Low fund yields frustrating investors

Associated Press

NEW YORK – A lot of money market mutual fund owners are feeling frustrated these days. Fund yields are at some of the lowest levels ever – as little as 1 percent in some cases – and many shareholders are looking for alternatives.

One possibility is bond funds, specifically those tagged as “ultra-short” or otherwise implying a short-term focus. Indeed, many of the funds in this category boast higher yields or better returns than money market funds, making them especially attractive.

But there are significant differences between money market and short-term bond funds, and financial advisers caution against using them interchangeably.

“We don’t really look at short-term bond funds as a cash substitute, even though they might sound tempting when money market funds are returning so little,” said Lisette Smith, a certified financial planner in Boston. “There’s some market risk as well as interest rate risk to them.”

Investment style accounts for much of the difference.

Although money market and ultra-short bond funds both invest in short-term debt, ranging from certificates of deposit and Treasury bills to riskier corporate IOUs, money markets are more strictly regulated.

As a result, money market funds have to keep investments relatively conservative, while bond funds have more latitude. That means an ultra-short fund can make more speculative buys that potentially carry a greater reward – or downside.

The funds also have different goals. A money market fund seeks to preserve the initial investment, plus a small gain to compensate for inflation. The time frame is short, meaning an investor can cash in at any time and pretty much be assured of getting a full investment back. (Neither money market nor bond funds are insured by the government, however.)

A bond fund, by contrast, strives for modest growth rather than just principal preservation. Its perspective is longer term, so investors who pull out after a few weeks or months could face a loss.

“Bond funds are great investments, but they are not a substitute for money market funds, and if you’re going to be using the account to pay tuition or put money on a house, you could end up losing principal,” said Gary Arne, managing director and chief quality officer at Standard &Poor’s Corp. “A bond fund might get you higher returns, but it comes with higher risk.”

Experts say short-term bond funds are really only for people who know they won’t need the money for at least a year and can stomach the prospect of a possible loss. If that fits your needs, here are a couple of factors to consider before buying one.

  • Returns, not yields. Although yields get most of the attention with money market funds, focusing on this indicator is a mistake for bond funds, which are more volatile. Instead, look at yearly return.

    “Ask about periods of underperformance. For example, how many rolling three-month periods of time was the fund ever negative?” said Pete Moran, a principal at Turner Investment Partners, which operates the Turner Ultra Short Duration Fixed Income Fund. “That way you can get a sense of its history and consistency.”

  • Fees. Management expenses and costs are important, particularly in an environment where returns are so disappointing.

  • Credit quality. Bond funds can take more risks than money markets, so investors need to make sure they understand where the performance is coming from. For example, some funds might invest in emerging markets securities, which can be especially uncertain.

    If you’re a money market fund holder, prepare yourself for more disappointing returns. Money market yields correlate with interest rates, and interest rates aren’t expected to go much higher anytime soon.

    “It is pretty frustrating, but most of my clients are pretty understanding of this,” Smith, the Boston planner, said. “They’ve seen the downside of the market, so they’re less tempted to put short-term money into risky investments.”

    Copyright ©2002 Associated Press. All rights reserved. This material may not be published, broadcast, rewritten, or redistributed.

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