Reply #33: Is your money fund safe? [View All]

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http://money.cnn.com/2008/05/06/magazines/fortune/money_fund_benner.fortune/index.htm?postversion=2008050705

Money market mutual funds are known for being both liquid and solid. Liquid because you can get your money out of them at any time; solid because they maintain a steady value of $1 per share. And they're popular because they tend to pay slightly higher rates than Treasury bills or bank savings accounts. Individuals and institutions alike use them to park cash they are waiting to deploy and to ride out market storms. Amid the turmoil of the past year, assets have soared 45%, to $3.5 trillion. But with the credit crunch casting doubt on many formerly safe-seeming securities, the big question for many investors has become, Is my money fund safe?

The short answer is yes, with some caveats: Money market funds have been around since the mid-1970s, and since then no retail investors have lost a cent in one. "Money market funds have endured crises in the past and are still safe," says Alyce Zollman, a financial consultant at Charles Schwab. But investors are right to be concerned. "There is so much less risk with money market funds relative to other funds that people view them as risk-free," says Robert Plaze, an associate director in the Securities and Exchange Commission's division of investment management. "But they're not insured by the government. Saying there's no chance for problems is not accurate." The danger: A fund could suffer losses on its holdings and "break the buck" - see the value of a share fall below $1.

Money market funds typically hold a mix of short-term corporate bonds, Treasury bills, and other high-quality debt. But in recent years they also bought more exotic stuff: specifically, paper issued by structured investment vehicles (SIVs) - entities set up by banks to hold debt off their own balance sheets. "Last August, over half of money fund managers were buying SIV-related debt, which amounted to about 5% of money market fund holdings," says Peter Crane, whose firm, Crane Data, tracks money market funds. Crane goes on to explain that when the market for a security dries up, as it did for SIV debt, the value drops, even if the risk of default hasn't increased. And in a fund where even 1% of the assets have no buyers, says Crane, "the fund could break the buck."