Despite rate cut, money funds continue to attract assets

While short-term-bond mutual funds would figure to be the main beneficiaries of the Federal Reserve’s half-point interest rate cut last month, it’s money market funds that continue to rake in the cash.

They have been taking in money so quickly — $23.96 billion alone for the week ended Oct. 9, according to the most recent available data from iMoneyNet Inc., a money fund research firm in Westborough, Mass. — that they may reach total assets of $3 trillion by the end of the year. Assets in money funds currently stand at $2.89 trillion.

It’s a missed opportunity for short-term-bond funds, said Peter Crane, president of Crane Data LLC, a money fund research firm also located in Westborough.

In a declining rate environment, they should be experiencing healthy inflows, he said. That’s because such investments provide a certain level of safety in an uncertain environment — such as the current climate caused by the subprime mess — as they carry little duration risk but offer a higher yield than money funds.

Compared with money funds, net inflows into short-term-bond funds are lackluster at best, experts say.

Year-to-date through the end of August, investors had put $1.7 billion more into short-term-government-bond funds than they had taken out, according to the most recent data available from the Financial Research Corp. of Boston. That compares with $189 million in outflows for the year-earlier period, FRC reported.

Indeed, problems in the credit markets have scared investors into giving up yield for safety, Mr. Crane said.

It’s a trade-off, however, that investors don’t have to make, said W. Douglas Beck, managing director and head of products at DWS Scudder, the U.S. retail division of Deutsche Asset Management, a subsidiary of Deutsche Bank AG of Frankfurt, Germany.

At least that’s what DWS Scudder is hoping to convince investors through such products as the $1.8 billion DWS Short Duration Plus Fund.

The fund generally invests in high-quality, short-duration bonds, but aims to enhance returns by employing the firm’s integrated Global Alpha Platform strategy.

The iGAP strategy seeks to identify the relative value to be found among global bond, cash and currency markets, and then to benefit from disparities through the use of fixed-income futures and currency-forward contracts.

DWS Scudder has been talking with advisers about the fund, hoping to convince them that it’s a better place to park client assets than a money market fund, Mr. Beck said.

The market sell-off that led to the rush of assets into money funds is “overdone,” he said.

Richard Schroeder, executive vice president of Schroeder Braxton & Vogt Inc., a financial advisory firm in Amherst, N.Y., isn’t familiar with the DWS Scudder fund, but he agrees that putting more money into money funds probably isn’t the smartest move over the long-term.

“You want to stay ahead of inflation, and you won’t do that in money funds,” he said.

The seven-day average yield for all money funds was 4.52% for the week ending Oct. 2, while the fed funds rate was 4.75%, according to iMoneyNet.

As a result, Mr. Schroeder said, he’s more inclined to use short-term-bond funds.

That’s not to say that money funds don’t have their place, he said. For example, they can be used to fulfill a client’s need to access cash.

But they contribute little to the long-term growth of returns, Mr. Schroeder said.

Given the recent credit crunch and subprime-mortgage meltdown, however, it’s understandable that investors would be scared, said Jeff Feldman, president of Rochester Financial Services in Pittsford, N.Y.

He’s not rushing into money funds, but he’s much more aware of the credit quality of the bond funds that he invests in, he said.

It doesn’t appear that investors, however, will be tempted to leave money funds anytime soon, industry experts predicted.

“It’s a tough sell getting people to crawl out of the bunker,” Mr. Crane said.

Making it even tougher is the fact that average money fund yields have remained stubbornly high, he said.

Usually, money fund yields drop when the fed funds rate is cut, but that hasn’t happened, Mr. Crane said. He noted that they have come down slightly but not enough to reflect the half-point cut.

Investors, however, shouldn’t count on money fund yields’ staying so high, Mr. Crane said, as money fund rates will eventually catch up with the cut in the funds rate.

David Hoffman can be reached at [email protected].