A money market fund (MMF) can be broadly defined as an investment fund whose objective is to provide investors with security of capital and daily liquidity. It seeks to achieve that objective by investing in a diversified portfolio of high-quality, low-duration money market instruments. The return on a MMF tends to follow short-term interest rates with a low level of volatility.
Why do investors choose MMFs?
A MMF provides a number of benefits to investors in relation to comparable products such as bank deposits or direct purchase of short-term money market securities:
- Safety and liquidity: The primary objective of MMFs is to maintain stability of capital, and to provide daily access to cash or investments.
- Diversification of credit risk: MMFs have highly diversified investment portfolios, with limits on exposures to any one issuer. This can provide a greater degree of diversification compared with single-issuer credit risk.
- Credit risk management: Rather than relying on the ratings provided by the credit rating agencies alone, the use of professional fund managers who can undertake their own credit assessment using a range of complex tools reduces counterparty credit risk.
- Professional management: Investors have access to professional investment management and operational expertise.
- Yield: These funds offer competitive money market yields as a result of pooling investor assets in a range of money market securities.
- Working capital: These funds offer same-day settlement, which allows customers to use the fund for working capital management.
- Transparency: A range of information is offered by MMF providers in order to help investors better understand the risks of their investment, including factsheets displaying metrics such as weighted average maturity (WAM), credit breakdown and country exposure, as well as more detailed portfolio holdings reports providing a snapshot of the fund’s portfolio on any given day.
- Low costs: MMFs generally offer low, transparent management fees, which include custody and administration fees.
Who uses MMFs?
Any institutional investor looking for a secure home for surplus short-term cash balances, for example:
- Corporates;
- Insurance companies;
- Pension funds;
- Non-bank financial institutions (for example, asset managers, hedge funds, private equity firms, property funds);
- Local authorities;
- Charities;
- Universities and educational bodies; and
- Central banks and sovereigns.
How are MMFs rated?
All three of the principal credit rating agencies provide MMF-specific ratings, which fall on a scale from AAA to C or D, with a suffix (mmf, m or –mf) to denote that it is MMF-specific. These show the agencies’ opinions on a fund’s ability to preserve capital and provide liquidity. Each of the rating agencies has differing criteria, but with similarities regarding a fund’s governance, and assets and portfolio characteristics. A minimum ‘AAA’ MMF rating (for short-term MMFs) is a relatively common requirement in many treasury investment policies.
How are MMFs regulated?
As investment products, MMFs (and their managers) are subject to a variety of regulations in terms of how the funds are operated, as well as how they are marketed. In Europe, there are specific MMF regulations, which define and set rules for different types of MMFs, which in summary are:
- Public debt MMFs, which only invest in government securities, and which are highly liquid;
- Short-term MMFs, which invest in credit (for example, bank- or corporate-issued paper) as well as government securities, and which are highly liquid; and
- Standard MMFs, which take additional credit and duration risk, and are less liquid than short-term MMFs. These are most prevalent in the domestic French market.
When international MMFs are referred to in Europe, including the UK, this typically means short-term MMFs, which is what most investors understand as a fund offering daily liquidity.
What is the typical yield?
MMFs typically generate yields competitive with normal overnight or one-week short-term interest rates (for example, SOFR, ESTR or SONIA). The funds do not have a benchmark.
How is the yield generated?
A MMF typically accrues interest income on a daily basis and either distributes that income in the form of a dividend or accumulates the income in the form of accumulating shares. Dividend income can be either distributed monthly or reinvested in new shares.
How are MMFs valued?
MMFs can either have a stable net asset value (NAV), which means the unit price remains at a constant $1/£1/€1, or a variable NAV, which means the unit price can move up or down. In Europe, short-term MMFs are often ‘low-volatility NAV’ funds, which means they can offer a constant dealing price of $1/£1/€1 subject to certain rules and thresholds.
Do MMFs qualify as cash and cash equivalent?
Short-term MMFs are often classified as cash and cash equivalent across many markets, as they offer short-term investments in highly liquid securities that are readily convertible to cash. Any final determination, however, would always be made by an investor’s auditors.
How do MMFs compare to bank deposits?
