High interest, high liquidity draw cash to money funds

Money, money, money -- it has been flowing in record amounts into the money market funds. Fluctuating interest rates have battered bonds, staggered businesses, and clobbered traditional savings accounts. But they can hardly lay a glove on money funds.

Indeed, in the week ending Jan. 14 a record $2.8 billion of new cash flowed into the funds, according to the Investment Company Institute. It has apparently been attracted by the current high yields offered by the funds. It also was money fleeing the stock market.

But, whether the prime rate climbs up or down, money market fund yields tag right along behind.

When interest rates are high, as they are now, money funds are a good investment for the small saver who wants liquidity. The yield is higher than the return on passbook savings, and the money isn't tied up like funds placed directly in a bank certificate of deposit.

If rates fall, the funds may not be such a good deal, in relative terms. But they would have to fall to pre-inflation levels to cause money funds serious trouble.

The money fund interest rate relationship can be better understood by peeling back the prospectus and taking a look at the structure of the funds. Money market fund investors pool their resources and rent their money to banks, governments, and corporations for short periods -- days or months, but normally less than a year. Money fund yields, naturally, go up when interest rates rise for the shortterm investments that make up the money market. Or vice versa when they fall.

Funds invest in such securities as US Treasury bills, commercial paper (IOU's issued by corporations), and bank certificates of deposit. Plotting the interest rates paid on these shortterm securities (the fluctuation of three-month Treasury bills, for example, is often charted in newspapers) is a good way to predict which way money market fund yields will turn.

There is a lag time. Like little brothers, money market yields are always scampering after interest rates, trying to catch up.

By the same token, when rates fall money funds get dragged right along behind.