Market fears may lure investors to money funds

Mar 26, 2007 @ 8:04 am

By Kathie O’Donnell

NEW YORK — Stock market volatility and worries that more bad news from the housing sector could threaten the U.S. economy’s prospects for a soft landing are likely to make 2007 “a dynamite year” for money fund inflows, a well-known money fund expert said last week.

“The elements are all there for huge pools of assets to move into money funds at this point,” said Peter Crane, co-founder of Crane Data LLC, a Westborough, Mass., firm that tracks money market mutual funds.

This year could rival 2001 as the biggest year ever for money fund inflows — in dollar terms, at least — as investors are lured by the 5% yields many funds are sporting, and the safety appeal of cash, he said.

Money fund assets in 2001 increased by about $440 billion, or 24%, to $2.29 trillion, as institutional investors moved to money funds to delay the effect of falling rates, and investors sought safety in the wake of the Sept. 11 attacks. Last year saw the second-biggest increase in money fund assets — $328 billion, about 16%, to $2.39 trillion.

During the one-week period ended March 7, money fund assets rose by nearly $34 billion to a record $2.43 trillion, Mr. Crane said.

Retail-money-fund assets that week broke the $1 trillion mark for the first time since June 4, 2003, according to the Washington-based Investment Company Institute.

Hold on to stocks

While cash may look attractive, dumping stocks and running to cash after a few volatile days on Wall Street isn’t a good idea, some experts warned. The Dow Jones Industrial Average fell 416 points Feb. 27 and nearly 243 points March 13.

“Over a long period of time, you are a heck of a lot better off being in the market than you are being in cash,” said Bruce R. Bent, chairman of The Reserve, a New York-based firm with $54 billion under management, and the inventor of the money market fund. “And I make money when you run to cash.”

Duncan Richardson, a portfolio manager and chief equity investment officer at Boston-based Eaton Vance Corp., also cautioned against a hasty move to money funds.

“I think it might be a mistake to move to money funds at this point,” he said, adding that such a move could cause investors to miss out on opportunities elsewhere, such as large-cap stocks, which currently offer “exceptional” values. Large-caps are also a conservative haven in the equity market — a good place to be, considering that 2007 is likely to be hard on some of the riskier asset classes.

“It’s better to be in a brick house when the wolf comes to the door,” Mr. Richardson said.

Bonds have traditionally been seen as a safer alternative to stocks; however, these days, investors may have concerns about “land mines lurking out there from all this mortgage stuff” that might turn up in their bond portfolios, Mr. Crane said.

“A lot of the stuff you thought was bonds is engineered tranches of something or other, and that could be mortgage,” he said. “And then other things people would move into — real estate, commodities, international, gold — they’ve shown they can all come down.”

As the economy slows, high-yield and emerging-markets bonds — and even U.S. Treasuries — have “significant potential risk of capital loss” for investors who don’t hold them to maturity, said Mike Holland, chairman of New York-based Holland & Co., who oversees more than $4 billion in assets.

Investors who buy five-year Treasuries and hold them to maturity get their principal back, he said.

“If you are in a fund, and interest rates go up, you lose money, because bond prices go down,” said Mr. Holland, adding that investors who put $10,000 into a bond fund could end up with less than $10,000 when they sell, because the fund is continually investing cash as it comes in. “We should be watching out for the potential of loss in the fixed-income markets, particularly the ones where risk has been no longer priced in — like junk bonds.”

Reaching for yield is not a good idea, Mr. Holland said.

“More money has been lost on Wall Street reaching for yield than at the point of a gun,” he said. “That’s an old Wall Street saying, and it’s true. Why would you screw around with anything else in the world but cash and quality, dividend-paying stocks?”

Still, the money manager said, he sees the recent subprime-mortgage-lending issues as “a media event, not a financial event, to a great extent,” and said he hasn’t made any asset allocation changes in response to recent stock market volatility.

“I’m not doing anything different, but in the cash portfolio, I’m delighted to have a 5% yield,” he said.

Money funds are likely to attract more money from individual investors this year as people flee market volatility, Mr. Bent said. Financial advisers, in addition to preserving and increasing capital for clients, also have another job — understanding how much risk clients can tolerate.

“I can go to the stock market and say, ‘Well, I’m aspiring to 8%,’ or I can go to the money market and say, ‘I’m guaranteed 5%,’” he said. “Am I willing to give up sleep for another 3 [percentage points] or am I saying 5% ain’t bad?”

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