Reuters
Reuters

Money market funds are not right for long term savings

By Martin Hesse Time of article published May 11, 2021

Share this article:

Words on Wealth:

With Absa recently announcing the closure of its R80 billion money market fund, I thought it apt to consider what this type of a fund is, how it differs from a bank deposit, and the role it should play in an investment portfolio.

One of the reasons Absa gave for closing its fund was it found that the investors did not expect it to behave as it did; they expected it to behave like a bank deposit. One has to question why investors were invested in the fund if this were the case. Did their advisers not spell out to them how a money market fund operates?

Let’s first be clear about the differences between bank deposits and unit trusts.

  • Bank deposits may be fixed, in which case you can’t touch your investment for a fixed period (it could be 12 months or five years) and the interest rate is guaranteed for the investment term; or they may be notice deposits, whereby you need to give the bank notice of withdrawal (say 30 days or 60 days) and the interest rate fluctuates in line with the bank’s prime rate, which in turn is determined by the repo rate set by the SA Reserve Bank. How the bank uses the money you have deposited with it has no bearing on the outcome of your investment, which is predetermined.
  • Unit trust funds are collective investments managed by asset managers and governed by the Collective Investment Schemes Control Act. Investors buy units in the fund, in which the underlying investments are selected by the fund manager. Funds are classified according to what they invest in: lower-risk assets such as cash instruments and bonds, higher risk growth assets such as equities and listed property, or a mixture of the different asset types. The unit price, or net asset value (NAV), is calculated daily, according to the performance of the underlying investments, and therefore the return on your investment fluctuates daily. You can withdraw money any time you want, subject to a short notice period usually no longer than 24 hours.

How a money market fund works

A money market fund is a collective investment that invests in the money market (just as an equity fund invests in the stock market). “Money market” refers to the market in short-term debt instruments, which includes inter-bank instruments and short-term government and corporate bonds. Funds are limited to investing in debt with a duration of 13 months or less, with a weighted duration of not more than 90 days. The debt instruments may be issued at a fixed rate or they may have a floating interest rate linked to the inter-bank rate.

Unlike other types of unit trusts, a money market fund’s NAV remains constant (typically at R1.00). Its return is its yield, which is the interest it receives from the underlying investments.

Money market funds have the lowest risk out of all unit trust funds. However, their yields fluctuate daily, vary considerably among funds and, depending on market conditions, may deviate to a greater or lesser extent from the inflation rate. Let’s look at how wide this variation can be.

  • On March 31 last year, just after the financial markets plummeted, yields on South African money market funds ranged from 3.78% to 9.09% (according to ProfileData), with the average being 6.9%. Consumer price index (CPI) inflation was 4.1%, so the average fund was delivering 2.8% above inflation.
  • On March 31 this year, yields were in a far narrower range, 3.25 - 5.08%, averaging 3.9%. CPI inflation was 3.2%, so the average fund was delivering just 0.7% above inflation.

Variation explanation

In an article published in the first-quarter 2021 Personal Finance magazine, “Money market funds: some are more equal than others”, Samantha Steyn, the chief investment officer at Cannon Asset Managers, attributes the variations in yield within as well as between funds to two things:

1. A manager’s view of the interest-rate environment, which influences in what proportion the fund contains fixed-rate versus floating-rate instruments.

2. A manager’s appetite for risk. Even among these low-risk instruments, some are slightly more risky (thereby offering a slightly higher interest rate) than others.

“When choosing a money market fund, investors should first analyse the fund’s minimum disclosure document in order to assess the allocation of the fund’s investments to more risky entities. This is especially important in current times where companies are experiencing a drop-off in revenues and cash flows, potentially leading to more business closures, a rising number of defaults and the inability to service debt. In a default scenario, it is not impossible for money market funds to experience capital loss,” Steyn says.

Portfolio role

Money in a money market fund should, like that in, say, a 30-day notice account, be limited to savings you aim to use in the short-term. Because a money market fund is so liquid, it is ideal for “parking” your money before deciding what to do with it. It also makes a good home for your emergency fund.

While your investment should maintain its value by keeping abreast of inflation, it will not grow to any extent. It is therefore not appropriate for long-term savings. Neither is it appropriate as a long-term source of income for retirees, though it may be put to good use as a short-term income reservoir into which you can, perhaps annually, channel funds from an investment with higher growth potential.

PERSONAL FINANCE

Share this article: