The Best Money-Market Funds – MarketWatch

Money-market funds have received $632 billion in net inflows this year, putting net assets at $5.5 trillion, according to LSEG Lipper. That’s up $1 trillion from 2022’s year-end data and nearly double 2018’s levels.

“I’m happy that money-market funds are finally getting their day in the sun,” says Judith Raneri, senior portfolio manager of the $4.2 billion
Gabelli U.S. Treasury Money Market
fund (ticker: GABXX). “Money-market funds have definitely benefited from [the Fed’s] pivot.”

Tom Roseen, head of research at LSEG Lipper, says that in addition to strong yields, concerns about the stock market rally’s narrow breadth, persistent inflation, a potential recession, geopolitical worries over Russia’s war in Ukraine, and weakness in the Chinese economy probably drew investors’ dry powder.

“I think you’re seeing a little bit of a safe haven,” he says. “What would you rather have, a 5% return out of a money-market fund, or perhaps suffer a downturn in your equity funds? The same with fixed income. Investors are cautious jumping in because in a rising-interest-rate environment, there is a decline in the value of your bond.”

With investors piling into these funds, Barron’s surveyed the retail money-market fund landscape to see which funds are sporting the highest yields—and to dig into how these funds operate to remind investors what they’re buying. They are highly regulated to keep assets stable, but they do still carry a modicum of risk.

How They Work

Like other mutual funds, money-market funds are regulated by the Securities and Exchange Commission under the Investment Company Act of 1940, and are subject to further restrictions under the legislation’s rule 2a-7, which requires that these funds have high liquidity and a weighted average maturity of 60 days or less, and must limit their credit risk to the top two credit ratings, usually AA or higher.

The bulk of assets in retail money-market funds are in government funds, either those that just hold U.S. Treasury notes and Treasury repurchase agreements, or those that hold Treasury notes, agency debt, and repurchase agreements.

The other two categories are municipal money-market funds that own state and local government debt, and prime money-market funds, which own a variety of high-quality, very-short-term financial instruments including U.S. or foreign securities, and debt issued by corporations, financial institutions, and the U.S. government.

Low yields in bank money-market accounts have attracted investors to money-market funds, but Roseen stressed that investors shouldn’t confuse the two. Money-market accounts from banks are insured by the Federal Deposit Insurance Corp. The SEC regulations on money-market funds are meant to keep assets at a stable net asset value of $1, but these are still investment products and can lose money.

“That’s probably the main bugaboo that we have out there,” Roseen says.

There have been very rare times when money-market funds have dipped below the dollar value, known as “breaking the buck.” The best-known example was in 2008, when the Reserve Primary Fund broke the buck because it owned very short-term debt from Lehman Bros. Eventually, it ended up paying investors 99 cents on the dollar before closing.

Over the years, the SEC has tried to strengthen these products. Recently, it passed reforms requiring that issuers maintain at least 25% of a fund’s total assets in daily liquid assets and at least 50% of a fund’s total assets in weekly liquid assets.

Many portfolio managers say their liquidity levels are well above SEC requirements and publish these levels on their websites. Laurie Brignac, Invesco’s chief investment officer and head of its global liquidity team, manages Invesco Premier Portfolio (IPPXX) and
Invesco Government Money Market
(INAXX). She says the funds publish full holdings weekly, along with daily and weekly liquidity, yields, and portfolio structure, offering more transparency than seen in other investment products.

Big Differences

Unlike other investment vehicles where a long-term track record is crucial, in money-market funds, the seven-day yield gives investors the clearest picture of current yield and dividend payments. Because of the very short-term nature of these funds, the yield can fluctuate depending on what portfolio managers purchase that week.

An average maturity of 60 days or fewer benefited money-market funds this year as the inverted yield curve rewarded managers who stayed with very short maturities, Brignac says.

Barron’s top 20 funds kept their weighted average maturity far shorter than the required 60 days, with some funds having average maturities within 10 or 20 days to take advantage of rising rates quickly.

Prime and muni funds take credit risk to boost yield, and fund managers say credit analysts will review securities before they are added to the fund to ensure quality. Brignac says Invesco’s credit analysts keep an approved buy list. With that list in mind, she and the managers on the Premier Portfolio also weigh investors’ liquidity needs as well as sectors, credit quality, and bond maturity dates, given the interest-rate environment.

