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This chapter describes recent U.S. mutual fund developments and examines the market factors that affect the demand for equity, bond, hybrid, and money market funds.

With $13 trillion in assets, the U.S. mutual fund industry remained the largest in the world at year-end 2012. Total net assets increased $1.4 trillion from the level at year-end 2011, boosted by growth in equity, bond, and hybrid fund assets. Demand for mutual funds increased in 2012 with net new cash flows of all types of mutual funds totaling $196 billion. Investor demand for certain types of mutual funds appeared to be driven, in large part, by a continued trend toward investment diversification, the demographics of the U.S. population, and uncertainty surrounding the year-end fiscal cliff. Inflows to bond funds were quite strong and net withdrawals from equity funds picked up—their fifth consecutive year of outflows. Hybrid funds remained popular with inflows increasing again in 2012. After three years of sizable outflows, money market funds experienced a small net outflow of less than $500 million. This slowdown in net redemptions owed in large part to investors moving to cash at year-end because of fiscal cliff concerns.

Investor Demand for U.S. Mutual Funds

Investor demand for mutual funds is influenced by a variety of factors, not least of which is funds’ ability to assist investors in achieving their investment objectives. For example, U.S. households rely on equity, bond, and hybrid mutual funds to meet long-term personal financial objectives such as preparing for retirement. U.S. households as well as businesses and other institutional investors use money market funds as cash management tools because they provide a high degree of liquidity and competitive short-term yields. Changing demographics and investors’ reactions to changes in U.S. and worldwide economic and financial conditions play important roles in determining how demand for specific types of mutual funds and for mutual funds in general evolves over time.

U.S. Mutual Fund Assets

The U.S. mutual fund market—with $13 trillion in assets under management at year-end 2012—remained the largest in the world, accounting for 49 percent of the $26.8 trillion in mutual fund assets worldwide (Figure 2.1).

Figure 2.1

The United States Has the World’s Largest Mutual Fund Market

Percentage of total net assets, year-end 2012

Figure 2.1

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Note: Components may not add to 100 percent because of rounding.
Sources: Investment Company Institute, European Fund and Asset Management Association, and other national mutual fund associations

The majority of U.S. mutual fund assets were in long-term funds. Equity funds made up 45 percent of U.S. mutual fund assets at year-end 2012 (Figure 2.1). Domestic equity funds (those that invest primarily in shares of U.S. corporations) held 33 percent of total industry assets. World equity funds (those that invest primarily in non-U.S. corporations) accounted for another 12 percent. Bond funds accounted for 26 percent of U.S. mutual fund assets. Money market funds (21 percent) and hybrid funds (8 percent) held the remainder of total U.S. mutual fund assets.

More than 700 sponsors managed mutual fund assets in the United States in 2012. Long-run competitive dynamics have prevented any single firm or group of firms from dominating the market. For example, of the largest 25 fund complexes in 1995, only 15 remained in this top group in 2012. Another measure of market concentration is the Herfindahl-Hirschman Index, which weighs both the number and relative size of firms in the industry. Index numbers below 1,000 indicate that an industry is unconcentrated. The mutual fund industry had a Herfindahl-Hirschman Index number of 465 as of December 2012.

Nevertheless, in the past 12 years the percentage of industry assets at larger fund complexes has increased. The share of assets managed by the largest 10 firms in 2012 was 53 percent, up from the 44 percent share managed by the largest 10 firms in 2000 (Figure 2.2). In addition, the share of assets managed by the largest 25 firms was 73 percent in 2012 compared with 68 percent in 2000. Several factors likely contributed to this development. One factor is the acquisition of smaller fund complexes by larger ones. Second, total returns on U.S. stocks* averaged 3.5 percent annually from year-end 2000 to year-end 2012 and likely held down assets managed by fund complexes that concentrate their offerings primarily in domestic equity funds—many of which tend to be smaller fund complexes. In addition, domestic equity mutual funds have had outflows for seven consecutive years. Third, in contrast, total returns on bonds averaged 6 percent annually in the past 12 years. Finally, strong inflows over the decade to bond funds, which are fewer in number and have fewer fund sponsors than equity mutual funds, helped boost the share of assets managed by those large fund complexes that offer bond funds.

