What Are Money Market Funds?
Between money market funds, T-bills, certificates of deposit, and more, what is my best investment port in this rough financial ocean?
While financial markets can at times resemble a turbulent ocean, having a safe harbor and knowing when to use it is critical to maintaining financial health for your business. There are many tools available for managing your short-term cash. In this post, we will consider one of the most frequently used – the money market fund – and highlight alternatives to this popular option.
What are Money Market Funds?
In its purest form, a money market fund (“MMF”) is a mutual fund operated by an investment manager. The goal is to provide high liquidity with low risk while investment returns are on the back burner. The SEC regulates money market funds under the Investment Company Act of 1940. SEC Rule 2a-7 outlines the specific criteria to function as a money market fund.
Some characteristics of a money market fund are as follows:
1. Assets cannot have a remaining maturity longer than 13 months
2. An MMF may invest only in US dollar-denominated assets presenting minimal credit risk at purchase
3. No more than 5% of total assets can be in illiquid securities
4. A minimum of 10% of total assets must be daily liquid
5. A minimum of 30% of total assets must be weekly liquid
6. Portfolio holdings must be posted monthly on the fund’s website
How do they work?
Unlike a bank deposit, a money market fund is an investment vehicle – this means there is no guarantee on your investment principal, and there is still risk involved.
Investors pool their funds together into money market funds to invest in assets on an open-ended, continuous basis. The fund manager issues redeemable shares that investors can buy and sell daily.
The price of these redeemable shares, the Net Asset Value (NAV), is based on the underlying value of the assets in the fund. Money market funds are designed to have a stable NAV, which should hover around $1.00 per share, deviating only slightly in either direction. Fund managers achieve this by collecting income daily and issuing a monthly payout to investors that accrues at a variable daily rate.
It is highly uncommon for a money market fund NAV to “break the buck” or drop below $1.00 per share, but it has happened. Fund operators can avoid this occurrence, which indicates loss of principal for the holders of the fund, by purchasing stable assets or putting more of their own money into the fund if underlying asset values move negatively.
What types are there?
Investment managers offer a variety of money market funds. Each fund holds different assets that produce varying levels of expected return and risk. The four main types of money market funds are outlined below.
1. Treasury Funds – Cash Deposits, US T-Bills, Notes, Bonds
2. US Government Funds – Cash Deposits, US Treasury Bonds, Repos and GSE's Debt
3. Prime Funds – Cash Deposits, US Treasury Bonds, Repos, GSE's Debt, CDs, Commercial Paper, USD-denominated Foreign debt
4. Tax-Exempt Funds – Tax-Exempt Securities - Municipal Bonds
Should I put my money in an MMF?
Within the realm of money market funds, there is a huge selection of fund and manager types. How do you know which is right for your company or if a money market fund is the right approach?
Investing in a money market fund comes with some degree of each of the following risks – credit, liquidity, and interest rate. Below, we dive into each of these risks with a little more granularity to help paint the full picture of money market fund considerations as you decide on your investment strategy.
1. Credit Risk | You Could Lose Money
As noted earlier, a money market fund is an investment vehicle that strives to maintain a NAV of $1.00 but does not guarantee that. The assets inside each fund are purchased because of their perceived stability in price. While each asset price can move, on aggregate, the NAV of the fund should remain stable at $1.00. However, during extreme financial distress, the underlying assets in a money market fund can fluctuate. If you needed to redeem your funds at times like these, you could lose money.
2. Liquidity Risk | You Might Not Get Your Funds When Needed
Most investors in money market funds assume they can redeem and get their cash back at any time. Generally, this is true in peaceful waters; however, some money market funds have built caveats in the shape of liquidity provisions or limitations on redemption schedules.
In times of market turmoil, investors theoretically could attempt to redeem all their shares simultaneously, causing a run on the fund, similar to a run on the bank. In March 2020, this happened to a Goldman Sachs fund, requiring them to inject over $1 billion into it to maintain its NAV and prevent investor losses.
To avoid replays of extreme events, some money market funds now include certain provisions to mitigate future disruptions. Two of the most common are:
Redemption Schedule – time restrictions for fund withdrawals that slow the flood of cash leaving the fund in times of uncertainty.
Redemption Gate – a fee that an investor is charged to disincentivize them from redeeming their money.
Most funds do not have these provisions, but you should always ensure you know what you are buying.
