Choosing a Money Market Fund: Is Yield the Only Consideration?
Money market mutual funds have become the most popular way for US corporate and individual investors to park cash and savings, and they are fast-becoming a popular investment alternative in Europe and Asia. While diversity, safety, liquidity and convenience have made money funds attractive, yield is often their main selling point.
Yield is also the main reason investors choose one fund over another. But are money market mutual funds really commodities? Should investors go beyond yield in selecting funds?
Money market funds totalled a record US$2.6 trillion as of 1 August 2007 and account for almost one-third of US businesses’ short-term assets, according to the Investment Company Institute (ICI). Over the past 52 weeks, money fund assets have grown by US436bn, or 20%.
This article focuses on US dollar and US domiciled funds. Money funds in the US are regulated by the Securities & Exchange Commission via its Rule 2a-7 of the Investment Company Act of 1940. Rule 2a-7 mandates strict quality, maturity and diversity guidelines for ‘money market funds’, so be aware of differences in domiciles and regulatory regimes outside the US.
Europe currently has no regulations defining the term ‘money market mutual fund’, but ‘US style’ liquidity funds are slowly but surely gaining popularity. Fund providers will point to AAA ratings, ‘shadow 2a-7’ status or strict investment guidelines, but be aware that these funds may invest in securities that US funds do not invest in.
Money market funds invest in short-term, high-quality debt instruments. According to ICI statistics, the largest holdings of the average money fund include: commercial paper (31%), repurchase agreements (20%), corporate notes (17%), and certificates of deposit (10%). While investors may certainly buy these securities on their own, the economies of scale, diversity and convenience of the funds normally offer a compelling value.
While money market funds may have exposure to mortgage- and collateralised debt obligation- (CDO-) backed asset-backed commercial paper or asset-backed securities (ABS), it is unlikely that any funds will see any losses related to recent market troubles. The odds of a fund ‘breaking-the-buck’, or dropping below its US$1.00 a share, remain practically nil, given money fund’s strict mandates of quality and diversity.
Note that double-digit percentage declines such as those experienced recently by the AXA Libor Plus and Oddo Cash funds have never occurred in a true money market mutual fund. The biggest catastrophe in the history of US money funds, and the only buck-breaking, was a decline of 4 cents on the dollar. (Community Bankers US Government Money Market Fund, a US$100m fund, fell to US$0.94 in 1994 due to interest-rate related declines in its portfolio.)
AAA ratings (from Fitch, Moody’s or Standard & Poor’s) add another layer of reassurance. In order to get this highest rating, a money fund must keep its weighted average maturity (WAM) at 60 days or less (versus 90 days for all money funds), and must adhere to higher quality standards when selecting securities. Many companies and institutions require a triple-A rating as a condition of investing in a fund, and the vast majority of large institutional (and “offshore”) money funds carry these ratings.
As safety is practically a given, one must then look to features. Investors must understand why a fund yields a certain level. Something yielding 50 basis points over LIBOR, such as the AXA fund, clearly is taking risks beyond a money market fund. Money fund yields are determined primarily by expense ratios, but a higher yield may be indicative of a more aggressive portfolio. Higher expense levels may also accompany a higher level of shareholder service.
The sponsor and size also play a major role. Many companies require a minimum fund or portfolio size, or they restrict their investments to a certain percentage of the fund. Often only US$1bn or larger funds are allowed, though larger funds may be required for larger investment sums. We’ve recently seen a couple of market funds break the US$100bn level in total assets, and a number of funds are now able to handle huge inflows without making waves.
The fund company, or sponsor, is sometimes even the most important consideration. Relationships and reputation matter immensely, particularly since all mutual funds must disclaim ‘past performance is no guarantee of future results’. The money fund may be part of a bigger picture, or a reputable provider may make the decision to use a vendor an easier sell to a board or group.
Credit Suisse asset management director, Jack Winters, says, “I’m certain that some cash investors view money funds to be a commodity, particularly if they get past their initial due diligence where they are satisfied with the sponsor – the quality of the sponsor, the reputation of the sponsor, and their general capitalisation. Once the investor gets past that level of review, I’m sure some of them feel that money market funds, to some degree, are a commodity.”
He continues, “Most money fund sponsors wouldn’t agree with the ‘commodity’ assessment. But the investors are looking for differentiators, assuming they feel that the credit quality is all the same. At that point, I think you should look at the experience, expertise and reputation of the portfolio managers, just to gain a level of confidence in what’s going on in the fund. I think you also would be looking at the consistency of performance and the pricing structure of the portfolio. You want to look at the convenience and service features – deadlines, ratings, etc. – and the size of the fund, because the fund may be easier to use if it’s large. Those are some of the remaining differentiators.”
Finally, investors should be familiar with the various formulas and measurements of yield. Money market mutual funds normally use a seven day current annualised yield, which takes the dividends paid over the previous seven days, annualised (multiplies by 365/7) and puts in percentage (*100). A compound or effective yield would assume reinvestment of dividends. Yields are normally shown net of fees. Also, keep in mind the time period covered. Unlike bank products, money funds can’t tell you what they’ll yield tomorrow, only what they yielded yesterday. Money funds normally annualise based on a 365 day year, compared to some money market securities that use a 360 day convention.