Money Market Funds : Why You Should Seriously Consider This Option For Your Cash?
Every Christmas, my friends and I will come together to share and update one another on our lives. We always have one filthy-rich friend who will dominate the conversation with how much money he makes, how his two-year old Porsche has gone out of fashion, his vacations at different exotic places that nobody has heard of, and complain about having nothing to do with his stockpiles of cash… and then he will receive the death stare from other corporate slaves like myself.
We all know someone like that.
If you are working in corporate treasury, perhaps your company is facing the same problem as my filthy-rich friend – having too much money and not knowing what to do with it. Post-2008 financial crisis, more and more corporates are hoarding loads of cash to prepare for an uncertain political and economic environment, presenting a new challenge for corporate treasurers – what should I do with all the money?
The traditional option is to simply place the money with your local banks as deposits. Coming from a traditional company, I am used to placing excess cash in 1-month or 3-month time deposits, which provide better yield (~1%) than current accounts.
But with the development of the money market fund industry in Asia and other parts of the world, you might want to consider a viable alternative to bank deposits – money market funds. I will explain why as a corporate treasurer, you would want to seriously consider this option in the sections below.
Money-market funds… What exactly is it?
For non-finance professionals, the term ‘money market’ might be completely new to you. You might have heard of ‘bonds’ or ‘fixed-income’ before, but ‘money market’… what exactly is it?
Money market is basically a sub-set of the fixed income market. The difference between money market and bonds is that money market is short-term (typically less than one year), while bonds are typically longer term in nature.
Put it simply, money-market funds are liquid, safe and conservative investments – therefore, a viable alternative to bank deposits.
Before we talk about deciding which money market fund to choose from, let me bore you with some definitions and explanation of the different types of money-market instruments: Treasury Bills (T-bills), Certificate of Deposit (CD), Commercial Paper, Repos, etc.
Alright, I will keep the definitions short.. [Please skip this part, if you are already familiar with the different money market instruments]
T-bills is the safest and most simple instrument in the money market, because they are issued and backed by the Government. They are thus considered risk-free in the national markets. However, the down-side of holding T-bills is you won’t get a great return (your return might even be negative), in this low interest rate environment.
2. Certificate of Deposit (CD)
CDs are issued by commercial banks and can be bought through brokerages, unlike fixed time deposits. Compared to T-bills, they have slightly higher yield because of the slightly higher default risk of the commercial bank. CDs can be either fixed rate or floating rate, but generally fixed rate CDs are more common. They are widely used by corporates in the UK and Europe, and less common in Asia.
3. Commercial Paper (CP)
CP is unsecured, short-term loan issued by non-financial corporates to meet short-term obligations like accounts receivables, payroll, etc. Usually, these issuers of CPs are highly-rated companies, so the CPs are low risk and have higher investor demand. Just like a corporate bond, CPs are backed by the financial strength of its issuer. So, if the issuer is lower quality, you will take on higher risk, but will also get higher rates from holding the CPs.
The reason why corporates choose to issue CPs for short-term financing is the cheaper cost of financing – corporates want to avoid the expenses of securing a business loan from a commercial bank.
Repos is short for repurchase agreement. In a repo, a dealer or holder of T-bills sells the T-bills to a lender, and agrees to repurchase them at an agreed future date at an agreed price. This is extremely short-term (overnight to 30 days or more) and extremely low risk (due to Government backing).
Alright, enough of definitions of money market instruments!
Ready to get started in money market funds?
If you are in corporate treasury and considering where to park your excess cash for maximum reward to risk, you might want to consider money market funds, other than the usual time deposits with your bank.
IMPORTANT: Check your Company’s Investment Policy First!
Before you start investing your company’s cash in money market funds, you need to check your company’s investment policy. The company’s investment policy should state explicitly the permissible investments, and whether you are allowed to invest excess cash in market funds. A comprehensive investment policy should give guidance on the process of choosing the money market funds to invest in.
There are slight variations from company to company, but let me explain in simple language what you should consider when choosing a money market fund to invest in.
1) What are your objectives?
Are you just finding a place to park your excess cash? Or are you chasing after returns for your funds? Are you willing to sacrifice some liquidity for the sake of higher returns? Is chasing that extra basis point critical for your company?
I think the basic questions you should ask as a corporate treasurer are what is the risk appetite for your company, and which factor is more important for your company – high returns from excess cash, daily liquidity, low risk?
2) Shopping for the right money market fund
Now that you know what you want, it is time to go shopping! Let’s go! If this is your first time dealing with money market funds, you may not know where to start because of the sheer number of funds to choose from. What should you consider?
– Size of fund / ‘safety in numbers’ – Large funds normally have greater shareholder diversity, and this is good for several reasons. Firstly, the large size means that the funds have greater buying power, and greater yield potential. Secondly, that the fund is less susceptible to risk from a single investor redeeming his funds, i.e. exiting from the fund. For me, I feel safer when there are other big name corporates investing in the same fund as me – ‘safety in numbers’ principle.
– Liquidity of fund – Look at weighted-average maturity (WAM) of the fund to have a sense of the fund’s liquidity. The fund will be more liquid, if a higher percentage is invested in T-bills, repos and deposits. If you are a large investor of a fund, you probably want to discuss with the fund manager to understand the fund’s liquidity management policies, how the fund is managed, minimum amounts of investment required (if you decide to withdraw your funds later), who the other investors of the fund are, etc. so that you can make a good decision whether that is the right money market fund to park your excess cash.
– Fund Manager Performance – Does the fund have a good track record compared to other similar funds? Remember to look at the net yield, which is gross yield less any management fees, as this is what really matters to you as an investor. If the fund is performing well consistently, try to understand the reasons – is the fund more risky than other funds?
– Timely information – Do the funds provide information on a daily basis through the website? Or do you get updates weekly or monthly? If you have a query on the fund, who can you contact and who will help you address your queries or solve your problems? These details seems very basic, but it is important to understand before investing into a fund.
– Due Diligence – Read the fund prospectus, fund manager reports, fund annual reports and fund rating agency reports for due diligence before investing in the fund.
3) Maintain good relationships with the fund managers
It is important to have regular communication with your fund managers, since you are parking your cash with them. You probably will want to have a meeting with them to learn more about their fund management styles, and more importantly know who you can turn to, if you need any support with regard to your funds.
The Case for Money Market Funds
Money market funds have long track record of being a safe alternative as compared to time deposits. But just like any other investment, there is some risk in money market funds.
I won’t advise you where you should park your money, but I can highlight to you some differences between parking your cash in time deposits vs money market funds. Firstly, if you park your cash as bank deposits, you are exposed to high counterparty risk (single counterparty), as compared to parking your cash in a money market fund, which typically consists of portfolio of T-bills, CDs, CPs, etc. Secondly, there could be greater flexibility (liquidity) for a money market fund (depending on the fund of course), as compared to time deposit. And of course, yields for money market funds and time deposits will be different, depending on the composition of the money market fund.
So, if you ask me whether placing your cash in money market funds or bank time deposits is better, my short answer is ‘It depends.’ You can’t say one is better than the other, just like apples are not better than oranges, and stocks are not better than bonds. All I can say is that money market funds is a good alternative to bank deposits, and if I am flushed with cash, I will probably park my money in both for diversification.