If you have some cash in a money-market mutual fund, you're probably disappointed with its current yield of less than 6 percent. Occasionally, you may even wonder whether your principal is safe.
Unless you switch to another fund that's better managed or has lower annual expenses, you can't do much to increase your income from a money-market fund. You'll just have to wait until short-term interest rates rise again.
But starting next Saturday, you won't have to be so concerned about your fund's safety. That's the effective date for changes in Securities and Exchange Commission rules that will reduce the already low risk of investing in money-market funds.
In the nearly 20 years since the first fund registered its shares with the SEC for public sale, millions of people have used such funds to enjoy money-market interest rates, especially when those rates greatly exceeded what banks and thrifts could pay on savings accounts.
Businesses and institutional investors, which can afford to buy the large-denomination money-market instruments that are beyond the means of most people, also have invested heavily in such funds.
There are over 500 money-market funds that provide taxable income, and they have assets totaling more than $460 billion, according to the Investment Company Institute. Another 250 funds offer tax-free income and have $90 billion invested in short-term municipal securities.
You could count on these funds as being safe -- if not federally insured, as bank and S&L accounts are -- because SEC rules permitted them to maintain an asset base that equaled the value of your original investment. Of course, they have always contained an element of risk, even if no investors are known to have lost money in them.
There have been some close calls. On a few occasions in 1989 and 1990, issuers of securities held by several funds defaulted. Each time, the firms managing the funds saved their investors' money -- as well as their and the industry's reputations -- by buying the defaulted paper. They absorbed the losses instead of letting their shareholders suffer.
To reduce the chance that such losses can occur again -- and that investors might not be spared in the future -- the SEC earlier this year adopted the rule changes that will become effective in June.
To understand the risks that have been inherent in money-market mutual funds and what the SEC has done about them, it's important to know how the funds have been managed to provide high current income and stability of principal.
As the table shows, taxable money-market funds invest in securities issued by corporations and banks when they borrow large sums for up to a year (commercial paper and large certificates of deposit), repurchase agreements (usually collateralized by government securities) with banks and dealers, and securities issued by the U.S. Treasury and federal agencies.
Tax-exempt money-market funds invest in short-term state and local government securities or long-term securities that are converted into short-term obligations through put options -- options to sell at a specified price by a specified date -- or other provisions.
In running their portfolios, managers would adjust average maturities and credit quality to earn more interest, while trying not to risk the market value of their securities.
All worked reasonably well until recent times, when actual and feared defaults cast a cloud over holdings of some commercial paper, leading to greater reliance on government securities and to the proliferation of funds that concentrated on government issues. Among tax-exempt funds, problems arose with some issues whose credit quality was supposedly enhanced by bank letters of credit -- only to have the creditworthiness of the banks become questionable.
The SEC's action addressed both interest rate and credit risks. In essence, it:
*Reduced the maximum allowable average maturity of a fund's portfolio from 120 to 90 days.
*Stipulated that, except for 5 percent of its portfolio, a fund owning commercial paper hold only paper given the highest grade by rating services such as Moody's and Standard & Poor's; no single issuer's securities can account for more than 5 percent of a fund's assets. Paper given the second-highest rating can make up the portfolio's remaining 5 percent, but no single issuer of this lower-grade commercial paper can account for more than 1 percent of the fund's assets.
No fund calling itself a money-market fund can fail to comply.
How funds' assets are invested
Money-market funds invest assets in a variety of securities. This chart shows where the funds had their money invested in March 1991 and in March 1990. In March of this year, money-market funds had $461.4 billion invested; last year, the funds had $386.5 billion invested.
ND.. .. .. .. .. March.. .. % of total.. .. March.. .. .. % of total
.. .. .. .. .. 1991.. .. . investment.. .. 1990.. .. .. investment
paper.. .. .. $204.3.. .. .. 44.3.. .. .. $197.6.. .. .. .. ..51.1
securities.. . 105.1.. .. .. 22.8.. .. .. . 53.5.. .. .. .. . 13.8
agreements.. .. 73.4.. .. .. 15.9.. .. .. . 53.3.. .. .. .. . 13.8
S&L CDs.. .. .. 60.3.. .. .. 13.1.. .. .. . 61.1.. .. .. .. . 15.8
Other.. .. .. . 18.3.. .. .. 3.9.. .. .. . 21.0.. .. .. .. .. .5.4
Note: Totals may not add up to 100% due to rounding.
Source: Investment Company Institute