* Measured by the Wilshire 5000 Total Market Index.
Measured by the Citigroup Broad Investment Grade Bond Index.


Figure 2.2

Share of Assets at the Largest Mutual Fund Complexes

Percentage of industry total net assets, year-end, selected years

  1995 2000 2005 2010 2011 2012
Largest 5 complexes 34 32 37 40 40 40
Largest 10 complexes 47 44 48 53 53 53
Largest 25 complexes 70 68 70 74 73 73

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Developments in Mutual Fund Flows

Investor demand for mutual funds as measured by net new cash flow—the dollar value of new fund sales less redemptions combined with net exchanges—strengthened significantly in 2012 due to a slowdown in outflows from money market funds and an increase in demand for long-term funds. Overall, the industry had a net cash inflow of $196 billion (Figure 2.3). Investors added $196 billion, on net, to long-term funds, while withdrawing less than $500 million, on net, from money market funds.

Figure 2.3

Net New Cash Flow to Mutual Funds

Billions of dollars, 1998–2012

Figure 2.3

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* In 2012, less than $500 million was withdrawn from money market funds.
Note: Components may not add to the total because of rounding.

Global financial markets were fairly calm in 2012 and stock prices worldwide were bolstered by developments that turned out to be less negative than feared. In the summer, market participants’ concerns about a splintering of the European Union were abated when the European Central Bank pledged to do “whatever it takes to preserve the euro.” In the fall, the Federal Reserve announced another round of aggressive quantitative easing to keep long-term interest rates low in a bid to spur borrowing by U.S. households and businesses. The Fed also indicated that short-term interest rates would remain low into 2014. By year-end, market participants’ worries about a collapse in economic growth in China had eased somewhat. Even the threat of the U.S. federal government falling off the “fiscal cliff” did not derail financial markets at the end of 2012, although some investors took actions to protect themselves in case of such an event.

In the United States, economic conditions showed signs of improvement in 2012. Growth, although still below full capacity, picked up in 2012 with gross domestic product (GDP) expanding at a 2.2 percent pace, up from 1.8 percent in 2011. In addition, the start of a recovery in the housing market looked promising as home prices rose 7 percent from year-end 2011 to year-end 2012 and sales of existing and new homes increased 10 percent. The employment picture brightened as well, with the unemployment rate declining from 8.5 percent at year-end 2011 to 7.8 percent at year-end 2012. After-tax corporate profits increased nearly 16 percent in 2012 and stock prices ended the year with double-digit gains. The S&P 500 index climbed 13 percent and the NASDAQ composite index increased nearly 16 percent.

In the rest of the world, economic and financial conditions improved over the course of 2012. Growth in emerging and developing countries strengthened, while bond spreads in the euro-area periphery declined. World stock prices* rose about 13 percent in 2012, with stock prices in Europe up 15 percent.

* Measured by the Morgan Stanley Capital International All Country World Ex-U.S. Index.
Measured by the Morgan Stanley Capital International Europe Index.

Demand for Long-Term Mutual Funds

Investors added $196 billion in net new cash to equity, bond, and hybrid funds in 2012, up substantially from only $26 billion in 2011 (Figure 2.3). Increased investor demand for bond and hybrid funds more than offset larger outflows from equity funds in 2012.

Equity and Hybrid Mutual Funds

Investors withdrew cash from equity funds in 2012 at a faster pace than in 2011. In 2012, net withdrawals from all equity funds amounted to $153 billion for the year, more than the $128 billion investors withdrew, on net, the previous year. Some of the outflow from equity funds likely reflected opportunistic selling in the last months of 2012 by investors concerned about the repercussions of the fiscal cliff and anticipating higher capital gains tax rates. Net redemptions from equity funds picked up in November and December and totaled $54 billion. Through the first 10 months of the year, investors withdrew $99 billion, on net, from equity mutual funds.

