Choosing between money market funds (Updated Nov 2020)

While the differences between Money Market Funds (MMF) and High-Interest Savings Accounts can be obvious for yield-chasing aficionados, the contrasts between Money Market Funds and similar products are less apparent. There are different risks, and correspondingly, different yields between Money Market Funds.

Money Market Funds and its variants (cash funds, short duration bond funds) are used in many cash management solutions, such as Endowus Cash Smart and other similar products. Being aware of and understanding the risks of the underlying MMFs will better equip us to choose between the options available to us.

What are Money Market Funds (MMFs)?

A Money Market Fund (MMF) is defined as a fund that invests invests primarily in high quality debt securities and money market instruments or places eligible deposits with eligible financial institutions. These funds can normally be sold within a day for cash proceeds and have low risk.

Next, we have to understand the differences in risk before we can understand how to choose between them.

For Singapore investors, these funds are normally Unit Trusts, such as the LionGlobal SGD Money Market Fund and the United SGD Money Market Fund. The recently launched Phillip SGD Money Market ETF is the first MMF that is listed on the SGX as a ETF.

Differentiating between the types of risk associated with Money Market Funds (MMFs)

Credit Risk

Credit risk is quite simply defined as the chance of a loss arising from a borrower not being able to repay a debt. MMFs and similar variants can either hold debt from corporate or government entities, or lend money to financial institutions, as is with the case of the Fullerton SGD Cash Fund.

The risk of default from the debt and loan holdings of an MMF ranges from extremely low to low because of the financial stability of the companies that the money is loaned to, as well as the time to loan maturity.

Using an extreme example, it may be worth it from a credit risk-reward perspective to lend money to DBS for a 0.5% p.a. over 1 week for a non-liquid loan. To lend money to DBS for 2.5% p.a. over 30 years in similar terms? That may not be prudent.

Duration Risk

Duration risk is associated with the sensitivity of a debt or loan to changes in interest rates. The higher the bond's duration, the greater the interest rate sensitivity. When an MMF holds more instruments with higher duration, the MMF will be subjected to greater price changes from interest rate movements.

How Risk for Fixed Income products translate to returns

As the Singapore fixed income product markets is very well-developed, at a size of S$467.2 billion, companies and investors are spoiled for choice. This competitive landscape results in fixed income products being priced efficiently, with investors demanding a higher return for riskier fixed income product.

Consequently, this translates to MMF products and its variants being priced efficiently as well, since MMFs are often unit trusts that are redeemed or created at the value of its assets.

For example, the Fullerton SGD Cash Fund is currently projected to give a gross yield of around 0.26% (as of 20 November 2020), as it is invested into fixed deposits of Singapore bank institutions (low credit risk) and have low duration risk.

In comparison, the Phillip SGD Money Market ETF currently has a yield of 0.23%, and is similarly invested in low risks products, with 80% invested in Fixed deposits and cash, and 20% invested in Money Market instruments, all with a low duration of 90 days.

Other considerations for choosing between Money Market Funds (MMFs)

Skill of Fund Managers

Ultimately, Money Market Funds are managed actively by fund managers who aim to help its investors get higher returns, based on the investment mandate given to them. The fund managers have to stick closely to the funds' investment mandate, therefore there is assurance that there would not be inappropriate risk taking behaviour from the fund manager.

In the case of the LionGlobal Money Market Fund, it is stated that in the fund document that "The Fund aims to manage liquidity and risk while looking to provide a return which is comparable to that of SGD short-term deposits. The Fund will invest in high quality short-term money market instruments and debt securities. Some of the investments may include government and corporate bonds, commercial bills and deposits with financial institutions".

Within this framework, the fund manager has to be able to manage the fund and optimise returns to be able to get a higher yield for its investors.

Size of the Fund

The total fund expense borne by the fund, or more commonly known as the total expense ratio, is made up of a variable cost component and a fixed cost component.

As the fund size grows bigger, while variable costs increase accordingly, fixed costs remain the same and are thus average costs are lower overall. Consequently, the total expense ratio of the MMF, as with the case of other unit trusts or Exchange Traded Funds, will be lowered. This may in turn translate to a higher return.

Key Personal Considerations for choosing between MMFs and its variants

Now that we understand the different risk levels of MMFs and similar products, we should understand how our personal finance circumstances and considerations can affect our decisions.

MMFs are meant to be a safe vehicle for us store wealth, rather than grow our money for inflation. When we deliberate on whether to put our money into MMFs, we need to consider if the 2-3 business days needed for the funds to be withdrawn is quick enough for us.

We also need to consider the risk involved, be it credit risk or duration risk. If the money is meant as a short-term store of wealth for expenses needed in 1-2 months time, then it is safer to consider investing in an MMF safer variant like Fullerton SGD Cash Fund where there is very low risk. However, if you want slightly more yield and intend to hold your money for 6 months or more, then investing in slightly riskier product like LionGlobal Enhanced Liquidity Fund or even the United SGD Fund, both of which are used in the Endowus Cash Smart portfolio, would be more appropriate.

With a better understanding of the different risks involved, you are now more informed and equipped to choose the right cash management solution for yourself.

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