Quarter two 2020 industry statistics will reflect an enormous flow of money into cash type unit trusts.
The volatility in financial markets spooked investors prompting a flight to safety. It also triggered a review by many of how appropriately their funds were invested. So, let us remind ourselves what money market and low risk income funds are and how they should be used.
Money market funds are the lowest risk category of unit trusts. They offer preservation of capital, same day liquidity, exposure to a range of high-quality issuers – predominantly via bank paper, and a sound monthly distribution which is typically higher than the yield on a bank call account. For many years this yield, pre-tax, has even exceeded inflation. Money market fund investment requirements result in risk being minimised at all levels. Interest rate risk is kept low by the investment criteria stipulations that money market funds can only hold short dated paper – maximum weighted average term to final maturity of 4 months, and the maximum term per single investment of 13 months. Liquidity risk is mitigated by the liquid nature of the instruments held, while credit risk is in most cases minimised through highly rated paper.
The neighbouring fund category on the risk spectrum is the income funds. Unlike the money market funds where the rules dictate similar positioning, there is a far broader range of investment mandates and styles among income funds. Some income funds closely align to money market funds as they prioritise capital preservation – “money market plus”, and then there are other income funds that make use of credit, duration, property etc. to derive higher yields, which does result in capital fluctuation. While there is a role for both types of income funds, understanding a fund beyond just the yields is important. For example, all fund fact sheets disclose the top 10 exposures and it is always the same old names. More important, however, is a review of the bottom 10 exposures. That is where the most risk lies, but the disclosure is the poorest.
How should such funds be used? Generally, the role of money market type funds is as a parking place for surplus cash or as a building block in a portfolio. Parking cash with low risk, capital preservation, immediate access if needed and a sound yield makes sense. Cash is accepted as the ultimate positive return asset class, and for some time now has even delivered inflation beating returns. The role of cash in a portfolio is to offer diversification, some predictable returns in the form of yield, liquidity and optionality to switch to other asset classes from time to time. Corporate treasurers are large users of cash funds, enjoying the convenience of a single entry point to a diverse spread of exposures – mainly banks, and fixed deposit type yields with same day access, all in a highly regulated market. While investors are in the fund, they effectively have exposure to the longer dated paper of the fund giving them the benefit of higher yields, but they still have liquidity.
But there is a cost for the same day liquidity that money market funds provide, and that cost comes in the form of a lower yield. Many investors do not require same day access to their funds and can easily plan one day ahead. Doing so can add around 50bps to their yield making those income funds with a capital preservation mindset a more attractive alternative than money market funds, for those willing to transact on a T+1 basis.
Following the rapid fall in rates, with markets pricing in a high chance of a further 25bps cut in July 2020, the best call deposit rate offered by a major South African bank could soon be just over 3%. Even the marginally higher cash fund yields will be approaching the inflation levels and not be as exciting as they were – especially after tax.
As they say, there are not many millionaires out there who achieved their wealth by investing in cash. Cash is certainly not the go-to asset class for growth. But it can have a role as a parking place where funds will generate a pretty certain positive return, or for investors, many of whom have recently noted that they could have had the same, or better outcome over the last few years with a lot less stress, had they simply stayed in cash.