The role of money market funds in a world where instability is the new norm
The recent volatility in financial markets has caused investors to question whether the potential returns they can achieve compensate them for the risk they are taking on and the answer in many cases has been “no”. Looking at South Africa over the 50 years to December 2010, cash has delivered a steady return at 10.7% per annum (2.1% per annum above inflation).
This represents 61% of the returns generated by equities but at 1/15th of the risk. This 50-year period includes many phases and cycles; some of which favoured cash, but one cannot deny the merits of cash as a sound risk adjusted investment asset class. As warren Buffett said: “Holding cash is uncomfortable, but not as uncomfortable as doing something stupid!” In economic periods like the one we find ourselves in today this advice should be heeded and money market funds are the ideal vehicles through which to invest in or to park cash.
Money market funds are a relatively new investment phenomenon having been first introduced in the USA in the 1970’s. This concept of pooling investor cash for higher yield and constant net asset value was exported to Europe in the 1980’s and the first money market fund was launched in South Africa in 1997. Already, R270 billion has found its way into these funds.
The proposition of money market funds is simple: these funds invest in cash and high quality short- dated money market instruments. Investors have immediate access to their funds, similar to the accessibility of a call account, but they achieve better yields than call. The higher interest rates are a result of the fund manager investing in longer dated fixed income instruments, but still retaining some liquidity in the fund to fund investor withdrawals.
The money market fund is managed by professional investment managers who typically do a better job than investors who try to manage their own assets. Through a money market fund investors also achieve exposure to a spread of underlying money market assets and this diversification of duration, and credit, makes the fund a far better proposition than a deposit in a single instrument with a single bank. Fees in this space are very low.
However, before investing in a money market fund, investors should ask themselves the following questions:
· Is it preferable to invest with one bank or to earn the same yield by having exposure to many banks and rated issuers of money market investments?
· Is it better to invest in “locked up” fixed term deposits, or to earn the same yield with immediate access to your funds?
The answer in both cases above is the latter clearly illustrating the key proposition of money market funds. So money market funds can be used by a multitude of investors, as an investment asset class or as a building block in a portfolio. We like to say investments into money market funds can be “R1 to R1billion and for 1 day or forever”.
But it is not just investors who can make use of money market investment product. South Africa’s corporates have notoriously lazy balance sheets. Money market funds are increasingly being used by cash flush companies and high net worth individuals, to improve income returns without compromising on liquidity and risk, and to put their cash to work and reduce cash drag. Cash type investments not only comprise a significant portion of the investment universe, but they have proven to be a credible, risk adjusted, positive return investment asset class.
The money market fund proposition remains very compelling and hence their increasing popularity as this proposition becomes more widely understood. Nedgroup Investments offers one of the more successful money market funds with top quartile returns over ten years. This consistent performance has been achieved with Taquanta as the best of breed investment manager since the fund’s inception in 2000. Taquanta’s track record extends beyond just generating above market yields, but the August 2011 RisCura survey shows that they run lower risk that 20 of the 22 fund managers surveyed over three years. This is a function of a clear investment philosophy, a robust process, and a team that has been together for over a decade. It also reaffirms their appointment as the best of breed manager.
The role money market funds have for retirement funds, individual investors and corporates differs, and the level of investment into such funds varies depending on the economic environment and investor circumstances. Money market funds are here to stay and Nedgroup Investments will be paying more attention to this space in order meet the needs of our clients.
The saying “keep your powder dry” alludes to gunpowder which soldiers had to keep dry in order to be ready to fight when required, but today means saving ones resources until they are needed. Investors particularly have adopted this expression which is increasingly bandied about in today’s turbulent markets. Fortunately there is an asset class that ploughs on regardless: money markets!
