December 11, 2009 / 8:26 PM / 10 years ago

Short-debt funds alternative to money market

NEW YORK (Reuters) - Investors who have parked cash in money-market accounts have been paying for their search for safety with pitiful returns.

But mom and pop can do better without taking much additional risk, several fund managers said at the Reuters Investment Outlook Summit this week, highlighting the value of certain debt funds.

Over $3 trillion has been piled into money market accounts, even though they have been returning less than 0.25 percent, with yields down along with record low rates on Treasury bills and the disappearance of many corporate borrowers from the short-term debt market.

One alternative is to invest directly in short-term mortgage debt backed by the U.S. government, Martin Sass, chairman and chief executive of M.D. Sass, said at the Reuters summit in New York.

“You can get a 2 percent yield today on U.S. government agency mortgage-backed securities,” Sass said. “Isn’t that a much better place to park money than leave it in a money market fund making nothing?”

Investors should also consider short-term debt funds, Ken Volpert, head of the taxable fixed income bonds at Vanguard Group. Such funds tend to invest in securities with slightly longer maturities and lower credit ratings.

Vanguard’s Short-Term Investment Grade Fund, for example, yields 2.4 percent with an average duration of two years. Duration is a measure of a bond portfolio’s price sensitivity to changes in yield. Longer durations result in greater price volatility and therefore risk.

By contrast, Vanguard’s Prime Money Market Fund, which yields only 0.09 percent, holds securities with an average life of 113 days.

“It’s still a fairly safe place to hold short-term reserve cash,” he said, adding that the fund has benefited from the recovery in corporate yields relative to Treasury yields.

Volpert said the vast majority of both money market and short-term bond funds have become more careful about selecting only the safest securities.

Small wonder. In 2008, numerous short-term bond funds were burned by holding securities issued by structured investment vehicles — complex packages of loans and debt, including risky subprime mortgages and collaterized debt obligations.

And one of the largest money market funds, the Reserve Fund, traded for less $1 a share — a phenomenon known as “breaking the buck” — because it held securities issued by none other than bankrupt brokerage firm Lehman Brothers.

“I think as an industry participant, a money-market fund is a good thing and it should be a safe, liquid portfolio,” said Mary Miller, the head of fixed income at Baltimore-based T. Rowe Price. “I expect that we’ll see some changes that will shorten the average maturities and tighten up credit standards for money-market funds.”

Miller’s words shouldn’t be taken lightly: She was recently nominated by U.S. President Barack Obama as assistant secretary of the Treasury for financial markets.

Editing by Leslie Adler

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