Generally, demand for equity mutual funds is strongly related to performance in the stock markets (Figure 2.4). Net flows to equity funds tend to rise with stock prices and the opposite tends to occur when stock prices fall. This historical relationship, however, appears to have weakened in the past several years, particularly for domestic equity mutual funds. In 2012, U.S. stocks* returned a total of about 16 percent (including dividend payments) and investors withdrew, on net, $156 billion from domestic equity funds. Domestic equity funds have had seven consecutive years of withdrawals totaling $613 billion, more than would be expected based on the historical relationship between returns on U.S. stocks and demand for domestic equity mutual funds.

* Measured by the Wilshire 5000 Total Market Index.


Figure 2.4

Net New Cash Flow to Equity Funds Is Related to Global Stock Price Performance

Monthly, 1998–2012

Figure 2.4

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1Net new cash flow to equity funds is plotted as a six-month moving average.
2The total return on equities is measured as the year-over-year change in the MSCI All Country World Daily Total Return Index.
Sources: Investment Company Institute and Morgan Stanley Capital International

Asset-Weighted Turnover Rate

The turnover rate—the percentage of a fund’s holdings that have changed over a year—is a measure of a fund’s trading activity. The rate is calculated by dividing the lesser of purchases or sales (excluding those of short-term assets) in a fund’s portfolio by average net assets.

To analyze the turnover rate that shareholders actually experience in their funds, it is important to identify those funds in which shareholders are most heavily invested. Neither a simple average nor a median takes into account where fund assets are concentrated. An asset-weighted average gives more weight to funds with large amounts of assets, and accordingly, indicates the average portfolio turnover actually experienced by fund shareholders. In 2012, the asset-weighted annual turnover rate experienced by equity fund investors was 48 percent, well below the average of the past 33 years (Figure 2.5).

Investors tend to own equity funds with relatively low turnover rates. In 2012, about half of equity fund assets were in funds with portfolio turnover rates under 26 percent. This reflects the propensity for funds with below-average turnover to attract shareholder dollars.

Figure 2.5

Turnover Rate* Experienced by Equity Fund Investors

1980–2012

Figure 2.5

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* The turnover rate is an asset-weighted average.
Note: Data exclude mutual funds available as investment choices in variable annuities.
Sources: Investment Company Institute, Center for Research in Security Prices (CRSP), and Strategic Insight Simfund

Although sizable, these outflows from domestic equity funds by no means suggest a wholesale abandonment of the U.S. stock market by fund investors. Data on equity exposure for participants in 401(k) plans show that across all age groups, the percentage of participants who held no equities in their 401(k) accounts actually declined over the 10-year period from 2001 to 2011 (Figure 2.6). Rather, the data are indicative of a rebalancing of equity exposure for 401(k) participants aged 40 years or older. For example, among 401(k) participants in their fifties in 2001, 46 percent had more than 80 percent of their 401(k) accounts invested in equities. As of 2011, only 25 percent of 401(k) participants in their fifties had more than 80 percent of their accounts invested in equities. In contrast, the proportion of participants in their fifties with between 60 percent and 80 percent of their accounts invested in equities more than doubled from 15 percent in 2001 to 31 percent in 2011. 401(k) participants aged 40 or older continued to hold equities in their accounts in 2011, but at less concentrated levels than similarly aged participants in 2001.

Figure 2.6

Concentrated Exposure to Equities Has Declined Among Older 401(k) Participants

Percentage of 401(k) participants by age, year-end 2001 and 2011

Figure 2.6

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Note: Equities include equity funds, company stock, and the equity portion of balanced funds. Funds include mutual funds, bank collective trusts, life insurance separate accounts, and any pooled investment product primarily invested in the security indicated. Components may not add to 100 percent because of rounding.
Source: Tabulations from EBRI/ICI Participant-Directed Retirement Plan Data Collection Project. See ICI Research Perspective, “401(k) Plan Asset Allocation, Account Balances, and Loan Activity in 2011.”

