Tax-free money market funds commanded new money from investors last week - the second straight week of inflows - possibly marking an ebb, or at least a slowdown, in the rush of cash away from money funds the past two years.

Investors entrusted $1.61 billion to tax-free money funds during the week ended Dec. 27, according to iMoneyNet.

Inflows like this have been rare since 2008. According to the Investment Company Institute, investors have pulled $163.5 billion from tax-free money funds since the end of that year.

Money market funds offer investors the equivalent of cash by investing in supremely liquid and safe instruments. This type of paper often matures in a matter of days, or enables a money market fund to force the issuer to repurchase the debt at par.

It is unclear why investors have taken a break from withdrawing cash from money market funds. The factor that fund managers believed was leading to outflows since the beginning of 2009 persists: scanty returns.

Tax-free money market funds invest principally in tax-exempt variable-rate demand obligations, which is paper issued by municipal governments such as airports and hospitals with a short-term interest rate that resets regularly.

Because of the Federal Reserve's efforts to keep short-term interest rates tethered to zero, yields on tax-free VRDOs are almost nonexistent.

The average yield on a tax-free VRDO is 0.34%, according to a Securities Industry and Financial Markets Association index. After charging management fees, funds are only returning an average of 0.05% to shareholders, according to iMoneyNet.

Most shareholders cannot brook such low returns, so they have been shuttling money out for two years, reportedly in large part to bond mutual funds.

Municipal bond mutual funds have reported about $87.5 billion of inflows the past two years, though that trend has reversed in recent weeks.

The tax-free money fund industry meanwhile has shrunk by a third since the end of 2008, to $325.8 billion.

The latest inflows are further befuddling because financial markets appear to be showing more of an appetite for risk. The Standard & Poor's 500 Index yesterday closed at about 1,260 - the highest close since before the Lehman Brothers bankruptcy.

A measure of volatility known as the VIX is at 17, which is tranquil by recent standards.

Dan Seymour writes for The Bond Buyer.

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