Money market funds are today’s best bet for investors seeking a blend of safety and decent return.
Let’s define decent returns as 3 per cent or more, which leaves you about 1 percentage point above the inflation rate. And let’s define safety as a very low risk of losing money.
In normal times, you might not feel you need to probe further into the safety of money market funds. But with so much economic uncertainty right now, a further investigation is warranted.
Money market funds hold a diversified mix of treasury bills issued by government and commercial paper issued by corporations to fund operations. These borrowings mature in less than a year, and frequently in less than 90 to 180 days. The upshot here is that you’re not counting on the long-term health of the issuer. You just need them to pay what they owe in the next several months.
T-bills are very safe investments because they’re backed by governments that can, in the worst case, raise taxes to pay their obligations. Commercial paper poses somewhat more risk of default, but there can be safeguards. “Typically, when you have asset-backed commercial paper, for example, you tend to have banks actually standing behind the creditworthiness of that paper,” said Raj Lala, CEO at Evolve ETFs. He also noted that ABCP is typically secured by collateral.
Mr. Lala said the average credit rating for the commercial paper in the Evolve Premium Cash Management Fund (MCAD-T) is R1-high, which is the top tier at the bond-rater Morningstar DBRS.
A feature of money market fund stability is the level unit price, often with a floor price of $50 or $100 for money market exchange-traded funds and $10 for money market mutual funds.
The accounting that allows for a stable unit price is based in part on the fact that securities in these funds are held to maturity and not traded. Also, the interest payments that accumulate in the fund are paid out every month.
With money market ETFs, the unit price creeps incrementally higher during the month as interest payments build, then falls back to the floor after interest is paid out each month. Obviously, the ideal time to buy is after the most recent monthly interest payment.
There are no guarantees with money market funds – no deposit insurance coverage, and no certainty that the unit price will remain fixed. There were instances of U.S. money market funds losing money in the global financial crisis of 2008-09.
”I think the risk in money market funds is definitely low,” Mr. Lala said. “But if you want to go even lower from a risk perspective, then you look at high-interest savings account funds.
”HISA ETFs hold savings deposits at big banks and offer yields right now in the 2.8-per-cent zone. The modest yield bonus you get from money market funds gives you a sense of the additional risk over HISA ETFs. Note that there is no deposit insurance for these ETFs.
An even more conservative option is the investment savings account, which investors buy like mutual funds. ISAs are typically backed by deposit insurance, and offer yields around 2.6 per cent.