Money fund rule changes offer new reality to U.S. retail investors

By Tim McLaughlin and Ross Kerber

BOSTON, July 23 (Reuters) - New rules announced on Wednesday will likely drive safety-oriented retail investors away from some money market funds because they highlight risks and make it harder to pull cash out when market turmoil strikes.

The U.S. Securities and Exchange Commission's reform will force institutional "prime" money market funds to float their share price, a major change from the current convention that allows them to maintain a stable $1 per share net asset value. The new rules also would allow money funds to impose fees and restrictions on withdrawals during times of extreme market stress.

"Why would anyone stay in these money funds once they're floating, rather than just go to a government or treasury fund that's not floating at all?" said Diahann Lassus, president of Lassus Wherley & Associates, a New Jersey financial adviser.

Institutional prime money funds attract mostly professional investors and are considered more risky because of their exposure to short-term corporate debt. Investment advisers say money could flow away from these funds and into funds composed of safer government securities.

Bank-insured sweep accounts will be a clear alternative for the safety-first crowd, while short-duration bond funds appeal to investors hunting for higher yields, financial advisers said.

Money funds already have lost some luster during an extended period of near-zero interest rates. Investors typically receive yields of 0.01 percent on their money, a losing proposition if you factor in inflation.

Money fund providers have waived some $24 billion in fees over the past five years to give customers that yield.

Marie Chandoha, President and CEO of Charles Schwab Investment Management, a top money fund provider that oversees $158.2 billion in those investments, downplayed the new SEC rule imposing barriers or penalties on withdrawals.

"It's an extreme scenario where this would even be considered," Chandoha said.

Mike Vogelzang, who is president of Boston Advisors LLC, an investment management company with about $2.8 billion in assets under management, said some of his clients might push back against the rules. And if they do, he will suggest they use a bank-insured account for cash, he said.

"Most of this is going to be about education and having them understand that a dollar is not a dollar any more in these money market funds," Vogelzang said.

Annapolis, Maryland-based financial adviser Martin Hopkins, said the new rules will help investors understand they can lose money.

"Most clients see these as just like cash, and they are not," Hopkins said in an email.

Short duration bond fund assets, among the vehicles advisers think will benefit from a possible exit from MMFs, have already surged in recent years because of relatively high yields.

At the end of June, short duration bond fund assets totaled $319.4 billion, up 172 percent from $117.6 billion at the end of March 2009, at about the same time the stock market hit rock bottom.

(Reporting By Tim McLaughlin; Additional reporting by Sarah Lynch in Washington D.C.; Editing by Richard Valdmanis. Editing by Andre Grenon)