Liquidity is always important, but heading into the end of the year, it becomes even more so, since investors may need to access more cash or will buy more shares. She does this while balancing the possibility of another Fed interest-rate hike and wanting to have the ability to buy higher-yielding securities if monetary policy tightens further.

Justin Schwartz, head of municipal money-market funds at Vanguard and portfolio manager of the
Vanguard Municipal Money Market
fund (VMSXX), says Vanguard’s philosophy is to take a “very conservative” approach when adding holdings, with their baseline being a double-A rated or higher security with very stable to improving credit profiles, and high-quality revenue and tax bases.

He credits the fund’s above-average return to keeping a tight leash on maturity of about 10 days, which has allowed it to quickly reflect higher yields as the Fed raised rates.

Staying nimble and keeping maturities short helped some government funds post yields that competed with prime funds. Gabelli’s Raneri says she and Ron Eaker, portfolio manager of the Gabelli Treasury fund, structured it as a laddered portfolio with bonds maturing every week to capture incremental rising yields, with reinvestment cycles every Monday and Thursday.

Raneri had kept the fund with a shorter maturity, but started to go out slightly further on the yield curve about a month ago, as she and Eaker believe that yields are starting to peak. They expect one more 0.25% rate hike, so they’re pushing the maturity to closer to 55 days, although she says the maturity can fluctuate.

Shawn Lyons, taxable money funds manager for Franklin Templeton and portfolio manager of the $300 million
Franklin OnChain U.S. Government Money
fund (FOBXX), invests mostly in Treasuries and Federal Home Loan Banks, focusing on both liquidity and yield. Like others, he has kept maturities short—typically about 20 days—trying to spot “little kinks in the curve on a daily basis where you can pick up a couple of basis points,” he says.

OnChain, a relatively new fund, uses blockchain technology for the ledger of investments and to record shareholder activity. It doesn’t invest in cryptocurrencies. Roger Bayston, head of digital assets at Franklin Templeton, says regulators are working with the fund to see how blockchain could benefit investors.

“It feels like there’s probably improved utilities that shareholders may experience in the future as a result of this new environment of using blockchains,” he says.

Minding Taxes

Fund buyers should keep taxes in mind as they choose a money-market fund, as some funds’ dividends are taxable. Vanguard’s Schwartz says his fund appeals to tax-sensitive, high-net-worth investors looking to shelter some gains from federal taxes, for example.

Some investors choose government and Treasury money funds for the potential tax shelter from state and local taxes, although they will still be on the hook for federal taxes. Buyers need to be aware of what a fund holds. States aren’t allowed to tax federal debt, so a 100% U.S. Treasury fund is free of state and local taxes, Gabelli’s Raneri says.

Additionally, debt from certain agencies, including Federal Farm Credit Banks, Federal Home Loan Banks, Sallie Mae, and the Tennessee Valley Authority, are free from state and local taxes as direct government obligations. Debt issued by Ginnie Mae,
Fannie Mae,
and
Freddie Mac
is subject to taxes.

Watch out for repurchase agreements, or “repos,” in government funds, warn Raneri and Lyons. The income earned from Treasury or direct government obligations repos are subject to taxation.

“Repurchase agreements are a short-term loan, collateralized by U.S. debt. So, when [investors] think of Treasury repos, they’re like, ‘Oh, same as a Treasury bond or Treasury bill.’ As far as tax provisions go, it’s not the case,” Raneri says.

How We Choose Our Top 20

Working with LSEG Lipper, we narrowed down the money-market fund universe to those available to retail investors, who make up about 40% of the total assets under management in these vehicles. Institutional money-market funds are used by 401(k) providers and other large entities looking to park money for the short term.

While a fund’s seven-day yield reflects its current dividends, to choose our funds, we also considered the one-year return to get a sense of how portfolio managers took advantage of the Fed’s steep hikes over the course of time, and how they are investing now. Fees mattered, as well, especially in a time where inflation still bites at real returns, so we looked for funds with the lowest annual costs relative to returns and yields.

We also looked at minimum initial investment, seeking to keep minimums relatively low. We put a cap at $25,000 to expand the diversity of funds that met our criteria, with the idea that many investors may use these funds as a place to park a chunk of cash for the short term. While many high-yielding funds have investment minimums as low as a few thousand dollars, some have no minimums. Above $25,000, investment minimums quickly escalate, putting funds out of reach for investors with low cash balances.

Finally, we sought a range of different types of funds available, from a multitude of issuers, to show investors the breadth of what’s available.

Email: editors@barrons.com