Monetary funds: what they are, how they work, pros and cons (2023)

What is a money market fund?

A money market fund is a type of mutual fund that invests in short-term, highly liquid instruments. These instruments include cash, cash equivalent securities and short-term, highly rated debt-based securities (e.g., US Treasuries). Money market funds are designed to offer investors high liquidity with very little risk. Money market funds are also called money market funds.

Although they sound similar in name, a money market fund is not the same as onemoney market account(MMA). A money market fund is an investment sponsored by a mutual fund company. Therefore, there is no primary guarantee. A money market account is a type of savings account that earns interest. Money market accounts are offered by financial institutions. are insured byFederal Deposit Insurance Company(FDIC) and typically have limited transaction rights.

This is how a money market fund works

Money market funds work like a typical mutual fund. They issue redeemable units or shares to investors and are required to follow guidelines set by financial regulators (e.g. US).Securities and Exchange Commission).

A money market fund may invest in the following types of leveraged financial instruments:

• bank acceptances(BA): Short-term debt guaranteed by a commercial bank
• Certificates of Deposit(CD) - Short-term savings bond issued by a bank
• Commercial paper—short-term unsecured corporate debt
• repurchase agreements(Repo) - Short-term government bonds
• US Treasuries: short-term government bonds

The returns on these instruments are dependent on prevailing market interest rates and therefore the total returns of money market funds are also dependent on interest rates.

Types of Money Market Funds

Money market funds are categorized into different types based on the class of assets invested, term, and other attributes.

most important investment

A central money fund invests in floating rate debt and commercial paper for non-Treasury assets such as those issued by corporations, US government agencies and government-sponsored enterprises (GSEs).

State Monetary Fund

A sovereign money fund invests at least 99.5% of its total assets in cash, government bonds and repurchase agreements fully collateralized by cash or government bonds.

treasury

A Treasury fund invests in standard debt securities issued by the US Treasury, such as B. Treasury bills, treasury bills and treasury bills.

tax free money background

A tax-exempt cash fund provides income that is exempt from US federal income tax. Depending on the exact securities you invest in, a tax-exempt cash fund may also be exempt from state taxes. Municipal and other debt securities are primarily this type of money market fund.

Some money market funds aim to attract institutional money with a high minimum investment (usually $1 million). However, other money market funds are retail funds and are accessible to private investors due to their low minimum amounts.

Special considerations

There Net Asset Value (NAV) Standard

All the characteristics of a standard mutual fund apply to a money market fund, with one key difference. A money market fund aims to: anet worth(NAV) out of USD 1 is Shares.Excess interest income from portfolio holdings is distributed to investors in the form of dividend payments. Investors can buy and redeem shares in money market funds through mutual fund companies, brokerage firms and banks.

One of the main reasons for the popularity of money market funds is the maintenance of NAV of $1. This requirement forces fund managers to make regular payments to investors, which provides investors with a regular stream of income. It also allows for easy calculation and tracking of the net gains made by the fund.

break your mouth

On occasion, a money market fund may fall below $1 NAV. This creates a condition sometimes referred to by the colloquial term "break the ball.” When this condition occurs, it can be attributed to temporary price fluctuations in the money markets. However, if it persists, the condition may trigger a period when the money market fund's investment income does not exceed its operating expenses or trading losses.

For example, if the Fund is using excessive leverage when purchasing instruments, or general interest rates have fallen to very low levels near zero and the Fund has lost the ball, any of these scenarios could result in a condition that the Fund is unable to meet. ransom demands. In this case, the supervisory authorities can intervene and force the liquidation of the fund. However, cases of broken money are very rare.

In 1994 the first case of breach of responsibility occurred. The Community Bankers of the US Government Money Market Fund settled on $0.96 per share.This was the result of large losses suffered by the Fund after a period of heavy investment in derivatives.

In 2008, after the collapse of Lehman Brothers, the venerable Reserve Primary Fund also failed. The fund held millions in Lehman Brothers debt, and panicked redemptions by its investors reduced its NAV to 97 cents a share.The cash withdrawal resulted in the dissolution of the Primary Reserve Fund. This event unleashed chaos in all forex markets.

