years also is the one investors couldn’t seem to get enough of in January.

Money market mutual funds, which now pay an average annualized yield of just 4.44%, attracted nearly $61 billion in net new investment in January, data reported last week show.

That sum, and additional inflows in recent weeks, lifted the total assets of money funds to a record $1.43 trillion as of last week, IBC’s Money Fund Report said.

To put those numbers in perspective, consider that stock mutual funds attracted a relatively modest $15.7 billion in net new investment in January.

What’s more, for every dollar investors now have in stock funds--$3.08 trillion in all--they also have 46 cents stashed in the safety of money market funds, where there is virtually no risk of principal loss.

On the face of it, that suggests that many Americans are just plain chicken when it comes to investing these days. The tide turned last August, when stocks suffered their worst decline since 1990, as the Dow Jones industrial average fell nearly 20% in about six weeks.

Blue-chip stocks, at least, have recovered since, and the Dow even hit a new high in mid-January. But for millions of mutual fund investors, the confidence needed to drive the stock-fund buy decision just isn’t there anymore. So money market funds may simply be winning by default.

Indeed, January’s surge of dollars into money funds wasn’t a fluke. For 1998 overall, money funds attracted a stunning $235 billion in net new investment, while stock funds took in $159 billion. Not since 1990 have money fund inflows been greater than stock fund inflows.

Have Americans really turned chicken? There’s an interesting fracturing that has occurred here. On one hand, it would appear that many investors are worried enough about the stock market’s prospects that they’re willing to accept a paltry 4%-plus yield on a money fund as a reasonable trade-off.

But we also know that many more Americans are buying, and trading, individual stocks today as opposed to simply investing in mutual funds. The Internet stock mania of the last few months brought that trend home.

Could it be that the cash building up in money funds is, at least in part, the raw material that many individuals are using (or will use) to create their own stock portfolios--instead of handing it to stock fund managers?

There is undoubtedly some of that going on, fund industry analysts acknowledge. But when we’re talking about a money fund asset pool of $1.43 trillion, spread across 1,360 funds and 33 million shareholder accounts, that’s a lot of people with a lot of personal reasons for keeping money where it is.

For most, money funds over the last 20 years have become a substitute for either a bank savings account, a checking account or both. Although the funds aren’t federally insured, as bank deposits are, what they own--very short-term IOUs from the government, government agencies, banks or major companies--has historically been nearly risk-free.

A money fund collects the interest from those IOUs and just passes it through to fund shareholders. The concept was developed by a financial entrepreneur named Bruce Bent, who in 1972 created the first money fund, called the Reserve Fund.

It took 25 years for money fund assets to hit the $1-trillion mark. Just 18 months after that threshold was crossed, the funds are nearly halfway to the $2-trillion mark.

These aren’t exclusively individual investors’ dollars. Businesses and government entities also use money funds. And nearly 36% of current money fund assets are in institution-only funds, available only to large investors such as pension funds.

For all of these investors, the long-held assumption is that money funds merely serve as a temporary parking place for cash that will ultimately be shifted to higher-risk, higher-return assets.

“There is some validity to the idea that this is cash to invest,� says Peter Crane, managing editor of Ashland, Mass.-based IBC Financial Data, the foremost tracker of money fund data.

In 1992 and 1993, for example, money funds recorded net cash outflows of $16.3 billion and $14.1 billion, respectively. That was in a period when money fund yields were at record lows, as the Federal Reserve kept interest rates down to revive the economy.

Coincidentally, stock mutual funds in 1992 and 1993 saw net cash inflows of $79.2 billion and $129.6 billion, respectively. That was the great liftoff for individual investors’ participation in the 1990s stock bull market via mutual funds.

Likewise, prior to 1995 the record-inflow year for money funds was 1989, when the funds took in $64 billion. Stock funds, by contrast, took in just $5.8 billion that year, as many investors remained leery of stocks in the wake of the 1987 market crash.

But as Crane also points out, money fund assets were growing at a record pace in 1996 and 1997, even as stock fund purchases also were the highest ever. Then as now, Crane says, money funds were benefiting in part as more individuals shifted bank account assets to money funds.

The surge in money fund assets since last August, Crane says, does stem partly from small investors’ actively cashing out of stock funds in favor of a safer haven.

But he thinks something else is afoot: More investors, he says, may be using new savings to adjust their personal asset allocations for stocks’ great bull run of the last few years.

“I think investors are racing to rebuild their cash and bond allocations because of the stock market’s gains,� Crane says.

For example, an investor who had 60% of assets in stocks and the rest in bonds and cash (money market securities) three years ago may have seen that rise to, say, 85% stocks and just 15% in bonds and cash by last summer, as the Dow index more than doubled between 1994 and then.

The market’s tumble in August was a wake-up call for such investors, Crane says--a warning to readjust their asset mix to bring it back in line with the level of risk they’re comfortable taking.

That would explain, he adds, not only why people have been shoveling more cash into money funds since summer (even as fund yields have been driven down with the Fed’s autumn interest rate cuts), but also why net new investment in bond mutual funds nearly doubled last year from 1997’s level.

Long-term, though, aren’t money funds a lousy investment? The short answer is yes: Any security with low risk ought to pay relatively little over time.

But when investors sense that safe is better than sorry, money funds are the logical alternative. And lately, there’s a lot of that mind-set going around.

Tom Petruno can be reached by e-mail at [email protected].

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Suddenly, Cash Is King

Investors shoveled a record $235.2 billion into money market mutual funds in 1998, the first time since 1990 that money fund net inflows exceeded net inflows into stock funds. Annual net cash flows, in billions of dollars:

‘98

Money market funds: $235.2 billion

Stock funds: $158.8 billion

Source: Investment Company Institute