With interest rates remaining higher than expected for longer than expected, cash may once again claim its kingship, but it faces a new threat to its throne in the form of money market funds.
While these may still be unfamiliar products to many retail investors, they are rapidly growing in popularity as they often pay higher interest rates without increasing risk.
Money market funds also seek to compete with government securities such as Treasury bills by offering higher yields, greater flexibility and greater safety.
When yields hit 5%, investors flocked to the market, and total investment exceeded $6 trillion.
Instant access, diversification, and less volatility have given money market funds the edge for now, but will this continue to be the case?
Money market funds are a type of mutual fund that are usually sold in the usual way on retail investment platforms.
They invest broadly in short-term, high-quality financial assets, such as cash, U.S. Treasury bills, fixed-rate certificates of deposit (CDs), and high-quality corporate bonds with maturities of less than one year.
As a result, your funds are safe and you can access them at any time.
Damien Hitchen, chief executive of Saxo Bank Mena, said the popular Fidelity Government Money Market Fund, which yields 4.95 percent, offers conservative investors an “attractive” alternative to cash and bonds.
Interest rates have been rising recently amid increased competition: Dubai-based high-yield money-market fund Salwa Save+ raised its interest rate from 3% to 5.1% in June, but it charges no fees for transferring money to local accounts and has no minimum investment.
While some individual government bonds can offer good yields, money market funds may have an advantage in other ways, Hitchen said.
“They incur less capital risk as they focus on short-term, high-quality instruments that are less volatile than the longer-term securities held by bond funds. This also gives them more stable and predictable yields,” he says.
Amol Sithole, head of fixed income at Mashreq Capital, said money market funds are a better option than investing directly in government bonds as they invest in a diversified portfolio of short-term securities.
“These bonds have relatively low reinvestment risk because the proceeds from maturing bonds are periodically reinvested in new short-term securities at market interest rates,” he says.
Tony Hallside, chief executive of STP Partners, said the bonds further reduce risk by targeting high-quality, short-term debt, “making them suitable for investors looking to minimise volatility, preserve capital and earn moderate returns.”
Many investors park their cash in money market funds while they wait for the right opportunity to invest in riskier assets such as stocks.
This is especially appealing to people for whom investment platforms pay low or no interest on cash holdings.
“They’re ideal for investors who need liquidity and stability without investing for the long term or taking on the high risks associated with the stock market,” Hallside says.
After last year’s phenomenal success, many predicted money market funds would fade in 2024 once central banks start slashing interest rates.
That would send yields plummeting, forcing investors to return to riskier, higher-yielding assets like dividend stocks and real estate investment trusts. But so far, that hasn’t happened.
Mohamed Hashad, chief market strategist at Noor Capital, said that despite the European Central Bank and the Bank of Canada deciding to cut interest rates by 25 basis points, the U.S. Federal Reserve has so far refused to follow suit.
The policy rate is being kept in the range of 5.25% to 5.5%, with only one rate cut possible before the end of the year.
Hashad said this bodes well for money market funds, as yields tend to move in tandem with interest rates.
“The 7-day SEC yield, which reflects interest rates on U.S. money market funds, is 5.3%, right in the middle of the Fed’s interest rate range.”
Not only do they preserve your capital and withstand market turmoil, but they also typically have low annual fees of around 0.11% and modest minimum investments of $3,000 (depending on the fund).
Hashad says money market funds may be a good choice for people saving for short-term goals, such as buying a car, saving for a down payment on property or saving for emergencies.
Nowadays, money market funds offer returns that beat inflation, but that wasn’t always the case. But in some ways, money market funds are riskier than cash.
Many countries protect cash savings accounts with deposit protection schemes, which mean that the government will pay compensation up to a certain amount if a bank goes bankrupt. Money market funds do not benefit from these schemes.
Total investments in money market funds could exceed $7 trillion this year as inflation and interest rates remain high, said Vijay Valecha, chief investment officer at Century Financial.
“With inflation running above its 2% target, the Fed is in no rush to ease monetary policy, so yields are expected to remain elevated. Given the outlook, money market funds are a promising place to park your money.”
Valecha lists five money market funds worth considering, all of which offer “competitive yields, low expenses and large amounts of assets under management.” While not available in all locations, investors should be able to find local equivalents.
Vanguard Cash Reserve Federal Money Market Fund currently offers a yield of 5.27% and a low total expense ratio (TER) of 0.10%.
The Fidelity Institutional Money Market Portfolio has an even higher yield, at 5.30%, but a slightly higher TER, at 0.14%.
Allspring Government Money Market Fund combines a high yield of 5.32% with an ultra-low TER of 0.05%.
Valecha also likes the JPMorgan U.S. Government Money Market Fund, which yields 5.28% and has a TER of 0.13%, and the State Street Institutional U.S. Government Money Market Fund, which yields 5.02% and has a TER of 0.11%.
Money market funds may not reign forever. When interest rates eventually start to fall, their throne may topple. That doesn’t matter, given their liquidity. Investors can simply pocket the proceeds and move on quickly to the next investment.
Last updated: June 26, 2024, 5:00 AM
