What are Money Market Funds and why is more and more investing in them?
With MMFs, investors benefit from the experience of the fund managers, which helps them diversify their risk.
Much has changed since the first money market fund (MMF) was created in the United States in 1971. Today they are an indispensable treasury management instrument for many insurance companies and pension funds around the world.
Other users, such as companies, family offices and foundations, have also incorporated them into their daily activities. The current size of the sector is around $5.1 trillion in the United States and around $1 trillion in Europe.
What are money market funds?
MMFs (money market funds) are open-ended investment funds that trade short-term instruments , such as commercial paper, floating rate notes, term deposits, covered bonds, and repos. These instruments have short maturities .
They are very liquid instruments and are used for diversification , along with traditional bank deposits. Investors and treasuries with idle cash often face internal counterparty restrictions and limitations on their bank credit lines. With MMFs, investors benefit from the experience of the fund managers, which helps them diversify their risk.
As with all investments, the underlying assets of the MMF are held separately (in custody). Instead, money from ordinary deposits remains on the bank’s balance sheet.
Due to their scale, MMFs allow investors to participate in a more diverse and higher quality portfolio than if they invested independently . It is also quite common for investors to use multiple MMFs. MMFs are considered cash or cash equivalents because of their high liquidity and daily access to invested cash.
Short-term MMFs that adhere to ESMA (European Securities and Markets Authority) guidelines must meet certain requirements. These include restrictions on liquidity, duration, minimum rating requirements and exposure to the issuer. To be rated AAA , short-term MMFs must meet the following characteristics:
-a minimum of 10% of the fund volume with maturity in one day
-minimum maturity of 30% within seven days
-maximum WAM (weighted average maturity) of 60 days
-maximum WAL (weighted half-life) of 120 days
-maximum participation of 5% for any individual underlying issuer (excluding government deposits and overnight deposits)
The growth of MMFs
MMFs have grown greatly in size and importance over the years, and their main investors are institutional clients and companies. “But they are also used by institutions such as municipalities, public service companies, universities and private investors, which expands the user base. This is because MMFs usually offer a competitive interest rate, close to or higher than the current interest rates ,” says Álvaro Antón, Country Head of abrdn in Iberia. In addition, they do not usually have access restrictions, which makes them a highly liquid asset with attractive returns.
But be careful: “money market fund” is a broad term that covers different funds and investment time horizons . “Therefore, investors should consult the prospectus to ensure that the MMF corresponds to their desired risk profile,” says Antón.
“For example, some MMFs use derivatives to earn additional returns, which adds another layer of risk. Therefore, investment managers must clearly indicate the use of derivatives in the prospectus and fact sheets,” he adds.
MMFs also cover different investment horizons, which investors should take into account when choosing a specific fund. The same can be said for profitability. Higher profitability is usually accompanied by higher risk.
The rise of investing in money market funds
Recent central bank rate hikes have brought interest back to a sector that has gone unnoticed for some time, especially in the Eurozone, where rates were negative or zero for ten years. Rate increases to curb inflation occurred in several currencies.
Among them, the ten consecutive increases by the European Central Bank (EUR), the fourteen by the Bank of England (GBP) and the eleven by the US Federal Reserve (USD) since last year. “These rapid increases have sparked interest in MMFs, and EUR-denominated funds now show attractive positive returns ,” Antón concludes by analyzing the appetite that has currently been opened.
