Money Market Mutual Funds
An important addition to the family of mutual funds resulting from the financial innovation process described in earlier chapters is the money market mutual fund. Recall that this type of mutual fund invests in short-term debt (money market) instruments of very high quality, such as Treasury bills, commercial paper, and bank certificates of deposit. There is some fluctuation in the market value of these securities, but because their maturity is typically less than six months, the change in the market value is small enough that these funds allow their shares to be redeemed at a fixed value. (Changes in the market value of the securities are figured into the interest paid out by the fund.) Because these shares can be redeemed at a fixed value, the funds allow shareholders to redeem shares by writing checks on the fund's account at a commercial bank. In this way, shares in money market mutual funds effectively function as checkable deposits that earn market interest rates on short-term debt securities.
Conflicts of Interest. The Mutual Funds and the Internet
In September 2003, New York Attorney General Eliot Spitzer accused a number of mutual funds of exploiting conflicts of interest in which they allowed favored customers to engage in illegal, late trades in the fund. These trades would be made after the fund's share value was set officially at 4 PM If the underlying value of the assets had changed after 4 PM, these customers could earn profits by buying the funds at a price below their market value or selling them at a price above the market value. (In Congressional testimony, Spitzer explained that "late trading is like betting on a horse race after the horses have crossed the finish line.") The profits from this activity were made at the expense of the general shareholders of the mutual fund.
Subsequent SEC investigations have found that illegal trading has been widespread in the mutual fund industry. As a result, more than 300 lawsuits have been filed against individual mutual funds, and the mutual fund industry has already paid out billions of dollars in settlements and fee reductions. In addition, some investment managers have been thrown in jail. Government regulators such as the SEC have addressed the scandals by insisting that directors of mutual funds be more independent from the funds' managers, requiring that trades after 4 PM be priced at the next day's net asset value, increasing enforcement of fees for redeeming mutual fund shares (which in effect makes it hard to profit from late trades), and increasing transparency of fund operating practices to the public.
In 1977, the assets in money market mutual funds were less than $4 billion; by 1980, they had climbed to more than $50 billion and now stand at $1.28 trillion, with a share of financial intermediary assets that has grown to nearly 6% (see Table 1). Currently, money market mutual funds account for around one-third of the asset value of all mutual funds.