“While tumbling interest rates have prompted some individual investors to pull out cash from money-market mutual funds, that same rate trend has led some corporations, municipalities and other institutional investors to rush in,” writes Karen Damato in today’s Wall Street Journal.

“Assets in money funds for individual investors have shrunk 12% from a $1.1 trillion peak for April 2001, as people have shifted dollars to bond funds or banks in search of higher yields. But assets in institutional money funds have risen 28% to $1.2 trillion during the same period.”

“A big part of the appeal of money funds to institutions: Every drop in interest rates paid on commercial paper and other money-market instruments isn’t matched immediately by a fall in money-fund yields because money-fund portfolios include instruments purchased earlier and still paying interest at higher rates.”

“As a result of that delayed reaction, ‘the money-market funds are going to lag the rest of the market’ when yields are dropping and temporarily offer investors higher returns, says Jim Hartley, chief investment officer for the state of Ohio, which recently had $337 million invested in a half-dozen money funds.”

“Of course, money-fund yields also will lag behind the market whenever interest rates begin moving up again. That raises the question of how much of the institutional cash that has surged into money funds as rates declined will move out when rates start to increase.”

“The institutional response is expected to vary. Some big investors may well sharply reduce their use of money funds, in some cases going from having the majority of their operating cash parked in funds to having only, say, 20% there, says Tom Newton, a senior managing director of Institutional Cash Distributors, one of several electronic ‘portals’ that offer one-stop shopping to institutional buyers of money funds. Because some institutional investors aggressively shop around for yields, ‘we are obviously going to see some money pulled out’ of money funds when rates rebound, he says.”

“But Mr. Newton and others don’t expect the assets in institutional money funds overall to drop precipitously — partly because corporations and municipal governments that hadn’t been money-fund users in years past are finding they are handy parking places for cash. Indeed, while money funds have been a solid hit with individual investors since the late 1970s, their widespread acceptance as a cash-management tool for corporations and municipalities has been a far more recent and still-developing phenomenon.”

http://online.wsj.com/article/0,,SB105839549662138900,00.html