Factors such as lower investor risk tolerance, investor demographics, a trend toward greater investment diversification, and product development appear to be playing an important role in investors’ reduced demand for domestic equity mutual funds. In the past decade, households have endured two of the worst bear markets in stocks since the Great Depression. U.S. household surveys show that within specified age groups, willingness to take investment risk is lower relative to 2001 (after the bursting of the dot-com bubble) and relative to 2008 (prior to the nadir of the financial crisis) (Figure 2.7). For example, 26 percent of households headed by someone younger than 35 were willing to take above-average or substantial investment risk in 2012, about the same percentage as such households in 2008, but below the 30 percent of such households in 2001. For households headed by someone between 50 and 64 years of age, only 19 percent were willing to take above-average or substantial investment risk in 2012, compared with 24 percent of such households in 2008 and 23 percent in 2001.

Figure 2.7

Willingness to Take Above-Average or Substantial Investment Risk by Age

Percentage of U.S. households by age of head of household, selected years

Figure 2.7

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Note: Age is based on the sole or co-decisionmaker for household saving and investing.
Sources: Investment Company Institute and Federal Reserve Board

The aging of the population likely also has contributed to a reduction in the demand for equity funds. As investors grow older, willingness to take investment risk tends to decline and they gradually shift their assets away from equity products and toward fixed-income products. In 2012, only 7 percent of households headed by someone aged 65 or older were willing to take above-average or substantial investment risk, compared with 25 percent of households in which the household head was between 35 and 49 years old (Figure 2.7).

Older investors also tend to have larger account balances than younger investors, as they have had more time to accumulate savings and take advantage of compounding. In 2012, households headed by someone aged 65 or older held 19 percent of households’ mutual fund assets; whereas, households headed by someone younger than 35 held only 7 percent (Figure 2.8). The vast majority of the Baby Boom Generation are in households headed by someone between the ages of 45 and 64, and these households held 62 percent of all mutual fund assets in 2012. Therefore, as Baby Boomers have begun to pare back their exposure to equities, this shift likely has restrained flows into equity funds. This pattern is expected to continue for some time to come.

Figure 2.8

Mutual Fund Assets by Age Group

Percentage of households’ mutual fund assets held by each age group, selected years

Figure 2.8

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Note: Age is based on the age of the sole or co-decisionmaker for household saving and investing.

Perhaps related to lower risk tolerance and investor demographics, investors increasingly have diversified their portfolios. Investor demand for hybrid funds, which invest in a combination of stocks and bonds, strengthened further in 2012, with investors adding $46 billion, on net, to these funds, up from $29 billion in 2011. Over the past four years, investors increasingly have turned to hybrid funds with net inflows amounting to $116 billion. Also, over the past decade, funds of funds have become a popular choice with investors and flows into these funds are directed to underlying equity and bond funds. Funds of funds received $97 billion in net new cash flow in 2012 and $859 billion over the past 10 years.

Funds of Funds

Funds of funds are mutual funds that primarily hold and invest in shares of other mutual funds. The most popular type of these funds is hybrid funds—a little more than three-quarters of funds of funds’ total net assets were in hybrid funds in 2012. Hybrid funds of funds invest their cash in underlying equity, bond, and hybrid mutual funds.

Assets of funds of funds have grown rapidly over the past decade. By the end of 2012, the number of funds of funds had grown to 1,156, and total net assets were nearly $1.3 trillion (Figure 2.9). About 60 percent of the net inflow to funds of funds since year-end 2002 is attributable to increasing investor interest in target date funds (also known as lifecycle funds) and lifestyle funds (also known as target risk funds). The growing popularity of these funds, especially for retirement investing, likely reflects their automatic rebalancing features. In addition, target date funds often are used in defined contribution plans when participants are automatically enrolled, particularly since the Pension Protection Act was passed in 2006. Target date funds follow a predetermined reallocation of risk over time, and lifestyle funds maintain a predetermined risk level.

For more information on target date and lifestyle funds, see chapter 7.