3. Interest Rate Risk | You Can’t Replace the Yield
A money market fund rate is not locked in. Rates change daily as the yield on the assets inside the fund adjusts. If rates are rising, this is positive; when rates trend lower, this quickly becomes a problem.
The final consideration we’ll raise is that money market funds are pooled investment vehicles vs. individual asset portfolios. Often, parties will default to money market funds for a pre-packaged solution. Still, your money is important. We think it is worth tailoring the exact investment policy you want for your company rather than settling on one that many others might be using as a generic solution.
What are the alternatives to money market funds?
The general point of a money market fund is to keep cash safe and retain quick access to funds, but as alluded to above, it’s not the only type of investment you can use to achieve your goals of safety and liquidity.
Below, we’ve outlined individual instruments that can serve this purpose. Yes, some of these are indeed leveraged as component assets in a money market fund. However, you might find that you prefer a unique, tailored mix of these assets for your company’s investment policy – spoiler alert, that’s where Rho can step in to partner. But first, let’s take a look at these options.
1. Cash – Checking & Saving Accounts Yes, keeping a large balance of cash on hand is a simple solution to the safety and liquidity conundrum. However this could mean that you earn no return and lose buying power due to inflation. These accounts are typically best for holding only as much cash as is needed for immediate operations.
2. Bank Certificate of Deposit A bank certificate of deposit is a deposit loan to a banking institution for a certain period. The bank generally gives an interest rate above what you can get with government bonds in exchange for locking the money up for a certain amount of time.
The downside is that if you need your funds early, you will likely pay an early termination penalty. These penalties can cost you all or most of the interest you have earned. Always ensure you understand the early termination penalties are when buying a CD.
3. US Government Treasuries Most bank savings products derive their interest rate from US Treasuries. If you want to cut out the bank and the potential penalties, you can buy US government treasuries directly. US Treasuries are one of the safest assets in the world because the full faith and credit of the US government backs them. They provide next-day liquidity for your funds and cost little to buy or sell.
4. Individual Bond Issuers Many government entities, municipalities, and corporations issue bonds. These tend to provide a higher yield than US Treasuries. That higher yield is due to increased risk. The two primary risks are below:
Credit Risk – You can mitigate this risk by only investing in issuers with the highest creditworthiness and projected future ability to maintain their payment obligations.
Mark to Market Risk – because these individual issuer bonds trade in the open market, prices can fluctuate. You face price risk if you need to sell before maturity.
In general, we believe holding bonds to maturity is the best course of action for corporate cash management purposes.
How can Rho help?
Managing your corporate cash requires maintaining a delicate balance between safely storing your cash and generating market-competitive yield without unnecessary risk. There are many tools at your disposal – depending on your cash and investment policy, you might consider looking beyond generic money market funds to craft a bespoke solution that puts your company’s interests at the forefront of investment decision-making.
At Rho, we always recommend a periodic review of your corporate cash and investment policy. The decisions you made quarters ago may no longer be helping you achieve the goals you set out to accomplish. The financial markets and economy are constantly shifting, so it’s important to be proactive.
Rho offers Prime Treasury, a tailored, automated treasury management service that grants scaling businesses the professional level of cash management technology and services that the world’s largest companies receive. Use our Prime Treasury as an extension of your team to optimize and protect your idle cash so you can focus on your business. With our integrated Rho technology and robust investment options, including FDIC deposit-insured accounts, US Treasuries, Bank Certificates of Deposit, and Investment Grade corporate bonds, Rho can help you define custom investment portfolios and bond ladders, as well as reinvest capital when assets mature.
Reach out to one of our specialists to learn what our bespoke treasury management can do for your business.
Investment management and advisory services provided by RBB Treasury LLC, an SEC-registered investment adviser. RBB Treasury LLC facilitates investments in securities: investments are not deposits and are not FDIC Insured. Investments are not bank guaranteed, and may lose value. Investment products involve risk and past performance does not guarantee future results.
This material presented is for informational purposes only and should not be construed as legal, tax, accounting or investment advice. Under no circumstances should any of this material be used for or considered as an offer to sell or a solicitation of any offer to buy an interest in any securities. Any analysis or discussion of financial planning matters, investments, sectors or the market generally are based on current information, including from public sources, that we consider reliable, but we do not represent that any research or the information provided is accurate or complete, and it should not be relied on as such. Our views and opinions are current at the time of publication and are subject to change.
