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Investors fleeing money markets

By Todd Wallack
Globe Staff / October 23, 2011

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Money market mutual funds, long one of the most dependable places for people to stash their cash, are losing their appeal.

Over the past three years, investors have yanked $1.2 trillion in assets from money market funds - 13 times more than they withdrew from stock funds - because of concerns about their safety and abysmally low rates. Today, money market funds now have $2.6 trillion in assets, down a third from January 2009.

“I use money market funds as little as possible,’’ said Chat Reynders, chief executive of Boston investment firm Reynders, McVeigh Capital Management, which manages $650 million in assets and advises clients on $4 billion in investments. He said his firm and clients increasingly sock away cash in short-term government and corporate bonds, certificates of deposits, and plain vanilla bank accounts.

The switch is especially important locally because Boston has long been a hub for many mutual fund companies. For instance, Fidelity Investments is the nation’s largest money market fund operator with $441 billion in assets.

Its largest money market fund, Fidelity Cash Reserves, has $119 billion alone, more than double the firm’s largest stock fund. “It’s a franchise business for us,’’ said Robert Brown, president of Fidelity’s money market business.

Since the early 1970s, investment companies have pitched money market funds as a convenient and safe place for investors to park their cash while waiting to invest money in stocks, bonds, or other riskier investments.

In 1974, Fidelity helped revolutionize the industry by allowing investors to access the money market funds by writing a check, an innovation other firms quickly adopted - making money markets a strong competitor to bank accounts.

The funds grew in popularity because they typically earned higher rates than ordinary savings accounts, without much more risk.

But now investors are returning to traditional bank accounts.

The biggest reason is rates. Most money funds, including Fidelity’s, are paying nearly nothing in the aftermath of the Federal Reserve’s efforts to drive down interest rates. Rates have averaged 0.02 percent or less since April.

By contrast, Internet banks offer savings accounts or penalty-free CDs paying 1 percent or more. Even brick-and-mortar banks generally offer better rates on their traditional savings accounts. Domestic bank deposits, meanwhile, rose about 10 percent to $8.2 trillion from December 2008 to June 2011, according to Market Rates Insight, a research firm in San Anselmo, Calif.

Unlike bank accounts, money market mutual funds are not insured by the federal government against losses. And in a few rare cases, investors have lost some money in these funds, even though they generally invest only in short-term Treasury bonds and other ultraconservative vehicles.

After the collapse of Lehman Brothers in 2008, shares in the Reserve Primary Fund, one of the oldest and largest money market funds, slipped from the standard $1 value investors paid to 97 cents - something called “breaking the buck’’ - after the fund was forced to write off short-term debt securities, known as commercial paper, issued by Lehman.

That prompted the federal government to temporarily step in to guarantee existing deposits at other funds, but that program expired in September 2009.

Now the European debt crisis, recalling the turmoil of the US financial crisis, is raising new concerns about the safety of money markets.

“We think there is a good amount of risk in some of these funds,’’ said Reynders. “A lot of people would be surprised that some money market funds, despite all this news about Europe, still have significant holdings in European bank paper and sovereign bank paper.’’

To reduce the risk, Reynders recommends sticking to funds that invest solely in US government bonds.

But many industry executives and analysts downplayed the risk, especially since the federal government has stepped up its regulation of the money market industry, requiring companies to disclose more information about their holdings. That allows investors to make sure their funds have low-risk holdings.

The bigger problem for investment companies has been record low interest rates, making it harder and harder for fund managers to generate enough interest from safe investments to cover expenses.

Many fund managers, including Fidelity and Boston-based MFS Investment Management, have been forced to slash or waive management fees to make sure the funds continue to offer investors at least a sliver of interest.

Charles Schwab Corp. said it was forced this year to waive $160 million in fees in the third quarter alone, up from $128 million in the second quarter. And revenues have fallen even further because so many investors have withdrawn from the funds.

In fact, some investment firms, including Credit Suisse Group and Janus Capital Group, have decided to shut down some or all their funds because it became too difficult to turn a profit. For instance, eBay Inc.’s PayPal unit closed its $471 million money market fund in July. Overall, investment companies have closed or merged about 180 of 1,305 taxable funds in the past three years, according to iMoneyNet, a Westborough financial research firm that tracks money market funds.

Fidelity, which is privately held, declined to say how much it has lost in revenue or whether the funds are turning a profit. But Brown, who runs the company’s money market business, said Fidelity remains committed to these funds, despite the short-term challenges. In fact, Brown said, he’s adding employees to the team.

“We’re managing the business for decades, not for 12 or 24 months,’’ he said.

Todd Wallack can be reached at twallack@globe.com. Follow him on Twitter @twallack.