Money market funds are not completely risk free

Rands with dice and cardsThe fallout in South African money market funds from the collapse of African Bank is a timely reminder that these investments are not completely risk free. Small capital losses have sparked big runs on money market funds in other markets. Investors should be sure to put as much emphasis on return of capital as they do on return on capital, regardless of asset class.

Investors may not be aware of the risks involved in their money market investments, says Doug Thomson, Head of Business Development at RECM. “Investors who think that putting money into a money market fund is always as safe as money in a bank should check those assumptions,” says Thomson. “The highly competitive nature of the money market industry has made it harder for most funds to generate good returns without either increasing the duration of the fund or taking on more credit risk.”

Thomson points out that the losses investors incurred as a consequence of ABIL’s curatorship are by no means the first suffered by money market investors. In the US in 2008, news that The Reserve Primary Fund had exposure to Lehman Brothers sparked a run on the fund. Despite being one of the oldest and biggest money market funds, investors withdrew $40 billion in two days and the fund’s assets fell more than 60%. In the two days that followed, investors withdrew nearly 10% of the total assets across US money market funds until the Federal Reserve stepped in to provide liquidity.

“The interesting thing is that the Primary Fund’s exposure to Lehman Brothers was only around 1.3% of the fund, but it still started a $200 billion run on money market funds,” says Thomson. “The meltdown of African Bank and its impact on money market funds locally demonstrates that money market losses can also happen here. While investors may be mentally prepared for a decline in the value of an equity fund, most don’t expect that kind of thing to happen in a money market fund. Given the lower returns compared to equities, even a few percentage points loss on a money market fund is a big deal.

“RECM’s Money Market Fund occupies an interesting niche, in that it aims to generate a competitive yield while not compromising on the quality of the underlying assets,” says Thomson. The Fund has been a consistent top performer in the South African money market and currently leads MoneyMarket.co.za’s ‘Top 6 Money Market Funds’. “This performance is as much a function of its investment strategy as the low fees we charge on the Fund. In the case of money market funds, fees have a significant impact on investment returns over time.”

According to Thomson, it is well worth taking the time to understand how a money market fund is being managed and what risk the managers may be taking on to improve returns. “People who rank money market funds only on the basis of their historic returns are likely to misjudge the risk in their money market portfolios. Capital loss seldom manifests in money market funds – but it just has. It’s critical to look deeper than yield to understand a money market fund’s liquidity, its fee structure and how the yield is derived.”

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