Money funds for the rich
Boston — What's the best way to make sure a new product makes a lot of money -- fast? Sell it to rich people. That seems to have been the strategy of several mutual fund companies when they introduced the tax-free money market funds last year. The nature of the funds almost requires an investor to be in the 50 percent tax bracket to make them more worthwhile than the older, regular money market funds.
The strategy paid off. Bringing in money from individuals and institutions, the funds have watched their assets zoom from zero to over $2.4 billion in a little over a year. Despite the fact there are only 10 of these funds, they have taken a preeminent position in the industry: Excluding the other money market funds, the tax-free funds account for more than one-third of all mutual fund sales.
"The tax-free funds have been the story of the year for us," said Heidi Brine of the Fidelity Group in Boston. That firm's Fidelity Tax exempt Money Market Trust, introduced in January, currently has assets of over $623 million. "We se this as the second generation of money market funds."
In recent weeks, the new funds have not been flying quite as high as before, because institutions, with their "what have you done for me lately?" attitude, have seen short-term interest rates rising elsewhere and have taken millions of dollars out in a search for higher interest. They have found better rates in places like municipal bonds. Treasury notes, and bank certificates -- the very things both types of money funds buy. But with so much more cash to play with, the institutions have been able to buy them directly.
"There's been a lot more redeeming going on lately," said Reg Green, spokesman for the Investment Company Institute (ICI), the mutual fund industry's trade group. "We aren't having the headlong pace we had earlier. . . . Still, they're very big. With total assets of over $2.4 billion, that's a heck of a lot of money for us.
The reason for the 50 percent tax bracket requirement can be seen by comparing the yields of the tax-free money funds and their taxable relatives. The taxable funds are currently paying 10 to 11 percent interest. An investor in these funds, who is also in a 50 percent-plus tax bracket -- usually earning in taxes. Thus, tax-free funds -- paying 4.5 to 6 percent -- are better for these people. For someone in a lower tax bracket, however, the taxable funds are still a better deal.
"Many of our investors are more likely to be in the 60 to 70 percent brackets ," said Richard Cahill, portfolio manager of the Chancellor Fund. Mr. Cahill expects the recent slippage in the tax-free funds to stop soon. While institutions go in and out of them, individuals will probably stay, he believes.
At some of the new funds, the customers need even higher incomes to meet minimum deposit requirements that can be quite large. Fidelity, for instance, has a $20,000 minimum on its fund, Miss Brine said. But other funds have much lower minimums, ranging from $1,000 to $5,000, Mr. Green of the ICI said.
With their deposits, the tax-free funds invest in short-term federal, state, and local bonds and notes. The funds might buy some federal notes use to pay for a particular housing project, for instance. The older money funds invest mainly a bank certificates and Treasury notes.
Eventually, Mr. Green said, more and more people will be in the 50 percent tax bracket, a development that will help the growth of the tax-free funds. With inflation pushing up wages as well as prices, and with the number of two-income families continually increasing, "everybody is being pushed into a higher tax bracket today."