The volatility in financial markets towards the close of 2011 has caused investors to question whether the potential returns they can achieve compensate them for the risk they are taking on and the answer in many cases has been ‘no’. Looking at South Africa over the 50 years to December 2010, cash has delivered a steady return at 10,7% per annum (2,1% per annum above inflation).
This represents 61% of the returns generated by equities but at 1/15th of the risk. This 50-year period includes many phases and cycles; some of which favoured cash, but one cannot deny the merits of cash as a sound risk adjusted investment asset class. As Warren Buffett said: “Holding cash is uncomfortable, but not as uncomfortable as doing something stupid!”
In economic periods like the one we find ourselves in today this advice should be heeded and money market funds are the ideal vehicles through which to invest in or to park cash.
New – but growing
Money market funds are a relatively new investment phenomenon and the first money market fund was launched in South Africa in 1997. Already, R270 billion has found its way into these funds.
The proposition of money market funds is simple: these funds invest in cash and high quality short-dated money market instruments. Investors have immediate access to their funds, similar to the accessibility of a call account, but they achieve better yields than call. The higher interest rates are a result of the fund manager investing in longer dated fixed income instruments, but still retaining some liquidity in the fund to fund investor withdrawals.
The money market fund is managed by professional investment managers who typically do a better job than investors who manage their own assets. Through a money market fund, investors achieve exposure to a spread of underlying money market assets and this diversification of duration, and credit, makes the fund a far better proposition than a deposit in a single instrument with a single bank. Fees are very low.
Understand your needs
However, before investing in a money market fund, investors should ask themselves the following questions:
- Is it preferable to invest with one bank or to earn the same yield by having exposure to many banks and rated issuers of money market investments?
- Is it better to invest in ‘locked up’ fixed term deposits, or to earn the same yield with immediate access to your funds?
The answer in both cases is the latter, clearly illustrating the key proposition of money market funds, which can be used as an investment asset class or a building block in a portfolio. We like to say investments into money market funds can be ‘R1 to R1 billion and for one day or forever’.
But it is not just investors who can make use of money market investment products. They are increasingly being used by cash flush companies and high net worth individuals, to improve income returns without compromising on liquidity and risk, and to put their cash to work and reduce cash drag.
Cash type investments not only comprise a significant portion of the investment universe, but they have proven to be a credible, risk adjusted, positive return investment.
A compelling option
The role money market funds play for retirement funds, individual investors and corporates differs, and the level of investment into such funds varies depending on the economic environment and investor circumstances. Money market funds are here to stay and Nedgroup Investments will be paying more attention to this space in order to meet the needs of our clients.
In today’s turbulent markets there is an asset class that ploughs on regardless: money markets!