NEW YORK -- How safe is your money market mutual fund? As safe as any investor could reasonably expect. Your principal is always worth $1 a share. Only the yield fluctuates, as interest rates in the market change. Any time you want, you can take out the money you invested plus the yield it has earned.
Last month, however, money-fund investors got a scare. A handful of funds got stuck with some losses on risky securities they held. Every $1 kept in those funds might have dropped to a value of 99 or 98 cents, had the fund sponsors not injected enough cash to bail everybody out.
No one has ever lost money in a true money-market fund, but there have been some close calls. Here's what's going on:
* 1. Which funds ran into trouble?
Nearly two dozen are said to have stumbled, but all their names will never be known. Only a couple have confessed. The $105 million Zweig Cash Fund needed $415,000 from its sponsor, to prevent investors from losing some of their principal. BankAmerica put $67.9 million into two of its Pacific Horizon funds, the $3.2 billion Prime Fund and the $648 million Government Fund, both bought principally by institutions. BA representative Shirley Norton blamed some of the Prime Fund's problem on high redemptions, which forced it to sell securities prior to maturity.
No specific rule requires your fund to tell shareholders about a bailout. If the cash infusion is large enough for accountants to deem "material," it has to be disclosed in the annual or semi-annual report. Even so, it might be buried in an untranslatable footnote.
To me, that's deceptive. Money-fund investors put safety first. When considering a new fund, they should be told if its managers once had to be rescued from a risky investment choice.
Teresa Redinger, editor of the Money Fund Report in Ashland, Mass., thinks that current shareholders should be told about bailouts immediately rather than having to chance on them in the newspaper. Guaranteed disclosure would also save people in innocent funds from wondering whether their own investments had been at risk.
* 2. Which securities are the baddies?
Funds are getting smashed by derivatives -- complex investments whose returns are derived from price changes in other markets. Some derivatives aren't particularly dangerous; others can lose an unexpected amount of value when interest rates rise. The losers include some derivatives linked to federal government securities, which investors in government money funds mistakenly assume are safe.
Arthur Levitt, chairman of the Securities and Exchange Commission, has written to the 80 largest money funds, warning them to take another look at the risks in their derivatives. The SEC is proposing to tighten up on the types of these securities that the money funds can buy. It also wants prospectuses to disclose more about these risks, says Commissioner J. Carter Beese.
At present, however, prospectuses don't clearly alert you as to whether your fund buys high-risk derivatives. Suggestion: Call the fund and ask. Among the questionable investments fingered by the SEC (and too arcane to write about further) are those called inverse floaters, capped floaters, CMT (constant maturity Treasury) floaters, leveraged and deleveraged floaters, range floaters, dual index floaters and COFI (cost of funds index) floaters. Money managers also worry about SBA floaters, which are linked to the payments on pools of loans backed by the Small Business Administration.
Note that, so far, all the potential losses have arisen in taxable funds, not in the tax-exempt money funds.
* 3. Are money market mutual funds still safe to buy?
In my opinion, yes. The vast majority don't own risky derivatives. All the fund sponsors whose funds did get caught in poor investments -- now and in earlier years -- have so far honored their commitment to investors by adding any money needed to keep the share value at $1.
The average taxable money-market mutual fund is yielding 3.7 percent, according to the Money Fund Report. The average bank money-market account -- which is federally insured -- yields only 2.4 percent. By sticking with money funds, you pick up an extra 1.3 percentage points in earnings each year. That's more than enough to make up for any remote risk of loss.
One tip when shopping for money funds: Those with higher yields than the competition are often the ones most apt to be taking the highest risks.
Jane Bryant Quinn is a syndicated author. Write her at: Newsweek, 444 Madison Ave., 18th Floor, New York, N.Y. 10022.