When you compare the relative attractions of money market mutual funds, big can be beautiful.
To any student of the art of mutual-fund investing, that may sound like a surprising idea.Traditionally, in arenas such as the stock market, small funds are often considered to have an edge on their larger competitors, in part because they can be more flexible and maneuverable.
But in the $400 billion-plus money-fund business, which engages in a different battle waged in a different marketplace, analysts who have studied the subject say just the opposite principle applies.
"Large money funds have a tendency to yield more to their shareholders than small money funds," says the investment advisory letter Income & Safety, published by the Institute for Econometric Research in Fort Lauderdale, Fla.
Income & Safety arrived at this conclusion by examining the field of money funds it monitors, grouped by where they ranked in the service's system for forecasting fund yields.
The funds with above-average yield forecasts, it turned out, had an average of $3.7 billion in assets; those with average yield forecasts, $2.3 billion, and those with below-average yield forecasts, $600 million.
In other words, pointed out Norman Fosback, the institute's president, "taxable money funds with above-average yields had, on average, an asset base six times as large as funds with below-average yields."
Fosback cited several reasons why this correlation appeared to be more than coincidental:
"First, large funds experience some economies of scale in their day-to-day operating expenses. As these relatively fixed costs are spread over a larger asset base, expenses per dollar of assets fall, and lower expense ratios equal higher yields."
Secondly, Fosback said, sponsors of large funds tend to collect smaller percentages from the funds' assets for their annual management fees. "In part," he observes, "this reflects the fact that many management companies scale back their fees as fund size increases.
"Third, very large money funds can sometimes obtain slightly better returns by purchasing commercial paper (short-term IOUs issued by corporations and other entities) and certificates of deposit in huge denominations.
"Finally," Fosback added, "the market for money funds is quite efficient. Investors are attracted to funds with superior yields and avoid those with below-average returns. This helps the best-yielding funds to grow still larger."
Fosback and other observers caution that size should not be the first criterion used in trying to gauge any fund's merits.
The prime questions are usually relative yield and safety, as reflected in the kinds and maturities of investments a fund has in its portfolio.
There also may be special factors to consider as well. The Dreyfus Worldwide Dollar Money Market Fund, for instance, has used an aggressive marketing strategy to help promote its rapid rise to the ranks of both the biggest and highest-yielding funds.
For more than a year and a half since the fund was established, the sponsoring Dreyfus Corp. has picked up all the fund's operating expenses and collected no management fee.
It has promised that it will continue to forgo the management fee until at least next June 30. But starting Oct. 1 it began charging part of the operating costs to the fund.
But with all those caveats, Fosback observes, "size does matter."
A stock mutual fund can, in theory at least, fall victim to its own success, attracting more money than it can put to work in the strategies that have won it acclaim.
By contrast, in a money-market fund popularity apparently can be a blessing rather than a bane.