How Safe Are Money Market Funds in the Current Economy?

How Safe Are Money Market Funds in the Current Economy?
Page content

What Are Money Market Funds?

Money market funds are investment instruments that maintain a net asset value of $1 per share. These funds are generally held for short periods of time (i.e. usually less than one year). Directed more specifically towards the risk averse investor, money market funds offer a stable investment alternative but do not usually provide a good return on capital investment. Money market fund portfolios are composed of liquid debt and monetary instruments. It is common practice that portfolio managers (such as retirement fund managers) who wish to stay fixed within a specified fund with hopes of a long-term, prosperous, financial relationship would not usually choose money market funds as part of their selective diversification options. How safe are money market funds though? For the most part, money market funds are short-term, low-risk, low-return funds.

They usually consist of high rated, quick maturing debt and are therefore quite liquid in nature. Money market fund securities consist primarily of short-term bonds, repurchase agreements and commercial paper. For individual investors of money market funds, retail money funds are best suited. Retail funds can consist of tax-free funds, non government funds and government only funds. Institutional money market funds are highly sought after by governments and corporations. These types of clients can fulfill the high minimum investment requirement of these types of funds and benefit from the low expense share classes available to them. Companies, in particular, utilise institutional money market funds for overnight investment purposes.

Why the Skepticism?

Considering their high quality, almost inevitable (yet negligible) profit yielding history, why then would they fail to meet at least the most minimal of profit expectations? As it stands, a profit (as minimal as what it may appear from the outset) is still a profit nonetheless. Investors, however, may see a large portion of this profit being offset with broker charges, administrative costs and basic fund maintenance expenses.

Given the benchmark of a $1 net asset value that all money market funds should ideally incorporate as part of their secure investment strategy, it’s rare where the Net Asset Value of a money market fund falls below this benchmark. “Breaking the buck” is a term given to companies who fail to achieve this benchmark. There are, however, phenomenally stringent Securities and Exchange Commission rules and regulations that govern the $1 a share standard. However, failure to meet this standard has happened twice since the inception of money market funds in1971. Once in 1994, the Net Asset Value of the Community Bankers US Government Fund broke the buck and ended paying its investors 96c per share. Secondly, after Lehman’s Brother’s Holdings filed for bankruptcy in 2008, the exponential effect it had on the Reserve Primary Fund caused that fund to break the buck bringing down its share value to ninety-seven cents per share.

The current rationale of most investors is to maximize their capital investment with a fairly promising return. Given the climate of investor critics with more of them being prudent and cautious as opposed to risk inclined, it’s always a thought that if the buck could be broken twice, surely it could happen again? With that being said, money markets provide the best form of liquidity to financial providers and intermediaries which means that they have and will continue to be sought after for many years to come.

The Way Forward

Although money market funds were negatively affected by the recession, their overall performance continues to remain fairly streamlined (as history has proven). The reason for this is three-fold. First, a recession governed by non-payment of debtors only held influence for those companies who had a multitude of long-term debt. Money Market instruments are specifically short-term. Second, companies offering money market funds as investment instruments are particularly cautious in ensuring that the benchmark, minimal share price of $1 is continuously achieved. Finally, the US Department of Treasury has offered an optional insurance undertaking to all eligible money market funds that guarantees the restoration of the $1 share price should there be any inevitable expectation that the fund would break the buck.

Going forward, it seems as if money market funds could continue to perform in the way that we have retrospectively become accustomed to. When examining how safe are money market funds, fund yield values in the current climate are perhaps the only negligible factor that avid short-term investors are seriously scrutinizing. If anything, as long as the NAV of $1 looks promising, money market funds will continue to be considered as a short-term investment option by investors worldwide.