Effective cash management is critical for any organization. Holding the right amount of cash, in the right types of vehicles, can have a major impact on an organization’s ability to meet its responsibilities and goals.
Organizations can hold their cash in a variety of vehicles. Each option offers a different combination of key characteristics, including:
Money market funds are among the most common and useful tools for managing cash holdings. Any professional who may be asked to weigh in on decisions related to cash management can benefit from a basic understanding of money market funds — what they are, how they work, and how they compare to other options.
What is a money market fund?
A money market fund is a mutual fund that invests in cash equivalent short term high quality debt instruments. Money market funds have a key feature that distinguishes them from other cash options: most use amortized cost accounting, which enables them to maintain a consistent net asset value (NAV) of 1.00 per share in nearly all circumstances. To pursue that goal, they invest in very short term debt safety and liquidity as the primary objective.
Depending on the specific fund, eligible investments may include:
There are different types of money market funds, differentiated by the kinds of assets they are allowed to hold. The following types are most common:
There are many rules that govern money market funds in both Europe and the US that limit risk and increase the safety of the vehicle. Besides the rules on the investment strategies listed above the two major rules have to do with duration and liquidity. There are limits to duration on the portfolio and the specific investments and there are minimum levels of liquidity that must be held by the fund.
There are many additional rules that govern money market funds as well as specific rules that NRSRO Rating Agencies apply to money market funds. For a more detailed discussion on these rules please reach out to your State Street representative.
Fund types differ in their levels of risk, potential return, and tax-efficiency. Be sure to request official fund documents such as a fact sheet and prospectus whenever researching and or choosing investment options.
The primary appeal of a money market fund lies in its combination of cash-like liquidity and stability with the potential to generate a market rate of return. A money fund’s stability and liquidity may be essential for an organization to perform certain critical functions, such as meeting payroll, paying operating expenses, making debt payments, and funding capital expenditures. For a large organization managing substantial volumes of cash, the potential to earn market returns from a diversified portfolio of investments may generate revenues that help strengthen the organization. For these reasons, money market funds may complement bank deposit accounts. Deposits are stable and can be liquid but expose you to a single bank and may not pay a competitive return. The rate a Bank deposit pays is determined by the specific bank and can change at any time without notice.
A possible disadvantage of a money market fund is the management fee it charges. The fee is disclosed in the fund’s prospectus, and typically in other fund materials as well. One should consult fund documents to know exactly what you are paying for your investment. Additionally, one should understand who the investment manager is. How committed to the business they are and what their history has been managing money market funds.
There are many attributes that can be looked at to evaluate a money market fund. Some of those include the following:
There are risks to all forms of investing, even in money market funds. One should always perform thorough due diligence before investing.
Glossary
Money Market Fund | Typically, a commingled vehicle that must abide by a set of rules established to minimize risk and maximize safety. They can be globally available to a variety of investors, large and small, retail or institutional |
Net Asset Value (NAV) | The weighted average price of all of the assets in a commingled vehicle (fund) |
Amortized cost accounting | An accounting method that values securities based on the price paid for them and then amortizing the security to its maturity value, usually par. |
Constant (stable) net asset value (CNAV) | A type of accounting that a fund can use to price the assets at their amortized cost so the NAV of the fund remains at 1.00 and does not vary. Most money market funds use amortized cost accounting, enabling them to maintain a 1.00 NAV. |
Mark-to-market accounting | A method of accounting that values the asset at its current market price. Almost all stock and bond funds use mark to market accounting to value the securities they own. |
Variable (floating) net asset value (VNAV) | Certain money market funds use mark to market accounting and have variable NAVs, meaning their price per share fluctuates based on the market value of the securities they own. |
Liquidity fees | Certain Prime funds in the US and LVNAV funds in Europe could impose a fee on withdrawals given certain fund criteria. This is done to reduce outflows in times of crisis. In the US the SEC has clearly defined how a fee would be applied to an institutional prime money market fund. In Europe LVNAV funds have discretion when applying a fee. |
Redemption gates | Redemption gates exist for some European LVNAV money market funds and can be used at the managers discretion. Gates have been eliminated for US registered MMFs |
LVNAV | LVNAV stands for Low Volatility NAV. This is a specific type of fund registered in Ireland or Luxembourg. It uses amortized cost accounting and trades at 1.00. |