Figure 2.9

Total Net Assets and Number of Funds of Funds

Billions of dollars, 1998–2012

Figure 2.9

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Investors also have sought to diversify within the equity mutual fund space. In contrast to domestic equity funds, world equity funds have received inflows each year, with the exception of 2008, for the past seven years. In 2012, international stock prices were up about 17 percent (including dividend payments)* for the year, and world equity funds received $3 billion in net new cash. Over the past seven years, investors have purchased $300 billion, on net, of world equity funds.

* Measured by the Morgan Stanley Capital International Total All Country World Ex-U.S. Index.

The development of other investment products likely has diverted cash away from domestic equity mutual funds. Asset allocation strategies used by funds of funds and hybrid funds have resonated with investors. In addition, exchange-traded funds (discussed in detail in chapter 3) are being used increasingly by retail investors and their advisers.

Bond Mutual Funds

In 2012, investors added $304 billion to their bond fund holdings—a strong pace, up from $125 billion in 2011, but still below the record $380 billion pace of net investment in 2009. Traditionally, cash flow into bond funds is highly correlated with the performance of bonds (Figure 2.10). Bond prices, one component of bond performance, are inversely related to interest rates. Thus, the U.S. interest rate environment typically has played a prominent role in the demand for bond funds. Movements in short- and long-term interest rates can significantly impact the total returns offered by these types of funds and, in turn, influence retail and institutional investor demand for bond funds.

Figure 2.10

Net New Cash Flow to Bond Funds Is Related to Bond Returns

Monthly, 1998–2012

Figure 2.10

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1Net new cash flow to bond funds is plotted as a three-month moving average of net new cash flow as a percentage of previous month-end assets. The data exclude flows to high-yield bond funds.
2The total return on bonds is measured as the year-over-year change in the Citigroup Broad Investment Grade Bond Index.
Sources: Investment Company Institute and Citigroup

Total returns on fixed-income securities were mixed in 2012, with U.S. government securities returning far less than corporate bonds. The continuation of “Operation Twist” by the Federal Reserve—exchanges of short-term Treasury securities for longer-term Treasury securities—helped to keep long-term rates on Treasury securities low and fairly stable. The announcement of a third round of quantitative easing in September helped boost bond prices a bit, but much of these gains evaporated in the last two months of the year as the federal government approached the fiscal cliff without a resolution. Because prices of Treasury securities ended 2012 little changed from year-end 2011, much of the total return on U.S. government securities came from their yields. At year-end 2012, the four-week Treasury bill yielded just 2 basis points at an annual rate and the annual yield on the constant maturity 10-year Treasury security was 178 basis points. In contrast, prices of most corporate bonds, particularly those rated BBB and below, continued to rise through 2012. Coupled with the higher yields corporate bonds offer relative to Treasuries, total returns on corporate bonds ranged from around 10 percent* to nearly 16 percent at an annual rate, depending on the credit quality of the bonds.

* Measured by the BofA Merrill Lynch U.S. Corporate Total Return Index.
Measured by the BofA Merrill Lynch U.S. High Yield Total Return Index.

The pace of inflows into taxable bond funds was strong through the first 10 months of 2012 ($23 billion average monthly rate), but slowed in November and December ($14 billion average monthly pace) as investors most likely reacted to the fiscal cliff and the potential for higher income taxes and higher capital gains taxes in 2013. For the year as a whole, taxable bond funds had net inflows of $254 billion in 2012. Strategic income bond funds, which have the flexibility to invest in multiple bond asset classes to obtain broad exposure to the bond market, received $114 billion, or 45 percent, of total net new cash flow to taxable bond mutual funds. Corporate bond funds, which focus primarily on investing in debt securities of U.S. companies, received $44 billion (17 percent). Investors have become more interested in global bond funds in the past few years, likely for the same reasons that they have been attracted to global equity mutual funds. Global bond funds received $38 billion (15 percent) of net new cash flow in 2012. Bond funds focusing on mortgage-backed securities and high-yield bonds garnered $30 billion (12 percent) and $24 billion (9 percent), respectively. Funds focusing on U.S. government bonds had only $3 billion (1 percent) in net new cash flow.

