Wednesday, March 26, 2008

Are money market funds really any safer than ultra-short bond funds?

Some reporters are simply dense and will never get it no matter how many times you tell time. Other reporters know that they are saying something misleading but do it anyway just to attract more curious and anxious readers. There was a story on MarketWatch by John Spence and Greg Morcroft entitled "Are money market funds next? - Outflows at ultra-short bond funds show credit pain is spreading", which was clearly trying to artificially raise the anxiety level of readers and investors by posing a hypothetical which is more than a little bit far-fetched. To answer their headline question, No, money market funds are not "next"! Or to answer my own headline question, Yes, money market funds are MUCH safer than ultra-short bond funds. The two are not even comparable.

Much as with auction rate securities, a lot of people were misled into believing that ultra-short bond funds were a "good investment" that was... "as good as cash" and "as good as a money market fund" only that they would pay a higher yield than money market funds. Alas, the promises were not completely true.

Just as with auction rate securities, ultra-short bond funds are still "bond funds" and subject to the investment volatility of any bond fund. Bond funds do not just produce income. They also put you principal at risk for an investment gain or loss. Although the value of your principal in a bond fund can rise, that is not guaranteed and the value of your principal in a bond fund can decline.

Money market funds have an entirely different financial structure, investing only in very short term commercial paper, repurchase agreements, CDs, and other very short-term debt, with an average duration of well under 90 days. Another key difference is that money flows in and out of money market funds at very high rates, so that their financial structure needs to be capable of handle very large short-term outflows. The fact is, many people use them as checking accounts, so that shows you the kind of money flows that money market fund managers have to deal with. Money market funds also tend to be much larger and hence able to handle larger inflows and outflows. There are plenty of other differences, some of which are mandated for money market funds by the SEC. Granted, money market funds are still not as absolutely safe as bank deposits and do not have FDIC protection, but they are still quite safe and nowhere near as risky as other forms of mutual funds such as ultra-short bond funds.

To their credit, the reporters do mention that "The Schwab fund, and others like it, are not technically money funds", but then they go right ahead and confuse the two anyway, telling us "but they are similar enough that major problems with them have left some investors to wonder if anything other than cash is safe at this point." I am sorry, but this is classic yellow journalism, seeking to incite fear and anxiety unnecessarily, when all the reporters needed to do was a little homework and check with some financial experts to verify that money market funds are not like ultra-short bond funds in any way that should be a source of fear or anxiety.

These two reporters should be ashamed of themselves. I know that they can do better. Enough of this kind of yellow journalism.

Just to recap, Yes, your money market funds really are MUCH safer than ultra-short bond funds.

-- Jack Krupansky

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