A Tamer Breed of Ultra-Short Fund

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 ( JMGSX), which yields 0.48%, and Fidelity Conservative Income Bond ( FCONX), which yields 0.83%. Other fledgling funds are Oppenheimer Short Duration (OSDYX) and Putnam Short Duration Income (PSDTX).

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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 Federal Reserve 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.

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