Flows to tax-exempt bond funds were strong for the first 11 months of 2012 and then turned negative in December as investors seemed worried about possible tax changes in 2013 that would impose federal income tax on tax-exempt interest for certain taxpayers. For 2012 as a whole, tax-exempt bond funds had $50 billion in net inflows, likely supported by attractive yields on municipal bonds relative to Treasury securities and by improved state tax revenues from higher GDP growth and lower unemployment. Total returns on tax-exempt bonds averaged about 7 percent* in 2012.

* Measured by the BofA Merrill Lynch U.S. Municipal Securities Total Return Index.

Inflows to bond funds surged in 2012; in fact, inflows since 2004 have been stronger than expected based on the historical relationship between bond returns and demand for bond funds (Figure 2.10). Some of the same secular and demographic factors that appear to be restraining flows to equity funds may have served to boost flows into bond funds: the aging of the U.S. population, the reduced appetite for investment risk, and the increasing use of target date and other asset allocation funds, many of which are offered in a funds of funds structure. First, the leading edge of the Baby Boom Generation has started retiring, and because investors’ willingness to take investment risk tends to decline as they age (Figure 2.7), it is natural for them to allocate their investments increasingly toward fixed-income securities. These investors also hold the majority of mutual fund assets (Figure 2.8) and shifts among different asset types are likely to have a noticeable effect on equity and bond mutual fund flows. Second, lower risk tolerance for investors aged 35 and older compared with similarly aged investors prior to the financial crisis of 2008 (Figure 2.7) likely boosted flows into bond funds over the past several years. Finally, funds of funds remained a popular choice with investors and a portion of the flows into funds of funds was directed to underlying bond funds.

Index Mutual Funds

Index funds remained popular with investors: of households that owned mutual funds, 33 percent owned at least one index mutual fund in 2012. As of year-end 2012, 373 index funds managed total net assets of $1.3 trillion. Similar to funds of funds, demand for index funds remained strong in 2012, with investors adding $59 billion in net new cash flow to these funds (Figure 2.11). Almost half of the new money that flowed to index funds was invested in funds indexed to bond indexes, while 31 percent was directed toward funds indexed to domestic stock indexes, and another 20 percent went to funds indexed to world (global or international) stock indexes. Demand for domestic equity index funds remained steady in 2012, with these funds experiencing an aggregate inflow of $18 billion.

Figure 2.11

Net New Cash Flow to Index Mutual Funds

Billions of dollars, 1998–2012

Figure 2.11

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Note: Components may not add to the total because of rounding.

Equity index funds accounted for the bulk of index mutual fund assets at year-end 2012. Seventy-nine percent of index mutual fund assets were invested in index funds that track the S&P 500 or other domestic and international stock indexes (Figure 2.12). Funds indexed to the S&P 500 managed 33 percent of all assets invested in index mutual funds. The share of assets invested in equity index funds relative to all equity mutual funds assets moved up to 17.4 percent in 2012 (Figure 2.13).

Figure 2.12

33 Percent of Index Fund Assets Were Invested in S&P 500 Index Mutual Funds

Percent, year-end 2012

Figure 2.12

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Figure 2.13

Equity Index Mutual Funds’ Share Continued to Rise

Percentage of equity mutual fund total net assets, 1998–2012

Figure 2.13

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Demand for Money Market Funds

In contrast to the sizable outflows in the previous three years, money market funds experienced only a small aggregate net outflow of $336 million for 2012 (Figure 2.14). This likely was the result of fiscal cliff uncertainties near year-end. In the 10 months prior to the presidential election, money market funds had outflows of $145 billion, a somewhat faster pace than in 2011. Some of the factors that limited inflows to money market funds in 2011—the low short-term interest rate environment, lingering concern about the creditworthiness of some European financial institutions, and unlimited deposit insurance on non-interest-bearing checking accounts—continued into and throughout 2012.

