What is the money market?
The money market is the market from which companies, governments, state-owned entities and banks can borrow money over the short-term and where these cash-like instruments are traded.
There is no physical marketplace – rather this is an unlisted market where short-term loans or debts with high values are sold through events like bank auctions and traded through an electronic network of interested parties.
The instruments are issued, recorded, cleared and settled electronically through a regulated institution known as a central securities depository.
Fund managers who need cash investments in their portfolios buy and trade these instruments.
Money market instruments are sold by those who issue them – such as banks - to lenders or investors (in what is known as the primary market) and then they are traded over-the-counter among willing investors who are buying and selling (in the secondary market).
The market is used by investors who are able to invest or trade the large amounts involved – typically more than R1 million. It is therefore known as a wholesale market.
Interest rates on these bulked transactions are therefore a bit higher than you can get as an individual and the instruments are generally quite low risk because they are issued for short terms by credible institutions.
The money market is similar to the bond market, but the term to maturity of the loans and other instruments is much shorter. Read more: What is a bond and how can I invest in bonds?
Money market instruments have maturities of less than a year and include:
What is a money market fund?
A money market fund pools money from many investors and uses these scaled up amounts to invest in the wholesale money market in order for smaller investors to benefit from the market’s higher rates.
The fund can invest in some instruments with longer terms because investors remain in the fund for different periods and are replaced with new investors, so the fund is unlikely to be required to pay out all the investors immediately.
A money market fund is a collective investment scheme, which like all collective investment scheme funds, must:
Read more: How am I protected when I invest in a collective investment scheme?
In addition, unit trust funds do not have any terms and you can typically access your money within 24 to 48 hours, depending on when you submit the instruction and your bank.
A money market fund pools money from smaller investors and the fund manager uses it to invest in money market instruments in order to earn the highest possible return. The return on a money market fund is known as its yield.
The Collective Investment Schemes Control Act limits money market funds to investing only in instruments with a loan term or maturity date of no more than 13 months.
It also stipulates that the average term to maturity for all the instruments a money market fund holds – the duration of all the fund holdings - must not exceed 90 days and the weighted average duration to maturity of all the holdings may not exceed 120 days. This reduces the risk of the funds compared to other fixed interest funds which are allowed to hold instruments with longer durations and to have longer average terms to maturity of all the instruments held.
To protect investors, there are some restrictions on some money market fund investments.
There are no restrictions on money market fund investments in:
There are restrictions on the loans a fund can take from a company, bank or any other financial institution. These restrictions are:
Constant price
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Banks offer savings accounts known as money market accounts or market-linked savings accounts with easy access to your money and interest rates that are typically higher than bank deposits. However, the key difference between a bank money market account and money market fund from an asset manager is the account invests only in the bank’s own short-term money market instruments while the fund is required to be more diversified and invested across financial institutions. A money market account, therefore, is more at risk to bank failure being exposed to only one bank. |
The other thing that sets money market funds apart from other unit trust funds is that money market funds have a constant price of R1 for every unit you hold. The net asset value or NAV of the fund is always R1.
Fluctuations in the price of the instruments held are reflected in the yield of the fund that changes on a daily basis.
This means that for every rand you invest you can generally expect to receive the same rand amount back when you want to withdraw – your capital is reasonably secure.
The only time you may lose money on a money market fund is when an institution like a bank fails and cannot honour, or honour in full, the instruments issued to investors.
The limits on the investments money market funds can make, however, ensures that these funds are diversified across a number of institutions and protects investors by minimising the losses you can incur.
How money market funds make money
Money market funds earn interest from the instruments in which they are invested and this is distributed periodically to investors. This interest paid is quoted as the yield on the fund (the percentage return on the amount invested) and unlike interest on a bank savings account, the amount paid changes daily.
You can choose to receive these distributions or to reinvest them to increase the amount you invested.
The yields on money market funds differ between funds depending on the instruments in which they are invested.
Typically, money market yields are higher than what you would receive on a call account at a bank. The interest rates are more in line with what you would earn from a fixed deposit at a bank but you have access to your funds as you would with a call account deposit.
The yields on the funds will change if the central bank – the South African Reserve Bank in South Africa – takes the interest rates up or down. Read more: Who sets the interest rates and how do they affect me?
Published money market yields are typically quoted as an average of the past week, but check the fine print.
Who should use a money market fund?
A money market fund is a good parking place for money you plan to use in the short term. For example, for money you are setting aside for tax, or money you are saving for a deposit for a car or a house or money for emergencies.
Warning
Money market funds should not be used for long-term investments as they may struggle to keep up with inflation especially if you have to pay tax on the interest you earn.
As an individual, you can receive interest tax free up to the annual exemption or receive it tax free in a tax free savings account or retirement fund.
Costs
Money market funds charge annual fees that are among the lowest for unit trust funds. They range from around 0.1% to 0.5% a year and are taken from the yield.
These funds also do not charge fees for transacting – the costs of your deposits and withdrawals are from the yield.
Money market accounts