One person’s “flight to safety” is another person’s “panic,” but no matter what you call it, many investors are making an unnecessary trip in that direction with their money-market mutual funds.
Market concerns are behind the flight to quality that has pushed assets in money-market funds to a record $2.72 trillion. But if you have been thinking that you might join in that journey, think again; the journey isn’t only unnecessary, but you’re already too late.
That hasn’t stopped investors from making changes, and is undoubtedly why tax-free funds added nearly $4.4 billion last week, according to Money Fund Report, a service of iMoneyNet, a research firm that tracks money-market activity.
To see why you don’t need to change money funds, you must know how money funds work.
Money-market funds are ultra-safe investments, buying interest-bearing securities that mature within a year. The investments run from certificates of deposit to Treasury securities, from insured notes to asset-backed commercial paper like “funding agreements.” It’s this last category that has the public worried, because one way to define “funding agreement” is “group of second-mortgage loans.”
With the stock market rocked by the subprime lending crisis, investors are afraid that their money funds might be next to feel the pain.
Unlike ordinary mutual funds, money-market funds maintain a constant price of $1. Each day, a fund’s holdings are “marked to market,” meaning the current market value of its holdings is checked. If a fund has a big holding in an issue that goes kaflooey, the share price might “break the buck” and fall below $1. This dire money-losing scenario has happened just once, 13 years ago, to a no-name institutional fund that wound up being valued at 96 cents per share.
Still, investors want money fund investing to be worry-free.
“The whole issue is terribly overblown,” says Connie Bugbee, managing editor at iMoneyNet. “If I were reading the headlines and didn’t know better, I might be moving to a CD or money-market account.”
To “know better,” one must understand how money managers do their job. Typically, they hold ultra-short-term securities to maturity. If an asset class gets into trouble, they don’t bail out and sell at a loss, but ride out the weeks until the paper matures, typically without realizing any loss. At the same time, any new money coming in is put into a different type of paper.
“The current crisis is really concentrated in the asset-backed commercial paper area,” says Peter Crane of Crane Data, publisher of the Money Fund Intelligence newsletter. “But by the time you figure out if that is something your fund was holding, that paper is gone; the funds change their allocations every day. They don’t sell anything, they just stop buying anything that’s bad news so that, pretty soon, the fund has moved away from whatever paper it had that might have been considered dangerous.”
More important, if circumstances were the perfect storm that could put a money fund into break the-buck territory, the fund’s sponsor would bail it out. Since 1994, there are countless cases of fund firms buying back troubled paper to ensure that retail shareholders avoid a loss.
And if name-brand funds don’t give you sufficient solace, consider choosing your money funds from the “B list.” Normally, money funds are the one place where past performance is a real guide to what’s next; in the current environment, however, an investor might worry about what the top-paying funds are doing to stretch for their extra yield. If you have that fear, buy a fund with solid record and good yield, but that doesn’t push to top the charts.
Chuck Jaffe is senior columnist for MarketWatch. He can be reached at jaffe@marketwatch.com or Box 70, Cohasset, MA 02025-0070.
