Money market funds and a lesson in diversification

by | Aug 29, 2023

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Written by Steve Andrews is CEO of Novia Global

Willie Sutton was what’s known in US underworld circles as a hold-up man. He netted around $2 million in armed raids between the late 1920s and 1952, when he was arrested for the last time and handed a jail sentence of up to 120 years.

He was once asked why he robbed banks. He reportedly replied: “Because that’s where the money is.” It’s hard to argue with his logic, and a similar kind of reasoning is now steering more and more investors into money market funds.

 
 

According to fund settlement specialist Calastone, UK investors pumped just shy of £1.4 billion into bonds and cash proxies in June. They also pulled more than £662 million out of equity funds1.

Much the same pattern is evident across Europe, where money market funds recorded net inflows of €11 billion in April alone. As data provider Refinitiv Lipper highlighted, this made them the best-selling asset type on the continent2.

The shift can be explained in Sutton-like terms: at least right now, this really is where the money is. To put it slightly more technically: thanks to equity market volatility and an inverted yield curve, these products have in many ways set a benchmark for investment returns.

 
 

With platforms providing an excellent way to access this market, now seems an ideal time for advisers to remind their clients of money market funds’ potential benefits. Just as significantly, we need to remember where this asset class fits in the bigger picture.

Why money market funds appeal today

In my experience, investors like certainty. This is the case even in the very best of times. Understandably, their yearning for something dependable and consistent is heightened in periods of turmoil – such as we have today.

 
 

Money market funds can tick plenty of boxes in this regard. By investing in cash, cash-equivalent securities and debt-based securities with good credit ratings and short-term maturities, they can offer a compelling combination of high liquidity and low risk.

Naturally, assuming Willie Sutton doesn’t return from beyond the grave, cash deposits are still safer. But inflation’s unusually rapid erosion of purchasing power clearly puts a serious dent in this option’s appeal at present.

1 See, for example, Citywire: “‘Investors are nervous’: money market inflows highest since Covid crash”, July 5 2023.
2 See, for example, Funds Europe: “Money market funds’ record inflows in April”, May 30 2023.

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Although they involve little in the way of capital generation, money market funds do generate income. This can go a long way towards addressing one of the most pressing challenges now facing investors, which is the preservation of wealth.

Crucially, these funds strive never to lose money. This might sound spectacularly obvious, but there’s more to it than that. Money market funds aim to maintain a specific net asset value (NAV) per share – normally $1 in the US – and distribute any excess earnings through dividends.

It’s not unknown for a fund to fall below the $1 threshold. This is referred to as “breaking the buck”. But instances are rare and tend to stem from extraordinary circumstances – such as the 2008 liquidation of the Reserve Primary Fund, whose NAV slipped to $0.97 in light of extensive holdings in Lehman Brothers’ debtobligations.

A message for the long term

Add in a few other attractive benefits – which could include no entry or exit charges – and some investors might start wondering why they haven’t dived into money market funds before now. The answer, of course, is that these generally aren’t regarded as investments for the long term.

Traditionally, investors temporarily “park” their money in funds like these. Although we may stretch our definition of “temporarily” in the current economic climate, the fundamental notion of a short-term opportunity still holds today.

But I think there’s another, much broader opportunity that needs to be recognised here. It’s the opportunity for advisers to reinforce the all-important idea that the investment universe is vast – or at the very least a lot larger than many clients might think.

This feeds into the concept of diversification. It’s often only when the going gets tough that clients can truly appreciate the range of options available to them as they seek to maintain and augment their wealth.

One day, sure enough, we’ll see outflows from money market funds and inflows back into equities. Yet what really matters in the end is that all these asset classes are out there, ready to be accessed – via a platform or otherwise – and capable of playing a part in a well constructed portfolio.

Maybe even Willie Sutton might have done things differently if such an array of investment solutions had been around in his day. As it was, he served just 17 of those 120 years before carving out a new career – as a consultant on theft-deterrent measures for banks. Go figure.

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