The money market offers better returns than normal bank savings accounts - and at less risk than shares or even bond investments. But how does it work? And what are the inevitable pros and cons?
Investors typically look to the money market as a place to park their cash while thinking about where to invest, or as a safe haven during uncertain markets. Certainly, if losing your capital is causing you sleepless nights and low risk has become a priority, it's time to consider putting your cash into a money market investment.
What is the money market?
Essentially the money market is where large sums of money are borrowed and lent for periods of less than a year by participants such as the Reserve Bank, commercial and merchant banks, big companies, unit trusts, and large institutions such as Eskom and Transnet.
These organisations trade in the money market via a variety of specialist financial instruments, such as negotiable certificates of deposit, short-term loans to companies (known as commercial paper) or short-term debt instruments of government.
Unlike shares, which are traded on a formal exchange - the JSE Securities Exchange - money market instruments are traded informally or over the counter via computer and the telephone.
How to access the money market
Individuals do not have direct access to the money market because of the large sums of money involved, but you can participate in the money market by investing in either a money market unit trust or a money market deposit account.
A money market deposit account operates like a bank account, offering you instant access to your money and the ability to conduct transactions such as withdrawals, stop and debit orders. Some deposit accounts allow you to access your money via automatic teller machines (ATMs) and offer a cheque book.
A money market unit trust, on the other hand, is a unit trust fund in which the fund manager invests pooled funds from individual investors in the money market. It takes slightly longer to access your money and the fund doesn't offer the flexibility of transacting. But the interest rates (more correctly called yields) are generally slightly higher than those you would get from a money market deposit account.
Minimum balances
Most unit trust funds require a minimum balance, as do some deposit accounts.
Unit trusts minimums can be as low as a R5 000 for a lump-sum investment or as high as R50 000. The minimum monthly investment ranges from R200 to as much as R10 000. On average, you need to invest a lump sum of R20 000 or make contributions of R500 or R1 000 a month in order to invest in a money market unit trust.
The minimum balance for money market deposit accounts is between R5 000 and R20 000. While some accounts don't specify any minimums, make sure you are earning the true money market interest rate on lower amounts. Typically, you would earn a rate akin to an ordinary savings account on amounts lower than R20 000.
Interest rates
There are some significant differences between money market unit trusts and deposit accounts when it comes to interest rates:
- Interest rate levels: The average yield of money market unit trusts is generally higher than deposit accounts because these funds have access to the wholesale money market. Over the past year unit trust yields have been approximately 10 percent, dropping to around 9.6 percent currently within a generally decreasing interest rate environment. Interest rates on deposit accounts over the past year have ranged between six and nine percent.
- Interest rate changes: Banks regularly review the rates on their money market deposit accounts. The yield on a money market unit trust fund changes daily in line with the interest yields of the underlying money market instruments in which the fund is invested. The interest due to you is called a distribution and you can choose to have it paid out to you or have it re-invested.
- Tiered rates: Unlike a money market unit trust fund, which has a single yield, money market deposit accounts often have tiered interest rates (the higher the investment amount, the more interest you earn). The rates over R20 000 are generally more in line with rates on money market unit trusts. All money market investors in a unit trust fund get one rate, irrespective of the amount they invest (although minimum investment criteria apply). The total income earned by the fund is divided by the number of units in issue to get a cents per unit rate. This means that smaller investors get the same rate as those investing millions of rands.
- Time lag: There may be a time lag between the current money market rate and the rate the banks offer investors on their money market deposit accounts. The lag depends on how soon banks adjust their money market deposit account rates after a cut in the prime lending rate. If their rates are linked to the prime rate, you get the new rate immediately, otherwise you get it only when the bank adjusts it's rates on its money market deposit accounts. This time lag can work in your favour or against you, depending on whether the rates are going up or down.
Transparency
On any day you can open up a newspaper to see the latest money market unit trust yields.
With money market deposit accounts, however, you are not told how the bank arrives at the interest rates offered. Banks tend to set their rates using the money market and other investment rates as a guide. Some banks offer a percentage of the prime rate - for example, 60 percent. Banks also keep an eye on the rates offered by their competitors.
