Money market funds in a diversified portfolio
In the current low interest rate environment, conservative investors wanting a safe place to invest their cash while still getting the opportunity to earn above-inflation returns are well-suited to money market funds.
All investors should consider them as part of their long-term financial planning as they are ideal for giving the maximum return on the cash part of their portfolio. They are flexibille, liquid (investors can access their money at short notice) and earn wholesale rates of returns. They are well-diversified portfolios that provide above inflation returns with as little risk exposure as possible.
Welcome news
With the recent announcement by the South African Reserve Bank (SARB) to keep rates unchanged, it is assumed that interest rates will remain sideways for the remainder of 2015 due to lower inflation rates which is spurred on by lower oil and food prices.
As a result, returns on Fixed Income investments will remain fairly low for the foreseeable future, putting increased pressure on those relying on interest income.
Knowing your Ps and Qs
Investors are not always aware of the differences between money market accounts and money market funds. There are a few differences and it is important to make clients aware of these. The first is a bank account and sits on a bank’s balance sheet, while the other is a collective investment, invested in a wide range of financial instruments issued by the banking and corporate industries.
Another difference is that the rate an investor earns in a money market fund is the same regardless of how much he or she has invested in the fund. This is not the case for most money market accounts which have sliding scales depending on how they are invested . The best rate quoted only usually applies to amounts above the top threshold.
Investors also need to understand how the interest income earned on money market accounts versus money market funds is calculated to determine which investment tool is better for them.
Good diversification
Money market funds also differ from bank accounts. They are unit trusts that invest in money market instruments issued by banks in South Africa and are regulated by the Collective Investment Schemes Act. In terms of this Act, the maximum exposure to any single bank is 30% - this avoids concentration risk and ensures the funds are well-diversified.
In a money market fund, the investor is essentially a holder of a pool of money market assets issued by multiple debtors or counterparties. This means if one of the underlying institutions in which the fund invests, spreads the risk as a default, the loss would be diluted by the diversification of the money.
A money market fund is also restricted by regulations in terms of the interest rate risk that it can take on. The interest rate should reset every 90 days in a money market fund. This is particularly useful when prime interest rates rise. Fund managers can very quickly reset the rates in the fund to take advantage of the higher rates on offer.
This gives money market fund investors the benefit of the return on their investments literally resetting with market conditions.
Take advantage of the benefits
Money market funds normally offer better returns than call accounts because they can invest across the yield curve with a weighted average duration of 90 days.
Money market returns are averaging around 6% versus call rates of around 5%. Investors seeking similar returns to money market funds, but wishing to place their cash in banks, would have to invest in fixed-term rates. Money market funds compete well with short dated fixed deposits with the added benefit of ease of access – typically within 24 hours. They compare well to three or six month fixed deposit rates, while being accessible.
Money market funds are suitable for very conservative investors, investors with a short-term time horizon of up to a year, or someone who is close to or at retirement and who does not want the risk of the highs and lows that are inherent in the other asset classes.
