There is no doubt that Nigerians are in love with money market mutual funds going by the size of money market funds in relation to the entire mutual funds in Nigeria. Either because Nigerians are predominantly risk averse or they are always hungry for yield, the interplay of those two factors has made money market fund the mainstay of the Nigerian mutual fund industry.
There will mostly not be much left in mutual fund assets if money market funds are to be liquidated. It is the important position occupied by money market funds in the Nigerian mutual fund space that has prompted me to take a cursory look at the pains and gains of money market funds.
What is a money market fund?
Money market funds are mutual funds or pooled investments that invest in short term fixed income securities like Treasury Bills, Commercial Papers, and similar instruments that mature within a year. In return, they pay interests, often times computed on a daily basis.
One of the characteristics of money markets mutual funds is that they are low-risk investments and therefore suitable for those that are risk-averse; conservative and retired or retiring soon. Another advantageous characteristic of money market funds is that they are quite liquid. And because they are near cash instruments, they can easily be turned into cash without little or no loss of value. Money market funds thrive more in an environment of rising interests or when the yield curve trends upwards.
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Risks in Money Market Fund Investments
Many people are of the view that money market funds are not risky. That is a myth. Every investment has an element of risk. But the good news is that money market funds occupy the lower end of the risk continuum compared to other types of investments. Though money market funds are low-risk investments, there is no guarantee that you cannot lose your money if the fund manager goes under. According to the US Securities and Exchange Commission, “while investor losses in money market funds have been rare, they are possible”.
Money Market Funds are Uninsured
Money market funds are not bank deposits. Therefore, they are not insured by the National Deposit Insurance Corporation. The implication of this, therefore, is that unlike bank depositors who stand to be compensated, up-to-the legally stipulated limit if their bank goes bankrupt, there is no such compensation for investors in money market funds.
Reading some of the comments people make on some media platforms like Nairaland, it does look like people tend to equate money market funds to fixed deposit accounts with the banks. While they share some of their characteristics, especially that of liquidity, they do not enjoy the same protection from the deposit insurance agency.
Unlike fixed deposit accounts with banks where the depositor knows what rate of interest the deposit will earn over an agreed period, money market funds attract variable interests. The interests that money market funds attract depend on the dynamic nature of the yield curve and the activities of the economy as a whole. In a falling interest rate environment, money market funds tend to generate lower yield while the reverse is the case in a rising interest environment.
Money market funds’ yields may not always keep pace with inflation, especially in a situation or period with rising inflation. If that happens, money market fund investors may suffer losses in real terms but not necessarily in nominal terms. This happens when the inflation-adjusted return of a money market fund becomes negative because its yield lags inflation.
Fund Management Fees
Fund managers charge management fees and sometimes, performance fees on their Money market funds. In addition, they may charge such fees as early redemption fee, audit fee, legal fee, and so on. It is, therefore, advisable to be aware of the expense ratio of the money market fund you intend to invest in.
Most importantly, read and understand the prospectus of the money market fund to know what risks you may be exposed to, what instruments the fund intends to hold as that may give you an idea of what to expect by way of yield or interest income.