Understanding money market mutual funds
Money market mutual funds’ interest rates of return will continue to climb – based upon aggressive interest rate increases by the United States Federal Reserve and concomitantly by other global central banks.
The strategy is a continuing effort to contain runaway inflation – with current predictions that another 75 basis points raise is on the horizon. For us regular folk, 75 bps is three-quarters of a percentage point.
Conversely, if interest rates should head into a downward slide, the money market mutual funds’ interest rates will also slide down in tandem.
Those who experienced the 2008 capital market crash, precipitated by subprime mortgage investment losses, and the subsequent recession will remember that the US Fed and global central banks rapidly lowered interest rates in order to flood markets with cheap stimulus financing cash.
There are many, many of us who have not forgotten that debacle along with watching a new US president barely sworn into office coping with an unprecedented economic firestorm of catastrophic magnitude.
Consequently, money market funds’ returns then, also reflected the lowered interest rates, as they eventually dropped down to mere titbits of interest earned.
Why does this happen?
The answer lies in understanding the composition of the funds themselves, fully explained in the fund offering prospectus and accompanying current financial reports.
Yes, I know, just the thought of wading through 150 pages of investment jargon is exhausting in itself. And by the way, if you are interested in any mutual fund, you should receive a copy of, or a digital link, to that fund’s prospectus that is – in layman’s cooking terms – the specific recipe of all ingredients needed to manage the fund appropriately.
Investment management terms that recipe include the specific investment policy regulations for the fund, a dictate signed by fiduciaries that is considered legally binding.
Be warned: there are two almost interchangeable labels used to designate money market structures:
• Money market accounts (MMAs)
• Money market funds (MMFs, also known as money market mutual funds)
This close assimilation of words generates much confusion for the average investor.
It is imperative to understand the differences:
An MMA is a cash bank savings account.
An MMF is a pool of investment securities.
Money market account
Is simply a bank account opened with a fixed amount of principal earning a stated rate of interest. Generally in US banks, withdrawals cannot be made on demand; cheque writing is restricted. There are no securities held within the account, no definition of a net asset value and the insured protection is with the United States FDIC (Federal Insurance Protection Corporation). Canada (CDIC insurance) and UK banks (FSCS insurance) also offer money market savings accounts.
A quick perusal of local Bermuda banks and financial institutions (some information was not obtainable on websites) indicate that some offer money market funds, both floating rate NAV and a stable NAV (more on this later).
But, it appears that none locally offer money market bank accounts.
However, Bermuda islanders traditionally have had numerous connections, accounts, invested assets, and extended families in other jurisdictions, so while this information may be superfluous to Bermuda accounts, it is very applicable to investments held abroad in those same immediate neighbours, US, Canada, UK and probably more.
Breaking down the why?
According to investment gurus, there are four forms of investment assets: equities, fixed-income, commodities, and currencies. Cryptos have been designated commodities.
Money market fund
To start with, any mutual fund structure is an independent entity, a pool of investor money launched by, and held in a mutual fund company, some completely independent, such as Fidelity, Vanguard, or Blackrock, or by a bank or financial institution that offers traditional banking and investment-related services.
They are not FDIC-insured, while share trade orders can be transmitted/ executed through a brokerage, or directly through the mutual fund company. Investors can open a type of chequing account to withdraw assets, or transfer to a bank account at some prescribed minimum per day.
The composition of an MMF is of high-credit rated, low risk, redeemable on demand, highly liquid assets, paying dividends that reflect short-term interest rates, generally, not subject to market timing restrictions, no guarantee of protection of principal and regulated by the US Securities & Exchange Commission.
Because of their liquidity, they are often viewed as cash or cash equivalents, with more than $8.8 trillion worldwide, traded daily.
However, these funds are actually comprised of fixed-income securities of varying allocations, interest rates, credit quality, risk, liquidity, and maturities (generally up to nine months’ duration), depending upon the stated investment policy of the fund structure itself.
After the subprime capital market devastation in 2008 when numerous money market funds “broke the buck” due to their inability to maintain the stable $1.00 net asset value, the SEC implemented new reform regulations under Rule 2a-7 – amendments to portfolio liquidity requirements to address run risks in money market funds with the following three categories:
• Fixed NAV: government money market fund invested 99.5 per cent (formerly 80 per cent) or more of its total assets in cash, government securities and/or repurchase agreements that are collateralised solely by government securities or cash.
• Fixed NAV: retail money market fund that has policies and procedures reasonably designed to limit all beneficial owners of the money market fund to natural persons.
• Floating NAV: for institutional prime money market funds, which primarily invest in corporate securities, were significantly reformed with new investing / reporting / risk requirements – for example, floating NAV, redemption gates, liquidity fees, material event disclosure, removal of the 25 per cent basket, asset-backed sponsor guarantees, enhanced stress testing and more.
Next in part three: Dissecting a no-name money market fund’s recent prospectus and financial report. Kinds of securities, strategies, etc. The MMF is so named to avoid recommendation conflict and investment bias by the author.
Part three will be solely available on the Bermuda – Bermy – Island Finance Blog on the afternoon of September 15, 2022. To access, subscribe at email@example.com or go to the website http://marthamyron.com/bermuda-finance-blog
Disclaimer: This investment article is for general information purposes only and is not intended to be specific investment advice. Readers should consult qualified investment professionals for their personal investment advisory needs.
SEC Adopts Money Market Fund Reform Rules, https://www.sec.gov/news/press-release/2014-143
Investopedia: Introduction to money market mutual funds, https://www.investopedia.com/investing/introduction-to-money-market-mutual-funds/
• Martha Harris Myron is a native Bermuda islander with US connections. Author of Bermuda’s First Financial Literacy Primer – the Dawn of New Beginnings and the Bermuda – Bermy Island Finance Blog at http://marthamyron.com/bermuda-finance-blog. All her media proceeds are donated to the Bermuda Sloop Foundation. Contact: firstname.lastname@example.org