Figure 2.14

Net New Cash Flow to Money Market Funds

Billions of dollars, 1998–2012

Figure 2.14

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In the last two months of 2012, however, money market funds received $145 billion, on net. Some investors who had sold equity mutual funds moved to cash in the face of the uncertainties regarding possible higher taxes and the effect on the financial markets in early 2013 from automatic spending cuts. In addition, some corporations paid out hefty special dividends to shareholders at the end of 2012 in advance of increases in tax rates, and part of this cash was funneled to money market funds. It is unlikely that the impending expiration of the Federal Deposit Insurance Corporation’s unlimited insurance coverage on non-interest-bearing transaction accounts at year-end contributed to inflows to money market funds, as bank deposits also increased substantially in the last two months of 2012.

Retail Money Market Funds

Owing to Federal Reserve monetary policy, short-term interest rates continued to remain near zero in 2012. Yields on money market funds, which track short-term open market instruments such as Treasury bills, also hovered near zero and remained below yields on money market deposit accounts offered by banks (Figure 2.15). Individual investors tend to withdraw cash from money market funds when the difference in interest rates between bank deposits and money market funds narrows or becomes negative. Retail money market funds, which principally are sold to individual investors, saw an outflow of a little more than $1 billion in 2012, following an outflow of $4 billion 2011 (Figure 2.14). For the first 10 months of 2012, retail money market funds had outflows of $56 billion, but had inflows of $55 billion in November and December.

Figure 2.15

Net New Cash Flow to Taxable Retail Money Market Funds Is Related to Interest Rate Spread

Monthly, 1998–2012

Figure 2.15

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1Net new cash flow is a percentage of previous month-end taxable retail money market fund assets and is shown as a six-month moving average.
2The interest rate spread is the difference between the taxable retail money market fund yield and the average interest rate on money market deposit accounts.
Sources: Investment Company Institute, iMoneyNet, and Bank Rate Monitor

Institutional Money Market Funds

Institutional money market funds—used by businesses, pension funds, state and local governments, and other large-account investors—had an inflow of nearly $1 billion in 2012, following an outflow of $120 billion in 2011 (Figure 2.14). Similar to retail funds, the pattern of flows at the end of 2012 was driven by fiscal cliff concerns. For the first 10 months of 2012, institutional money market funds had outflows of $89 billion, but inflows of $90 billion in November and December.

U.S. nonfinancial businesses are important users of institutional money market funds. In 2012, U.S. nonfinancial businesses’ portion of cash balances held in money market funds was 21 percent (Figure 2.16). This portion reached a peak of 36 percent in 2008 and fell to 22 percent by year-end 2011.

Figure 2.16

Money Market Funds Managed 21 Percent of U.S. Nonfinancial Businesses’ Short-Term Assets* in 2012

Percent, year-end, 1998–2012

Figure 2.16

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* U.S. nonfinancial businesses’ short-term assets consist of foreign deposits, checkable deposits, time and savings deposits, money market funds, repurchase agreements, and commercial paper.
Sources: Investment Company Institute and Federal Reserve Board

In 2010, the U.S. Securities and Exchange Commission (SEC) significantly reformed Rule 2a-7, a regulation governing money market funds. Among other requirements, these reforms required money market funds to hold significant liquidity and imposed stricter maturity limits. One outcome of these provisions is that prime funds have become more like government money market funds. To a significant degree, prime funds adjusted to the SEC’s 2010 amendments to Rule 2a-7 by adding to their holdings of Treasury and agency securities. They also boosted their assets in repurchase agreements (repos). A repo can be thought of as a short-term collateralized loan, such as to a bank or other financial intermediary. They are backed by collateral—typically Treasury and agency securities—to ensure that the loan is repaid. Prime funds’ holdings of Treasury and agency securities and repos have risen substantially as a share of the funds’ portfolios from 12 percent in May 2007 to 31 percent in December 2012 (Figure 2.17). The dip at year-end 2012 was largely driven by a decline in repo holdings by money market funds, which stemmed from a reduction in repo borrowing by brokers and dealers at year-end.

For more complete data on money market funds, see section 4 in the data tables.

Figure 2.17

Prime Money Market Fund Holdings of Treasury and Agency Securities and Repurchase Agreements

Percentage of prime funds’ total net assets, monthly, 1998–2012

Figure 2.17

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