A bank account balance or deposit provides exposure to a single counterparty (ie, HSBC) in a single asset class (ie, a bank deposit). MMFs provide an easy way for an investor to access a diversified investment across counterparties and asset classes through a single investment. MMFs could be viewed as complementary to bank accounts and deposits, providing the client with additional choice in achieving their cash investment goals while broadening the products and balances they give to their bank. Investments in MMFs are with an investment company (which invest in a range of money market instruments), whereas bank deposits are placed on the balance sheet of a banking entity.
What do MMFs invest in?
Funds invest in a range of high-quality money market instruments such as bank deposits, commercial paper, certificates of deposit and short-term debt instruments. To be ‘triple A’ rated by most credit rating agencies, the WAM of the portfolio should be less than 60 days – this is also a regulatory requirement in many markets. Most MMF providers produce regular holdings reports to provide full transparency of the assets held by a fund.
How does a treasurer invest in a MMF?
While this can differ between asset managers, once an account has been opened, deals can usually be placed direct via phone, automated options or online through proprietary and third-party portals. Treasurers should be aware of cut-off times and minimum investments.
What currencies are MMFs available in?
MMFs are available in a variety of currencies globally, either as local funds typically available to domestic investors, or international funds that are available cross-border in a number of jurisdictions. Treasurers should be aware of the differences in local MMF regulations and practices, which may differ from international norms.
Is there a fee for investing in a MMF?
MMFs typically charge a management fee that is calculated based on the amount invested and is deducted from the gross yield of the fund, much like a spread on a deposit interest rate. The fee is inclusive of management, administration and custody fees.
Are MMFs guaranteed?
MMFs are investment products and as such are not in any way guaranteed.
What should treasurers look for in a MMF provider?
When selecting providers, some key requirements are:
- The experience of the team managing the funds, and how long the provider has been running MMFs as an asset class;
- The investment philosophy and approach to risk;
- The diversity of their investor base (for example, across geographies and industry sectors) and what the approach is to investor concentration;
- The range and scale of currencies they offer matched to an understanding of your requirements;
- The options available to trade into the MMF (for example, online, phone, etc) aligned to your requirements;
- Their performance over the long term, including how they have managed funds through times of market disruption;
- How the fund and manager incorporate sustainability into their investment processes and philosophy;
- Their client relationship and servicing model, as well as client reporting;
- The approach to sharing knowledge and ‘thought-leadership’; and
- Overall relationship with financial services providers.
Are MMFs impacted by banks’ capital and liquidity rules (for example, Basel III)?
As mutual funds, MMFs are not bank balance sheet products and therefore are not directly impacted by Basel III and other rules for capital and liquidity (which can drive the way banks value certain customer deposits). While there are some indirect implications for MMFs given that many of the instruments invested in are bank issued, MMFs remain an important option for cash investing, including where investors are seeking alternatives to short-term bank deposits.
How can sustainable investing be applied to a MMF?
There are a number of ways sustainability can be applied to MMFs, however, it is important an investor understands how these are applied and what the sustainable outcome is when comparing funds. The following are examples of environmental, social and governance (ESG) investment approaches:
- ESG integration is a process of including the evaluation of ESG performance in the credit process. An issuer is evaluated based on how they address ESG risks in addition to financial data. This typically results in the same investable universe as a regular (non-ESG) issuer.
- Sector screening is a process that removes issuers from the investible universe based on the activities of the sectors in which they operate. However, issuers in the eligible money market universe are typically financial institutions, sovereign and government agencies that do not operate in the screened-out sectors. Therefore, this typically results in no meaningful change in the investible universe.
- A best-in-class investment strategy incorporates ESG factors and identifies the highest-scoring ESG performers in the money market universe, meaning that investments are only made in issuers who have a better track record in managing ESG risks. This approach typically results in a meaningful change in the investible universe.
- Issuer engagement is an important process to help drive change and encourage issuers to address identified shortcomings and ensure companies are aware of how their ESG performance is considered in investment decisions by the MMF manager.
What are SFDR Article 6, 8 and 9 funds?
The EU’s sustainable finance regulation created three categories of funds, each with an increasing focus on sustainability. Asset managers self-assign their funds based on their fund’s investment guidelines. Article 6 funds can integrate E, S and G concerns in their credit analysis, but do not have any sustainability-related fund objectives. Article 8 funds include sustainability-linked fund objectives, but they are secondary to others (for example, preservation of capital, provision of liquidity or yield). Article 9 funds’ sustainability objectives are the primary objective of the fund – more important than other considerations.
To learn more about MMFs, get in contact with HSBC Asset Management here.