Money market funds can help cash work harder

Investors frustrated with volatile equity markets are turning to cash investments for stability and steady returns.

Investors frustrated with volatile equity markets are turning to cash investments for stability and steady returns.

Money market funds are the sturdy estate car of the investment world - functional, reliable and unquestionably safe.

While they may not be flashy, these funds, which invest in a portfolio of short-term, highly rated money market instruments, have performed very well in recent years. As a sector, they are up 15.7 per cent over the past five years, whereas the FTSE 100 over the same period is down 8.7 per cent, says TrustNet, the financial data provider.

For the most part, money market funds are for institutional investors. But recently high-net-worth individuals who are frustrated by - or have been burned by - volatile equity markets have been getting in on the game.

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Mr Nick Hoar, an executive director at Morgan Stanley in London says: "These funds are very easy to use and have instant liquidity. They are AAA rated, so there's very low risk. Plus, the yield is fairly competitive."

Mr Hoar concedes that equities will outperform cash in the long run. But he points out that money market funds are the most viable option for investors concerned about market instability or over-exposure to any one institution.

"With money market funds, you've got an incredibly safe and secure investment," he says.

The objective of a money market fund is to maintain capital value while providing a competitive market return to the investor.

They work like this: investors pool money to form larger deposits which will attract higher rates of interest. These deposits are then invested in money market vehicles such as repurchase agreements, bank deposits, commercial paper, asset-backed securities and certificates of deposit. Each investor owns a number of shares within the fund, the value of which depends on the share's price.

While no investment is risk free, money market funds are about as close to foolproof as they come. They are historically safer than banks since the risk is diversified through their investments in different securities with short durations. As a result of their low-risk profile, the funds tend to yield about 10 basis points less than the central bank base rate and to charge 10-20 basis points to investors.

Mr Jonathan Curry, head of European cash management of Barclays Global Investor says that, in a low-return, low-inflation environment, making cash work harder is essential for investors. "Within the cash world, money markets have a very high level of success," he says. "They are effectively getting wholesale market rates not normally available to retail investors."

Mr Paul Gibbs, manager of the £360 million (€514 million) Threadneedle UK money securities fund, agrees. "The perception of most people is that equities are best, bonds next best and cash is a poor alternative. But it's not true," he says.

Mr Gibbs, whose fund's cumulative performance is up 19.6 per cent over the past five years, attributes his success to a high proportion of asset-backed and mortgage-backed floating rates notes. "The more you've got of those assets, the more likely you are to outperform," he says.

"[The fund manager] doesn't make a judgment on which way he thinks things are going, he makes a judgment about yield versus credit risk. The trick is not to have a default but to take some credit risk to get a better yield," Mr Gibbs adds.

Money market funds, which began in the US in the 1970s, are relatively new to the UK. "They were introduced in Britain in the mid 1990s," explains Mr Marc Doman, managing director of AIM Global, the money market arm of Invesco. "Today, the business in the UK is worth about $200 billion [ €154 billion]."

Mr Doman expects that such funds will continue to grow in popularity in the UK, Ireland and continental Europe.

Not everyone is convinced of their merits. Mr Chris Cole, a certified financial planner at John Scott Partners, the investment manager, says he encourages clients to use cash accounts rather than money market funds because they are more transparent and cheaper. Still, he adds: "For those who trade heavily in large amounts and need access to liquidity, money market funds are a useful facilitator".

Mr Jim McIntosh, an independent financial adviser at McCrea Financial Services, is sceptical of the funds' long-term advantages because of the relationship between risk and return - the less risk, the less return you should expect.