This is a request we’re hearing a lot more from clients today, as they vent their frustration and seek alternatives to the derisory deposit rates on offer from Irish banks today. Since interest rates began to rise in mid-2022, we have been raising the awareness of our clients to the benefits offered by Money Market Funds as a means of generating a higher return on cash, while maintaining a low risk profile.
This article sets out an overview of Money Market Funds.
What are Money Market Funds?
They are heavily regulated and risk-managed funds, often operated by leading global asset managers. They have a primary objective of providing investors with security of capital and high levels of liquidity, while aiming to generate returns in line with prevailing money market rates. These funds are actively managed and invest in a range of money market instruments, such as securitizations, commercial paper, deposits, derivatives, repurchase agreements, and other Money Market Funds.
In 2008, following the global financial crisis, the G20 group of countries agreed to reform the Money Market Fund (MMF) industry, leading to the introduction of the European Commission’s Regulation on Money Market Funds. These regulations define specific types of short-term MMFs and standard MMFs in terms of eligible investments, maturity requirements, liquidity criteria, and valuation methods. Funds managed in accordance with these criteria are permitted to carry the label of being an “IMMFA (International Money Market Fund Association) Fund.”
How do they work?
Money Market Funds typically deal daily, with same-day or next-day settlement, providing investors with almost the same level of liquidity as on-demand deposits. They operate by actively managing a diversified portfolio of short-term money market instruments, which enables investors to access their capital in a timely manner.
What are the benefits of Money Market Funds?
The benefits are quite straightforward. In the current challenging environment for savers, Money Market Funds offer an attractive alternative. They provide the potential for higher returns than are currently being offered by traditional bank deposits, while prioritising the security of capital and maintaining high liquidity. Money Market Funds are subject to rigorous regulation and risk management practices, offering diversification benefits and the opportunity to earn returns in line with prevailing money market rates.
As savers seek solutions to combat the impact of low interest rates and inflation, Money Market Funds can play a vital role in their investment strategy. By considering these funds, investors can aim to achieve a better return on their cash holdings, while still enjoying the benefits of liquidity and security of capital.
Are Money Market Funds worth the effort of switching?
Depending on your level of deposits, they are definitely worth the effort! With the Euro short-term rate now standing at 3.905% p.a., which is the average rate available, we are advising any clients with more than a few hundred thousand euros on deposit to consider investing this cash in Money Market Funds. This provides them with an increase of approximately 2% p.a. (and more in some cases) above the rates being offered by their banks.
Of course fees and charges need to be considered too. If you would like to understand exactly what the expected income could be on your specific level of deposits after charges, I suggest you contact us. An Acuvest advisor will be able to guide you (without any fee or obligation) to understand better how Money Market Funds could benefit you .
What risks are savers and investors exposed to?
As with any investment, it is imperative to understand and consider each of the associated risks, along with relevant mitigating factors.
While a limited number of Money Market Funds operate on a NAV basis, with underlying investments being held on a constant value to maturity basis, most of the instruments held by Money Market Funds are traded on exchanges, with values changing as trades take place during market opening hours. Short term Money Market Funds do not generally experience extreme price variations. However, like most assets that are openly traded in liquid markets, the value at which they trade is based on underlying fundamentals of the amount the instrument will be worth at maturity, and is also subject to the laws of supply and demand and market sentiment. This can cause values to fall and spreads to widen in times of escalated uncertainty or crisis.
Further details on the main risks inherent in Money Market Funds are set out below. While it is important to know that investors in Money Market Funds can experience negative returns due to increasing interest rates, or extreme credit events, these risks are mitigated by the high credit quality (generally average of AAA) and relatively short duration (average maturity of 0-60 days) of the instruments that Money Market Funds trade in. This is in addition to the liquidity provided by the depth of the euro money market, and the objectives of the active manager to provide liquidity and avoid losses.
- Counterparty Credit Risk: At an underlying level, the investments are short term loans or other instruments that include a promise to repay a certain amount(s) of money to the investor at an agreed point in the future. Akin to depositing your money in a bank, or any other type of financial instrument, all of these assets have some level of counterparty / credit risk incorporated into them. These risks are mitigated by the rigorous credit assessment processes that Money Market Fund managers are required by regulation to operate.
- Liquidity Risk: Like any other non-cash asset, the ability to liquidate a money market instrument on any given day requires either the counterparty to repay their obligation (e.g. at end of term) or for another party to agree to purchase the instrument. Investors / asset holders have no guarantees in advance of being able to find a willing purchaser, or of the value that their assets will command. This can be seen during times of extreme uncertainty when lower liquidity results in widening spreads, higher credit default swaps (insurance instruments) and lower asset prices. That said, the ECB has significantly increased its level of regulatory monitoring of activity levels and systemic risks across the fund management industry, and its ability to inject liquidity into the market was evidenced during the COVID pandemic. In addition, the instruments held within Money Market Funds are widely traded in markets that are generally highly liquid (€1.3 trillion average daily transaction value in euro money markets versus $651 billion across global stock markets[1]). They also have a maximum term to maturity of 397 days, with a maximum average maturity of 60 days. However, managers tend to maintain an average of c.30 days.
- Interest Rate Risk: Any financial asset with a fixed coupon / rate of interest becomes less valuable if the prevailing interest rate rises, as was clearly demonstrated by the losses of over 20% experienced by holders of long government bonds in 2022. The (relatively) short duration of assets held by Money Market Funds (typically average of 30 days, up to a max of 60 days) is a significant mitigant to this risk.
Taxation & Deposit Guarantee
Gains on Money Market Funds are taxed on a gross roll-up basis and subject to Exit Tax at a rate of 41%, rather than annual DIRT at a rate of 33%. These funds are not covered by the Deposit Guarantee Scheme, because they are classed as funds as opposed to bank deposits.
Summary
In summary, Money Market Funds offer the opportunity of generating a higher return on cash, while maintaining daily liquidity and a low risk approach, similar to deposits. If you would like to understand better how Money Market Funds would benefit your specific circumstances or would like to hear more about any aspect of generating an increased returns on your cash, please do not hesitate to contact me at damianc@acuvest.ie or any member of the Acuvest investment advisory team at 01 6344510.
