NEW YORK (TheStreet) -- If you are tired of the puny yields on money-market funds, you might be tempted to shift your cash to an ultra-short bond fund. According to Morningstar, ultra-short funds yield 1.32%. In comparison, most money markets yield less than 0.05%. But ultra-short funds can lose money in downturns, while money markets nearly always hold their value.
Recently fund companies have begun offering an alternative, a new breed of ultra-short funds that yield a bit more than money markets while taking less risk than traditional competitors. The new entrants include
JPMorgan Managed Income Fund
, which yields 0.48%, and
Fidelity Conservative Income Bond
, which yields 0.83%. Other fledgling funds are
Oppenheimer Short Duration
Putnam Short Duration Income
and become a fan on
In order to yield more than money markets, ultra-short funds hold securities with longer maturities. Under rules that were imposed in response to the financial crisis, money-market portfolios must have average maturities of less than 60 days. The new ultra-short funds aim to yield a bit more by holding mixes that typically include money-market instruments as well as securities with maturities of up to one or two years. Many traditional ultra-short funds hold bonds with maturities of three years or more.
The longer their maturities, the harder bonds tend to drop in hard times. During the volatile markets of early October, some of the new ultra-short funds suffered small declines in share prices. Shares of JPMorgan Managed Income dipped from $10.00 to $9.98.
Some analysts worry that investors may not understand the risks of the new funds. "When investors reach for yield, they can get whacked," says Peter Crane, president of Crane Data.
The latest ultra-short group resembles earlier waves that appeared when interest rates sagged, says Crane. "We have seen this movie before," he says.
In 2003, the
lowered the federal funds rate to 1%, and the next year money market funds returned a scant 0.80%. To provide better results, companies began introducing ultra-short funds that yielded more than money markets. The new funds worked smoothly -- until some crashed during the financial crisis. During 2008, the average ultra-short fund lost 7.9%. Some funds declined more than 20%. The problem was that some of the ultra-short funds held toxic mortgage securities.
These days portfolio managers of the new ultra-short funds say that they are steering away from trouble by focusing on solid securities. Portfolios emphasize investment-grade securities with average credit qualities of A or better. "Our goal is to be a low-volatility player," says Chris Proctor, co-portfolio manager of Oppenheimer Short Duration.
To get a rough idea of how much a fund might drop in a downturn, consult a figure known as duration. Fidelity Conservative Income Bond has a duration of 0.2 years, an indication that the fund could lose about 0.2% if interest rates rise by 1 percentage point.
Because the new funds present risk, you should not use them as holding places for cash that you may need on a daily basis. Instead, you should continue to rely on money-market funds for short-term needs. For the cash that you will not need for six or 12 months, you could consider using the new ultra-short funds.
With short track records, it is hard to know exactly how the new funds will perform in a market meltdown. So far they have been outdoing money markets -- but not by wide margins. During the past year, JPMorgan Managed Income returned 0.30%, compared to 0.03% for the average money market.
The new funds faced a test in the third quarter of this year when concerns about European debt rattled U.S. bond markets. With prices of corporate bonds tumbling, traditional ultra-short funds lost 0.7% for the quarter. But the new funds did a bit better because of their high credit quality. For the quarter, Oppenheimer Short Duration returned 0.11%. The result was hardly momentous. But at a time of puny yields, cautious investors must be grateful for whatever modest returns they can get.
Stan Luxenberg is a freelance writer specializing in mutual funds and investing. He was executive editor of Individual Investor magazine.