When to invest in cash and income funds
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- The volatility in financial markets spooked investors prompting a flight to safety
- Generally, the role of money market type funds is as a parking place for surplus cash or as a building block in a portfolio
- 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
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.
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.