Unprecedented asset inflows suggest investors parking cash

You know it’s a different world when money market mutual funds are hot.

Investors poured $110 billion into U.S. money market funds in January, up from $24 billion in December and $50 billion a year earlier, according to iMoneyNet Inc., which publishes Money Fund Report, a newsletter.

The heavy inflows are continuing.

Money market funds took in another $42.93 billion in the week ended Feb. 7, pushing total assets to a record $2.005 trillion, according to the Investment Company Institute, the mutual fund trade association in Washington.

“The asset inflows in January and the beginning of February have been unprecedented,” says Peter Crane, managing editor at Money Fund Report in Westborough, Mass.

“In the short-term money funds, assets were pushed over the top by the struggling stock market, but more importantly by the Federal Reserve’s interest rate cuts.”

Institutional play

The Federal Reserve cut the overnight bank-lending rate by a full percentage point to 5.5% last month, in two half-point steps. The Fed hadn’t cut its target overnight rate by a full point in a single month since November 1984.

In an environment of declining interest rates, institutional investors increase their use of money funds because the yields on the funds – reflecting securities purchased over time – beat those available on new, direct purchases of commercial paper or other short-term securities.

Indeed, of the $42.93 billion that flowed into money market funds during the first week of February, institutional investors accounted for $32.57 billion, while retail investors added just $10.36 billion. It is unclear how much of that total was moved over from long-term funds within the same fund company, and how much was outside money.

While much of the money currently flowing into money funds is temporary (read “hot”), the industry is also reaping the benefits of several long-term growth trends.

Consider that it took more than 26 years for the money fund industry to reach $1 trillion in assets and less than four years to reach its second trillion.

“I would expect the next trillion to come in the next year or so,” says Mr. Crane, “especially if we hit a tremendous bear market.”

What are those growth trends?

The most powerful is the popularity of stock mutual funds. As more investors became acquainted with stock mutual funds through their 401(k) plans and individual retirement accounts, they learned about money funds as a higher-yielding alternative to bank savings accounts.

maintaining allocations

“Over the long term, money fund assets are highly correlated to stock fund assets,” Mr. Crane says. “Over the last several years, investors have been adding cash at a rapid pace to try and match the growth in their stock funds. They are trying to maintain a cash allocation.”

Money funds have also grown at the expense of corporate bank accounts. Under current federal regulations, banks are prohibited from paying interest on corporate checking accounts.

While efforts are under way to lift that restriction, “I’ve compared those efforts to being akin to closing the barn door after all the horses are already gone,” Mr. Crane says.

Then there’s the fear factor. In a topsy-turvy stock market environment, investors look at money funds as a safe place to park their cash until the storm is over.

“Last year, the Nasdaq was plummeting as technology and communications stocks were really stinking it up,” says Paige Wilhelm, a vice president and portfolio manager responsible for 12 money market funds at Federated Investors Inc. in Pittsburgh.

“People were pulling their money out of equity funds and trying to put it someplace safe for a while.”

Speaking of milestones, Federated, which is one of the top money fund managers in the country, last month hit the $100 billion mark for money fund assets.