As a unit trust fund, a money market unit trust is strictly regulated and has to comply with the rules and regulations of the Association of Unit Trusts and the Financial Services Board, the regulatory body of the unit trust industry.
Regulations stipulate that money market unit trusts may not be invested for more than one year; should have an average duration of 90 days (this prevents money market fund managers from investing in the bond market); and should invest in approved money market instruments.
Fund managers typically lend money to banks and other institutions for short-term repayment. Fund managers are obliged to spread the loans around different institutions: No more than 30 percent may be invested with institutions with assets of more than R2.5 billion; no more than 20 percent may be invested in institutions with assets of between R250 million and R2.5 billion; and no more than five percent may be invested in institutions with assets of less than R250 million.
Other than general banking regulations and guidelines, there are no specific requirements relating to money market deposit accounts offered by banks.
Other facilities
While many European, United States and Australian unit trust money market funds offer extra services, such as the ability to access your money via an ATM or debit order facilities, South African funds generally do not. With most unit trust funds, you have to sell your units in order to access your money. A few money market unit trusts allow you to access your funds via ATMs, but generally the fees associated with these funds are not designed to support a high level of administration.
A possible exception in the South African market is Innofin, a joint venture between Sanlam and Australia's Macquarie Bank. With the Innofin cash management money market fund, you are able to write cheques, place debit orders on your account and make electronic transfers from money that you have invested in the fund. But even the Innofin fund is not designed for day-to-day transacting, says chief executive Charl le Roux. Rather, it is intended as a vehicle for managing your investments.
Money market deposit accounts often offer other services, including internet access, stop and debit order facilities, the ability to transfer money in and out of the account, and possibly even a chequebook.
Accessibility of funds
You have instant access to your money in a money market deposit account. If you have the account linked to your bank card, you can draw the money from an ATM, whereas accessing your money from a unit trust takes 24 to 48 hours.
Risk
With a bank deposit account, your capital is guaranteed as is interest rate paid by the bank as long as you maintain the minimum balance requirements. The only danger is if the bank collapses.
With a money market unit trust, you will suffer only a partial loss of your capital if one of the banks or institutions in which the fund is invested goes belly up, because, unlike a deposit account at a single bank, you are not exposed to one institution only.
Investment costs
Unlike unit trusts in general, there are usually no initial charges payable on money market unit trusts, although there are one or two exceptions. No commissions are paid to selling agents and you are not charged Marketable Securities Tax (because shares are not bought or sold by the fund).
Even the annual fees, when compared to general unit trusts, are low - on average, approximately 0.5 to 0.68 percent a year of the amount you invest. This fee is worked into the yield, so you may not be aware that a fee is being charged. Some money market funds charge a commission on the reinvestment of income, while others do not.
Money market deposit accounts do not charge annual fees. It costs nothing to put your money into the account, but you are usually charged fees for the transactions you perform in the account.
Transaction charges tend to be based on the value of the account, the value of the transaction and the type of transaction.
Your needs rule
Understanding the options is the key to making the right choice. In general, over the long term, money market unit trusts will out-perform money market deposit accounts, says John Green, head of linked product company Investec IM.S
He says his company offers investors the option of holding cash in either a money market unit trust or a prime-linked call deposit account. The prime-linked call deposit account is very similar to a bank call account, which means the money is immediately available to you when you ask for it. The returns on these investments reflect the nature of their underlying investments and the differences in their structure.
The investments are clearly named so there can be no mistake about which type of investment you are going into. If your intention is to make an investment in the money market, then clearly you would be better off opting for a money market unit trust, with its superior returns, Green says. If you just want to put your money on hold in the short-term, and earn an interest rate linked to prime, then Investec's call deposit account is an option.
Your needs should dictate which option - a money market deposit account or money market unit trust - you should go for, Darrel Orsmond, the director of transaction products in Standard Bank's retail banking division, says.
While money market unit trust fund interest rates are currently more favourable, you need to take into account such things as the amount to be invested, the term of investment, risk, the accessibility to funds and charges, when deciding where to invest your money, Orsmond says.
If your needs cannot be met through a unit trust fund and you require the transactional capability of a deposit account, you will have to forfeit some of your returns for the sake of convenience.
