Why money market funds are emerging as an optimal cash management solution in a difficult business environment

Over the last year, we saw a sustained period of aggressive interest rate rises from the US Federal Reserve, European Central Bank and Bank of England. Many experts expect interest rates to peak (the so-called “terminal rates”) at varying times across the respective markets in 2023. If terminal rates go higher than the current market interest rates, the funds’ yields may increase as fund managers reinvest into higher yielding investments.

Combined with the events in the first quarter of 2023, this further reinforces the value of diversification in cash investing. We believe it is prudent to understand the key differences between bank deposits and money market funds (MMFs).

Bank deposits aim to provide clients with a location to store their cash for a specified length of time with a specified rate of interest.

Money market funds traditionally seek to prioritise maintenance of capital and liquidity by investing in a broad range of high-credit quality assets across a wide range of issuers (excluding government MMFs). This allows MMFs to diversify counterparty risk and facilitates reduced volatility.

Money market funds are a cash management solution that seek to achieve diversification, daily access to cash and operational ease.

The table above is intended to provide a general summary and is not exhaustive. A Money Market Fund (MMF) is not a guaranteed investment vehicle. An investment in MMFs is different from an investment in deposits; the principal invested in an MMF is capable of fluctuation and the risk of loss of the principal is to be borne by the investor. The MMF does not rely on external support for guaranteeing the liquidity of the MMF or stabilising the NAV per share.

Why diversification is important

A bank deposit results in sole credit exposure to that single banking counterpart. To diversify this exposure, an investor may seek to make deposits across different banks.

Money market funds are actively managed in accordance with offering documents as well as various regulatory and best practice thresholds. MMFs seek to mitigate risk by allocating across high-credit quality issuers and money market sectors (excluding Government MMFs). Concentration risk is managed through diverse issuer counterparty selection[1].

Overnight deposits provide the same liquidity profile as MMFs. However, term deposits typically lock up capital for a defined time period. Depending on the agreement, it can be difficult to gain access to the capital before maturity.

Money market funds are required to hold minimum levels of daily maturing and weekly maturing assets to help provide sufficient liquidity to meet investor needs. The active management of MMFs allows the fund to tailor liquidity levels through changing market cycles.

MMFs are designed to provide daily liquidity

Overnight deposits provide the same liquidity profile as MMFs. However, term deposits typically lock up your capital for a defined time period, and depending on the agreement, it can be difficult to gain access to your capital before maturity.

MMFs are required to hold minimum levels of daily maturing and weekly maturing assets to help provide sufficient liquidity to meet investor needs. The active management of MMFs allows the fund to tailor liquidity levels through changing market cycles.

Managing the cost of liquidity

Depending on the agreement terms, bank deposits may involve restrictions and/or penalties for accessing your capital before its maturity.

Money market funds incorporate costs and fees within the product itself as a single charge. There are no additional fees for subscriptions. Liquidity fees and redemption gates remain mechanisms that may be incorporated to help maintain fair treatment towards all MMF investors in times of uncertainty.

Active management of MMFs allows for the potential of enhanced yield

Deposits are issued either on a fixed or floating yield basis (often linked to an overnight reference rate). While the initial rate offered can often look attractive, we believe it is important to consider the ‘break-even’ compared to shorter-dated investments and how interest rate movements can impact the relative value.

Money market funds blend highly-rated, short-term securities with longer-dated securities (final maturity of up to 13 months in short-term MMFs). The ‘blend’ of securities and duration exposures are determined by a team of portfolio managers’ views on interest rates and market fundamentals. This means that MMFs can often actively adapt their positioning in line with the latest market dynamics.

MMFs minimise the volume of day-to-day operational needs even as they achieve diversification

Bank deposits are typically a direct bi-lateral agreement between the client and the bank. To achieve any level of counterparty and maturity diversification, multiple agreements may be needed to be executed with multiple banking entities, which can be resource intensive as they need to be rebooked each time.

Shares of MMFs can typically be traded directly with the MMFs transfer agent via various platforms.

Money market funds are also widely available across trading platforms with many execution options. After the initial subscription, only subsequent transactions based on your cash needs are required.

In most cases, MMFs can also benefit from a sweep functionality, which could automate the investment of surplus cash or the need to raise cash from existing holdings.

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Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.

Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy.

Changes in the rates of exchange between currencies may cause the value of investments to diminish or increase. Fluctuation may be particularly marked in the case of a higher volatility fund and the value of an investment may fall suddenly and substantially. Levels and basis of taxation may change from time to time.

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