In this case it’s essentially cash – rather investment assets that are cash-based. Underlying investments would typically be fixed deposits, calls deposits, treasury bills, negotiable certificates of deposit (NCDs), commercial paper and debentures.
An individual investor can access all those cash instruments without using a money market fund – but it would be at more risk and at a lower yield.
A money market fund spreads its investments across a number of banks, removing to an extent the danger of one bank failing. And because they operate in the wholesale market and bulk fees together, money market funds will get a better interest rate than an investor in a single bank.
The funds are about interest income not capital gains, as in an equity unit trust fund. But while equity funds are subject to capital gains tax only when withdrawn by the investor and collect tax-free dividends, the income from money market funds is taxed.
The after-tax income from money market funds can therefore only produce a relatively low real return and, at times in the past, that’s been lower than the rate of inflation.
But at other times – particularly when equity markets are volatile and the inflation outlook clouded – money market funds can provide the best returns.
For example, over the three-year period to end-June money market funds were the best performing unit trust category, with an annualised return of 9.81%.
Underlying investments are strictly controlled by the Collective Investment Schemes Control Act. Only investments with a maturity date of less than 365 days can be included in the portfolio and the average duration period is set at no more than 90 days.
That means money market funds are essentially about managing interest rate risk and trying to get the highest yield from cash instruments.