It's always interesting to learn what other investors are buying, so I was intrigued recently when all three portfolio managers on a financial program on TV spoke enthusiastically about the same investment: cash. They explained that rising interest rates have made it easier for them to park cash in money market funds while they wait to identify stocks that meet their investment criteria. The Federal Reserve's decision this week to raise the federal funds rate to 4.75% will provide even richer rewards for investors who own shares of money market funds.
One way investors might try to capitalize on the growing appeal of money market funds is to buy shares of Motley Fool Inside Value pick Federated Investors (NYSE:FII). Federated, which manages more than $160 billion of money market fund assets and another $55 billion of equity and fixed income funds, provides money market funds in a fragmented $2 trillion market. Federated has been seeking to expand its market position through acquisitions, including last year's purchase of AllianceBernstein's (NYSE:AB) money market funds. In low-margin money market funds, scale is needed to build a profitable franchise.
Investors should not, however, buy Federated for its corporate governance. The company, with $4 billion in market capitalization, has issued only non-voting B shares to the public. The Donahue family, who founded the company and fill the CEO and chairman positions, controls the voting A shares.
Investors also need to be clear about the difference between investing in a fund and investing in a fund manager. Unlike shares of money market funds, which have virtually no risk of a price decline, shares of Federated Investors could sell off despite rising rates. In fact, one frequent consequence of rising rates is "hot money," or institutional funds that react to rising rates by switching from money market funds to direct investments in short-term instruments. Obviously, that would reduce assets under management for managers of money market funds and thus lower their advisory fees.
But Federated's P/E multiple of just more than 18 times estimated forward earnings is less than the average for its peer group, and interest rate trends seem favorable for the company's money market franchise. In other words, despite the stock's strong run in recent months, shares of Federated have the potential for additional price appreciation with less downside risk than might be found in the stocks of other asset managers.
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Michael Leibert welcomes your feedback at [email protected]. He does not own shares in any of the stocks mentioned above.
