Returns from Investing in Money Market Funds, 1990 to 1994
Financial Services Review, Vol 6 No 3, 1997
Posted: 20 Jul 1998
Asset allocation models recommend that individuals and families allocate a portion of their portfolio to cash-e.g., bank checking accounts and money market mutual funds. In this paper, we study the factors affecting the cross section of net returns at money market funds from 1990 through 1994, and the persistence of funds' relative returns across years. We find evidence of economies of scale in the management of money funds until net assets reach $300 million. Among funds larger than $300 million, two factors explain 87 percent of the variance of five-year net returns. The first and most important factor is the expense ratio. Second, government-only (GO) funds, which can buy only U.S. government securities, produce slightly lower returns than other-taxable (OT) funds, which can buy commercial paper and other assets. Among funds larger $300 million, we conclude that all GO funds are essentially commodities and all OT money funds are essentially commodities. That is, (1) they produce similar gross returns, (2) differences in net returns are driven almost exclusively by differences in expenses, and (3) expenses are a dead-weight loss to investors. In addition, money funds' relative returns show strong persistence. Most funds maintain stable expense ratios. So, low-cost funds (except those with temporarily lower expenses) produce consistently high relative returns.
JEL Classification: G11, G12
Suggested Citation: Suggested Citation