Low Interest Rates Hit US Money Funds

FOR United States money fund managers, the cut in interest rates by the Bundesbank, Germany's central bank, was not entirely welcome. If the Federal Reserve System takes advantage of this new latitude to lower US interest rates again in the hope of boosting a weak economic recovery, it could stimulate an outflow of money from their funds.

Discouraged by low interest rates, some investors have already been shifting money from these funds and from bank certificates of deposit into stocks and intermediate-to-long-term bonds.

The Bundesbank action prompted a rally on Wall Street Monday. The Dow Jones industrial average rose 70.52 percent, its biggest jump this year.

Profit-taking trimmed those gains Tuesday. But market technician Dennis Jarrett, of Kidder, Peabody & Co., expects the Dow to climb to the 3,500-point range in the weeks ahead.

The trend away from money market funds has been underway for several months. For example, account managers at Massachusetts Financial Services Company (MFS) have noticed investors in the Boston firm's family of 36 mutual funds steadily moving assets away from money market accounts into alternative funds.

Last week interest rates on money funds, which invest in such short-term instruments as finance paper and Treasury bills, slipped below the 3-percent level. And the yield on 30-year Treasury bonds fell to a six-year low. Some bankers and economists expect that short-term rates could drop to the 2.8-percent range in the next few weeks.

"The outflow [from money market funds] began in May," says MFS spokesman John Reilly. "It continued in June and July, resulting in net redemptions during that period." More money was withdrawn from MFS's three money market accounts than was deposited into them. There was a slight inflow to the funds in August. But that may be as much linked to political or other factors, such as the need to have quick access to cash, as concern about interest-rates, Mr. Reilly says.

The amount of money flowing into money market accounts has slowed overall. Total assets in money market mutual funds reached $609.6 billion Sept. 9, up only modestly from assets of $593.9 billion at the end of June, notes Malin Jennings, a spokeswoman for the Investment Company Institute, in Washington. The ICI represents the mutual fund industry.

"What we're finding is that institutions [such as pension accounts] and individuals are now using money market funds for two distinctly different reasons," Ms. Jennings says. Institutional investors, she says, use money funds for purposes of arbitrage; that is, the accounts are used to earn money "off fine differences in interest rates from one week to the next." Individuals use money market funds as checking accounts.

Much of the money market "money" is now being moved into bond funds, Jennings says. Thus, total assets in bond funds as of the end of July were $530 billion, up from $448 billion at the end of January. "That's a very dramatic increase," Jennings says.

While yields on bond funds are also falling, they are still in the 6 percent to 7 percent range.

Bond funds are now growing faster than any other category of funds. As of the end of July, total assets in equity funds (stocks) reached $421.8 billion. Assets in all types of mutual funds reached $1.54 trillion in July.

"Investors are looking for attractive alternatives to money market funds," says a spokeswoman for Fidelity Investments, Boston.

One of that compan's options is the Fidelity Asset Manager fund. Launched in 1988, it allows the fund manager to shift assets between stocks, bonds, and short-term instruments.

At MFS, there has been a shift of assets into two new bond funds, the MFS Limited Maturity Fund, and the MFS Tax Free Limited Maturity Fund. The two funds invest in bonds with maturities of around 5 years. The Limited Maturity Fund is currently yielding around 6.3 percent; the Tax Free fund is yielding around 4.5 percent. Both funds, in other words, beat money market rates. Further, both funds offer less risk of losses should interest rates turn up and prompt a decline in the price of long-term bonds.

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