Money market funds offer investors an attractive retreat for the summer amid ongoing uncertainty around inflation and peak interest rates – but could face an exodus when the season changes, according to Irina Kurochkina, portfolio manager at Aegon Asset Management.
Money market funds (MMFs) – cash-like products that invest in securities with a maturity of up to two years – made a ‘spectacular’ return to portfolios last year amid sharp falls in equity and bond markets. With MMF yields hitting new highs, Kurochkina says that, for now at least, they remain a good tactical tool for investors waiting for clarity over the future direction of central bank policy.
“The unprecedented speed of rate hikes repricing had a prominent negative impact on all major asset classes in 2022, which led to a deep inversion of yield curves,” she says. “In this environment, investing in the front end of the curve offers higher yields than fixed income securities with longer duration. With money market yields still higher than those in long-maturity bonds and bank deposits, MMFs have seen blockbuster capital inflows.”
As of end of July 2023, the two-year German government bond traded at a yield around 3%, which was 55 basis points higher than the 10-year German yield. While the curve has steepened since then, it remains inverted – as it does in most major markets – giving rise to a 1980s-style ‘cash is king’ mentality among some investors. However, Kurochkina warns that MMFs are not all-weather solutions, pointing out that they tend to be attractive at times of weaker markets and high uncertainty.
“Once central banks begin to reduce rates and yield curves steepen, cash-like instruments will have lower yields compared to longer-maturity bonds,” she says. “Therefore, investors need to have a flexible approach to their allocation to MMFs to be ready for a timely move into longer-duration assets. The high liquidity of money market securities and typically low fees for these strategies allow investors to be tactical without increasing trading costs.”
In the meantime, however, Kurochkina says MMFs still can have an important role to play in asset allocation for investors unsure about the near-term direction of interest rates.
“With some market players still in doubt whether rates will peak soon, or if central banks will have to hike more due to the persistent inflation, MMFs offer an attractive combination of competitive yields with low duration and high liquidity, enabling quick change of asset allocation suitable for a different market environment,” she says.
“Whether investors expect a calm summer period while they are on holiday or are worried about potential episodes of volatility in a less liquid market, MMFs are worth considering as a retreat for the rest of the hot season.”