To prevent this, the SEC enacted new rules in 2010 to better manage money market funds in the wake of the 2008 financial crisis. These rules were intended to provide greater stability and resilience by imposing stricter limits on portfolio holdings and introducing provisions on liquidity fee charging and the suspension of redemptions.

regulation of money market funds

In the US, money market funds are regulated by the SEC. This regulator sets the necessary guidelines for the characteristics, conditions and range of permitted investments in a money market fund.

According to the regulations, a money fund invests primarily in debt securities of the highest credit quality, which must have a maturity of less than 13 months. The money market fund's portfolio must maintain aweighted average duration(WAM) Period of 60 days or less. This WAM requirement means that the average maturity of all invested instruments relative to their weight in the fund's portfolio does not exceed 60 days. This maturity limitation is intended to ensure that only highly liquid instruments qualify for investment and that investors' money is not tied up in long-term instruments that could affect liquidity.

A money market fund may not invest more than 5% in one issuer (to avoid issuer-specific risks). However, government bonds and repurchase agreements are exceptions to this rule.

Pros and cons of money market funds

Money market funds compete with similar investment opportunities as money market bank accounts,Ultra short bond fundand better cash. These investment options can invest in a broader range of assets and generate higher returns.

The main objective of a money market fund is to provide investors with a safe way to invest in safe and highly liquid, cash-equivalent, debt-based assets with smaller investment amounts. In the area of ​​investment fund-like investments, money market funds are characterized as low-risk and low-return investments.

Many investors prefer to invest larger amounts of money in these funds in the short term. However, money market funds are not suitable for long-term investment goals, such as retirement provision. That's because they don't offer much.capital appreciation.

Money market funds seem attractive to investors because they are free, with no entry or exit charges. Many funds also offer investors tax-deferred income by investing in municipal bonds, which are also exempt from federal (and in some cases state) taxes.

It is important to note that money market funds are not covered by FDIC federal deposit insurance, while money market deposit accounts, online savings accounts, and certificates of deposit are certainly covered by this type.Money market funds, like other investment securities, are governed by the Investment Companies Act 1940.

An active investor who has the time and knowledge to research the best possible short-term debt instruments that offer the best possible interest rates at their preferred level of risk may choose to invest in the various instruments available themselves. On the other hand, a less experienced investor might prefer to go the money market fund route by delegating the task of money management to fund dealers.

Fund members can usually withdraw their funds at any time, but there may be a limit to the number of times they can withdraw funds in any given period.

History of Money Market Funds

Money market funds were conceived and launched in the United States in the early 1970s and quickly gained popularity because they provided an easy way for investors to purchase a pool of bonds, which typically offered higher yields than those available in an account.

Commercial paper has become a common part of many money market funds. So far there have only been money market fundsgovernment bonds. However, this transition from pure government bonds led to higher yields. At the same time, it was this reliance on commercial paper that led to the Primary Reserve Fund's crisis.

In addition to the reforms the SEC introduced in 2010, in 2016 the SEC also implemented some fundamental structural changes in the way it regulates money market funds.

These changes required large institutional money market funds to fluctuate their NAV and no longer maintain a stable price. US government and retail money market funds were allowed to maintain the stable $1 per share policy. The rules also gave non-governmental money market fund bodies new tools to deal with foreclosures.

money market funds today

Today, money market funds have become one of the central pillars of today's capital markets. For investors, they offer a diversified, professionally managed portfolio with high daily liquidity. Many investors use money market funds as a place to store their money until they decide to invest elsewhere or for short-term financing needs.

The interest rates available on the various instruments that make up a money market fund's portfolio are the primary factors that determine the performance of a particular money market fund. A look at historical data is enough to provide enough detail on how money market returns have been performing.

During the decade from 2000 to 2010, Federal Reserve Bank monetary policy caused short-term interest rates (the rates banks pay to lend each other money) to fluctuate around 0%. These near-zero interest rates meant that investors in money market funds received significantly lower returns compared to previous decades. In addition, with the tightening of regulations following the 2008 financial crisis, the number of securities held as fixed assets was reduced.

Another economic policy in recent years that has had a negative impact on money market funds is thatquantitative easing(QE). QE is unconventional monetary policy in which a central bank buys government bonds or other securities from the market to lower interest rates and increase the money supply.

When major economies around the world, including the US, followed QE measures after the 2008 financial crisis, much of the QE funds ended up in safe-haven money market mutual funds. This outflow of funds kept interest rates low for a long time and hurt the performance of money market funds.