Should You Invest in a Money Market Fund?

VIDEO: What kind of returns should investors expect from money market funds? Morningstar Investment Management's Mark Preskett explains the options

Holly Black 18 November, 2019 | 11:21AM
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Holly Black: Welcome to the Morningstar series, "Ask the Expert." I'm Holly Black. With me is Mark Preskett from the Morningstar Investment Management team. Hello.

Mark Preskett: Hi.

Black: So, there's a lot of uncertainty in the market at the moment and we're seeing investors looking for safe havens and less risky places to stash their money. So, one of those that we've been seeing is money market funds. So, what do they do?

Preskett: So, a money market fund would generally in highly liquid cash instruments with very short maturities, and they're typically seen as one of the safest forms of investments you can make.

Black: So, what do they actually hold?

Preskett: So, there's a variety of instruments that a money market manager has at its disposal. So, probably the safest are T-bills. These are issued by the U.K. Government's debt management office. Every week, they issue one-month, three-month and six-month paper and generally, the return you receive is linked to the Bank of England base rates

Black: Is that a bit like they issue debt and you get a return on it?

Preskett: Absolutely. At the end of the period, so after three months if you buy three-month paper, you get your money back as well plus some interest over that period. There's also the specialist money market instruments that are issued by banks. So, certificate of deposits, commercial paper and time deposits. And generally, there the return is linked to the credit rating of the issuing bank. And there are other instruments like covered bonds, short-term credit and even asset-backed securities which are used by some managers to enhance yields.

Black: So, with all of that in a portfolio, what sort of return can you expect?

Preskett: Generally, you should frame it around the Bank of England base rates, which is currently 0.75%. And then, you should look at the credit rating of the fund. If the credit rating is typically lower than – if fund A has a lower credit rating than fund B, then the yield to maturity tends to be slightly higher. Also, duration or maturity, how long they're lending, how long the paper that they're buying. And finally, fees. That's probably the easiest way to see what return you're likely to get, especially in this low-yielding environment. So, a fund Royal London Short Term Money Market has an annual management charge of around – an ongoing charge of around 10 basis points. So, when you're getting 75 basis points, you're giving back around 10 to the fund manager. By contrast, BlackRock Cash is another well-known fund out there, has a 32 basis point ongoing charge, which you know, eats into around half of your return. And you can really see that in the return profile of the two funds.

Black: So, these are at the safer end of the spectrum. But this is investment, so there's always going to be some risks, right?

Preskett: Yeah, absolutely. I mean, I think it's fair to say that money market instruments are one of the safest forms of investment out there. And the low return you receive reflects that risk. However, there is always the risk of a bank defaulting, especially in a time of crises. So, the way that the money market managers try and work around that is to have a diverse range of banks that they deal with. So, the Royal London Fund has cash instruments with 35 different banks, Vanguard has around 29. So, that mitigates the risk of a single default. But we are seeing some money market managers dipping into the credit space which opens you up to credit risk and potentially interest rate risk. So, it's definitely – the shorter-term money market instruments are for those that are really nervous of keeping – preserving their capital will be where we would focus your attention.

Black: So why would I pick a money market fund in the first place? It seems like I could probably earn a better return in a high street savings account.

Preskett: Absolutely. You can get around 1.5% now from even an instant access account, some banks are offering around 1.5%, whilst the money market funds are linked to base rates. But these funds are suitable for inside tax wrappers like Sipps and Isas where you can't access a traditional bank account.

Black: Because once your money is in a pension or an Isa, you can't take it out without losing the tax benefits?

Preskett: Absolutely. Yeah. And as portfolio managers we're using money market funds, A, as a sort of – to preserve capital, keep powder dry in times of stress and take opportunities, but also to manage the overall duration. We're finding that a lot of the bond instruments that we can invest in are very exposed to interest rate risk. Governments are issuing longer and longer debt. So, we actually have higher than average allocations to cash right now as a way of protecting capital.

Black: Well, thank you so much for your time.

Preskett: Thank you.

Black: And thanks for joining us.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Holly Black  is Senior Editor,