Money Funds Seeing Huge Inflows, Opportunities

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A flood of retail and institutional investors have hit the sidelines and settled comfortably into money market funds in light of the equity market roller coaster and credit market stumble.

As of March 31, money fund assets topped $3.27 trillion, according to data from Crane Data of Westboro, Mass. Over the past 52 weeks, money funds have pulled in over $1 trillion in assets.

Fidelity Investments took in $139.6 billion of new money fund assets, while second-place BlackRock amassed $106.3 billion. Also of note, HSBC increased its money fund assets under management by a whopping 457% over the past 12-months ended March 31.

Therein lie opportunities for fund sponsors. Those lofty asset inflows from both existing and new investors mean savvy money fund firms can foster new long-term relationships that may lead to more assets to manage in the future.

Moreover, when those money market assets are ready to roll back into the equity markets, the real winners may be fund groups with an array of equity mutual funds that will appeal to investors.

"The credit crisis has been good for money market funds," said Peter Crane president and CEO of Crane Data. "Investors have looked at this as the only place to go."

Right now, with money funds returning somewhere in the 2% to 3% range, you might not think investors would be all too eager. After successive interest rate cuts from The Federal Reserve, money fund returns are down from a higher average level of 5.01% last year. But the truth is that no one is balking.

The current seven-day average for the Crane Index of Money Funds as of April 21 is 2.56%, with the highest-yielding retail money fund, the Dreyfus Basic Money Fund, showing a 3.04% seven-day yield as of April 21, and the highest yielding institutional money market, the Touchstone Institutional Money Market Fund, paying 3.37%, according to Crane Data.

Although money funds have been growing in size in tandem with retail investors' trepidation of the equity markets or institutional investors' loathing of other liquid securities including asset-backed commercial paper and auction rate securities, money funds haven't been without problems of their own. It turns out that a large percentage of money funds are exposed to distressed debt. In the past year, particularly mid summer just before subprime blew up, a succession of money fund sponsors received a no-action blessing from the Securities and Exchange Commission with regard to structured investment vehicles (SIVs).

Disclosures about millions of dollars that were spent in the form of capital support payments to at least a few dozen money funds are showing up in SEC filings. In many cases, fund sponsors reached deep into their own pockets to acquire shares of failed SIVs, including the now familiar Cheyne Finance LLC, Whistlejacket Capital LLC and others.

"We haven't seen a market like this before," said Robert Deutsch, head of global liquidity for JPMorgan Asset Management. "Retail investors and corporate treasurers have poured a lot of money into money market funds in the last nine months. We've seen new clients come to us at an unprecedented level."

Many of the corporate treasurers who relied on brokers for short-term investment alternatives, like structured notes and auction rate securities, saw their liquidity evaporate. These companies are reviewing their investment approach and will likely opt for asset managers and separately managed accounts, Deutsch predicted.

As the year progresses, as retail investors see second and third quarter account statements showing low money fund yields, they will start to shift back to the equity markets, he noted.

There's also a new appreciation of the skills it takes to manage cash, said Bruce Bent, founder and chairman of The Reserve, which has seen money fund inflows of $1 billion a week for the past 12 to 14 months. "There was a you-can't-screw-it-up-it's-just-cash attitude that prevailed until nine months ago," he said.

Institutional investors who had a trading desk with brokers selling them securities with an extra three or four basis points of return, are reconsidering. "Many have realized a money fund is not much of a commodity anymore."

Bent said his firm is in talks with five managers of money funds who want The Reserve to potentially take over management, or private label a money fund for their clients.

"I've been in this industry 27 years, and I've never seen anything like this," said Deborah Cunningham, chief investment officer and SVP, taxable money markets at Federated Investors. Federated has seen $40 billion of inflows during the first quarter of 2008 alone, she said.

"I believe there is huge opportunity in this landscape, some of which has come to fruition and some of which is being harvested," she said. Auction rate securities, once seen as the number one competitor to tax-free money funds, have been removed from competition, she added.

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