Money market funds avert predicted setback

The reports started coming in as soon as the banks lowered their prime interest rates. Then the stock market started taking off, and the occasional reports turned into a rush.

They all said much the same thing: With interest rates dropping and stock prices rising, the money market mutual funds had better batten down the hatches, because the ''great outflow'' was coming.

So far, however, there hasn't been much of a flow in either direction, and predictions that up to $50 billion of the money funds' $230 billion assets would leave the funds seem unlikely to come to pass. Part of the reason, fund executives and other financial experts say, is mechanical; another part is a fundamental change in the way people are saving their money these days.

The funds are taking steps to protect their future, using marketing that puts greater emphasis on services, rather than just high yields. The services include check-writing privileges, telephone redemption, individual retirement accounts, and the ability to switch money from a money fund to a stock fund at investment companies that have both types of funds.

When interest rates started falling, the money funds embarked on what has quickly become a standard defensive move in times of falling rates: they started buying money market instruments with longer redemption periods. A money fund's portfolio is composed of a variety of short-term corporate borrowing notes, bank-issued repurchase agreements (or ''repos'') and certificates of deposit, and government debt instruments such as US Treasury certificates.

When they make these purchases, the funds can select the length of time they will hold them before redemption. The average redemption period for all of a fund's securities is known as its ''average maturity.'' Earlier this year, average maturities were about 24 to 26 days. Now, maturities are averaging nearly 40 days. Some funds have maturities as long as 67 or 80 days.

Having longer maturities at a time of falling interest rates means the funds can ''lock in'' the higher interest rates for a few months. This makes them more attractive to investors for a time. Indeed, instead of having their assets fall, some funds see an increase, or at least their assets fall more slowly than might otherwise be expected.

If interest rates stay down for a long time, however, money fund yields will eventually have to follow. Even if they get below 10 percent, observers say, they should not lose too many shareholders.

''Money market funds are now a permanent part of many investors' portfolios, '' says Allen Sinai, senior vice-president at Data Resources Inc. of Lexington, Mass. ''We are now a nation of savers. The 1970s was the spending decade. The ' 80s is the savings decade.''

''Money funds provided an escape route for investors who were watching their savings slip away,'' observed William Melton, senior economist and portfolio manager for Investor Diversified Services Cash Management Fund. ''Money funds are providing people with a way to get a fair market rate.''

By paying higher yields and offering accounts people could move money in and out of quickly, Mr. Sinai explained, the money funds have helped boost the savings rate to its present level of about 8 percent. As a result, ''households are putting their money in all sorts of savings vehicles,'' Mr. Sinai said.

''There are two kinds of money in money market funds,'' noted Sumner Abramson , senior vice-president and manager of the investment department at Colonial Management Associates in Boston. ''There's institutional money and savings money. I don't think you're going to get any kind of runoff in savings money. . . . American consumers have gotten used to the idea of money market funds as a place to put their savings.''

''I think money market funds are here to stay,'' said Norman G. Fosback, president of the Institute for Econometric Research, which rates money funds for safety and tracks other investments. ''More money funds are coming on stream almost every day.''

In the past year the number of money funds has increased from 134 to approximately 250. ''While a few of these may be assimilated into other funds, '' Mr. Fosback said, both the number of funds and their assets will continue to grow.

If the funds do experience a drop in yields, fund managers say, it won't be because they lost money to the banks. Should the stock market rally that began this summer be of the long-term variety, some money fund customers may switch part of their money into stock and bond funds.

For the longer term, there are still questions about how much more the money funds can grow. The funds' $230 billion assets have mushroomed faster than any previous savings or investment vehicle. With lower and more stable returns, people shifting some of their money to stock and bond funds, and some of the institutions - including pension funds and insurance companies - moving some of their ''parked'' cash out of money funds, these funds may have peaked.

On the other hand, notes Richard Vesely, marketing vice-president for the Delaware Funds, there still aren't very many people who have invested in money funds, leaving a lot of potential for growth.

''You're talking about only 20 percent of the households in the US that have money funds, and that's a maximum figure,'' he said. ''Most accepted figures are closer to 10 percent. Money funds are primarily a Northeastern US, Chicago-area, West Coast phenomenon. A lot of people still confuse them with a bank certificate.''

With increased emphasis on services as well as higher yields, Mr. Vesely says , the funds can continue the pace of rising assets they have enjoyed for the past couple of years.

The possibility that some money fund shareholders might switch assets to stock and bond funds, if those markets appear headed for a long-term upturn, is positively tantalizing to William E. Donoghue, who as publisher of the Money Fund Report, has become closely associated with the money market funds.

''I'm counting on it,'' he says of portential money-to-stock fund switchers. He recently purchased a guide to all the mutual funds, and in February a book he has written on no-load (no-sales-charge) mutual funds will be published.

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