It's often said that history is the best predictor of future events. Yet the opposite has been true with money market funds, at least this year.
The last time there was a debt-ceiling standoff, in 2011, investors pulled back from money market funds. However, this year as the debt-ceiling drama increasingly heated up, U.S. money market funds kept hitting and surpassing record highs.
As of mid-June, money market fund assets totaled $5.45 trillion, according to figures from the Investment Company Institute (ICI). By contrast, as of Jan. 18, that figure was slightly over $4.8 trillion, representing more than a 13% increase.
This level of growth so far in 2023 is a "stunning contrast to when interest rates were near-zero," said Mike Kitchen, senior money market portfolio manager for Cavanal Hill Investment Management, Inc.
Money market funds' biggest surge came in March, when investors put a record $300 billion into them in just three weeks. The rush was driven by turmoil in the financial system early in the month, which drove some people to move their savings out of bank accounts and to money market funds because of their perceived safety.
"Since then, the velocity of flow into money market funds has slowed down, but I wouldn't say that investors' interest has diminished," said Bill King, president of Cavanal Hill Funds and president and CEO of Cavanal Hill Distributors.
No longer just a place to store cash
One crucial difference between now and 2011 is the higher-rate environment we're in, which has increased the yield on money market funds. As the Federal Reserve has moved the Federal Funds rate higher, the rate that money market funds pay to their investors has moved up, too.
The old view of money market funds as just a way to hold cash made sense when interest rates—and thus money market fund yields—were near zero. But with yields near 5%, investors are taking a new look at the role of money market funds in their portfolios, King said.
"In the past, you'd usually see around 2 to 5% of a portfolio allocated to money market funds to provide a place where people could store cash and have access to it," he explained. "In this environment, we're seeing much higher allocations in portfolios than we normally would see because investors are viewing money market funds as fixed income investments."
In addition to higher yields, money market funds are not correlated to the stock and bond markets and can provide stability when these markets are volatile, King said. Even when yields were near-zero, total money market fund assets still grew—although at a slower pace, Kitchen said.
"We like to say the value prop is safety, liquidity and yield, in that order," Kitchen continued.
Money market funds versus money market accounts
Although they may sound similar, these financial tools are very different.
Money market funds are mutual funds that invest in debt securities with short maturities and very low credit risk. Some money market funds invest primarily in government securities, while others invest in tax-exempt municipal securities or corporate debt securities. Money market funds that primarily invest in corporate debt securities are referred to as prime funds.
Money market accounts are accounts offered by banks or credit unions, typically with higher interest rates but less flexibility than regular savings accounts.
Money market accounts are FDIC-insured (up to $250,000), whereas money market funds are not. They are regulated by the Securities Exchange Commission (SEC) and most are rated by Standard and Poor's and Moody's. In 2010, the SEC adopted its first series of amendments to the rules on money market funds with the aim of making them more resilient.
The SEC's move was in response to the 2007-2008 financial crisis. Spurred by Lehman Brothers' bankruptcy, the Reserve Primary Fund "broke the buck"—that is, its net asset value fell to $0.97 cents per share—in 2008, marking one of the first times that a retail money market fund had failed to maintain a $1 per share net asset value.
"Some people might have the misconception that there is no risk with money market funds," said Bill King, president of Cavanal Hill Funds and president and CEO of Cavanal Hill Distributors. "But based on history, risk is possible, but not probable."
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