It is no surprise that 1998's volatile stock market sent many investors heading for the relative calm and safety of money market funds. But investors seeking cover were only part of the explanation for the success of money funds last year. Another key factor was the increased use of money funds by corporations to manage cash.
The entire universe of money market funds brought in a record $290 billion in 1998 to finish the year with $1.35 trillion under management, according to IBC's Money Fund Report, a service of IBC Financial Data in Ashland, Mass. Overall, money fund assets grew more than 27 percent during 1998. Assets in all money funds have more than doubled since 1995 (see chart page 10.)
In contrast, equity funds had roughly half the net cash flow of money market funds or $158 billion last year, according to the Investment Company Institute. Hybrid funds brought in another $10.5 billion, and the combined universe of taxable and municipal bond funds pulled in $74 billion. Money funds now account for 25 percent of the $5.5 trillion of total mutual fund assets.
"Mutual funds have reached critical mass," said Peter Crane, IBC's managing editor. Retail investors have been putting some of their 401(k) assets into money funds and are increasingly comfortable with mutual funds in general, and money funds in particular. Savers are moving into money funds from checking and savings accounts at the expense of banks, he said.
Money funds paradoxically gained more attention when yields dropped last year when the Federal Reserve cut interest rates .25 percent in October. Savvy investors have come to understand that as interest rates come down, money funds are able to provide a higher yield than those of new Certificates of Deposit because they already have higher yielding securities in their portfolios, Crane said.
Money funds have also emerged as winners becaause they have attracted new cash created by the multi-year bull market, said Crane.
"The wealth created by the stock market has left many individuals saying, I don't need any more stocks,'" said Crane. Many retail investors have become do-it-yourself asset allocators. Consequently, they placed liquid assets into money funds as part of their overall portfolio strategy. The volatility of last year's equity market also sent many investors seeking a safe haven in money funds, Crane said.
Merrill Lynch, Paine Webber, Prudential, Smith Barney and Charles Schwab attracted some of the largest shares of money fund assets last year. (See chart this page.)
A huge amount of cash flowed into Vanguard Group funds of all ssset classes, said John Demming, a Vanguard spokesperson. In 1998, $60 billion in new money flowed into all of Vanguard's funds, according to Financial Research Corp. Of that total, Vanguard's retail Prime Money Market Fund alone brought in $6.9 billion, according to IBC. Vanguard was fourth in the value of new assets it attracted in 1998. Assets in that one Vanguard money fund increased more than 25 percent last year.
"From July to September, investors showed a lot of caution and were putting new cash into money market funds," said Demming. But, assets poured into equity funds as well, he said. This past November and December, investors, fearful of incurring large capital gains, again invested in money funds with the intention of going back into the equity market in early 1999, he said.
While 65 percent of money fund shareholders are retail investors, the increasing presence of institutional investors is also bolstering dollar flows into money funds. In fact, institutional sales of money market funds continues to grow at a faster rate than retail sales, said Crane of IBC.
Companies' short-term investment dollars are increasingly being deposited in money funds, says Michelle Hoffmann, a consultant with Treasury Strategies, a treasury and cash management consulting firm in Chicago. Money funds are now tied for second place with government securities as the vehicle businesses use for depositing cash. They are now more popular than repurchase agreements, CDs, demand deposit accounts, tax advantaged investments and offshore investments, according to Treasury Strategies' 1998 Liquidity Management Survey. Commercial paper tops the list.
In contrast, in 1997, money funds ranked fifth in companies' preferences. Moreover, among businesses with $5 billion to $10 billion in assets, money funds were by far the preferred investment product last year.
"People will utilize mutual funds, as least in part, in lieu of individual securities such as 30-, 60- or 90-day T-Bills or repos," said Jim Getz, president of Federated Securities Corp. Federated manages $111 billion of which $77 billion is in money funds. Investors understand the attributes of money funds, such as the ease of administration, daily liquidity and the fact that their portfolios are marked to market every day, Getz said.
The popularity of bank sweep programs has also contributed to the shift of dollars into money market funds. Bank sweeps tied to money funds shift unused cash out of commercial bank checking accounts and into a specified money fund at the close of each business day or at other designated intervals. Seven percent of companies of all kinds now use bank sweep programs, up from two percent in 1997, according to Treasury Strategies' report.