WARNING
Money market investments come in two guises: Unit trust funds and company-structured deposit accounts.
Often the deposit accounts, which are similar to a bank investment, offer an interest rate lower than the returns from the actual money market, which is the virtual trading place for short-term loans.
The transparency of unit trust funds makes it difficult for companies to skim off a few percentage points by giving you a rate that is lower than the actual money market rate. You can see in the daily press what the yields on the various funds are and you are told upfront what fees are payable. At most, a unit trust fund can try to charge you an annual administration fee that is higher than usual, but competitive forces soon rectify any imbalance. A fund whose charges are out of line with the average is unlikely to attract business.
With internally structured deposit accounts, you are not told how exactly the institution arrives at the rate it pays to investors.
SPOILT FOR CHOICE
How do you choose between all the money market funds available? Is it a case of the biggest being best? Are some more risky than others?
There are over 20 domestic money market unit trusts available in South Africa. The assets of these funds range from R13.2 billion in the Absa Fund to just over R57 million in the newly-launched Allan Gray Money Market Fund, according to Liz Still, head of research at Equinox.co.za, an online linked product provider.
These are some of the things you need to be aware of when making your choice:
Fees
Most money market unit trusts are bought and sold for R1. The exceptions include the Absa Money Market Fund (100.4 cents per unit), the Oasis Money Market Fund (100.55 cents per unit), and the Sanlam Money Market (101.11 cents per unit on amounts less than R20 000).
Most funds have an annual fee of about 0.57 percent (including VAT). The exceptions are Coronation, which has an annual fee of 0.39 percent, and Absa, with a fee of 0.4 percent.
Minimum investments
Many money market unit trusts have minimum balance requirements and many more do not accept monthly deposits. So, if putting away money on a monthly basis is what you want to do, you will have to look around.
Benchmarks
Most money market fund managers use either the Alexander Forbes three-month deposit rate or a more general indicator, such as the threemonth call account rate, as a benchmark for the performance of their funds. According to Sanlam Money Market fund manager, Gert Steenkamp, most fund managers come near to or beat this benchmark.
Credit risk
Six of the 20 money market funds have been evaluated by CA-Ratings, a credit ratings company that works closely with the US-based credit rating company Standard & Poor. Companies generally submit their portfolios for credit rating for marketing purposes, Leon Claassen, a director of CA-Ratings, says.
With the equity markets being so volatile, there is more interest in money markets. The rating indicates the safety of the fund, Claassen says. The more As that appear in the rating, the higher the rating.
He warns that credit ratings have a limited shelf life. The rated funds are monitored at least every second week, and if the fund manager, the investment style or risk of the underlying investment portfolio changes, the credit rating is changed accordingly.
These are the credit ratings of the six funds that have applied for ratings, as of November 12, 2001:
MONEY MARKET CREDIT RATINGSAs of November 12, 2001
INSTITUTION
RATING
AbsaAAACoronationAInnofinAAALibertyAARMBAASanlamAAA
Practical considerations
There is very little to choose between money market funds when it comes to performance. A snap analysis over the three-month period ending November 9, 2001 showed a range of performance from 2.2 percent to 2.48 percent. Over a three-year period, the range was 41.08 percent to 42.54 percent.
However, Still says an important issue to consider when selecting a money market investment is the time lag when you transfer from a money market fund to an equity-based unit trust fund. An investment within a management company should take place on the same day, while a transfer from one management company to another could take up to four days.
For instance, if you are invested in the Sage Money Market Fund and decide that it is the right time to invest in the Sage Internet Fund, your money will be invested in the internet fund on the same day and at the price on that day. But if you are invested in the Sage Money Market Fund and want to invest in a fund of another management company - for instance, the African Harvest Rainmaker Fund - the administration process may cause a delay.
Like other linked product companies, we at Equinox.co.za have to have confirmation that our clients' money has been released by Sage before we can buy into the African Harvest fund, Still says.
We are thus dependent on the efficiency and administrative capacity of the management company where the money market investment is held.
In a volatile equity market, these delays can affect the value of your portfolio, she says. For this reason, you are advised to choose a money market investment with the next equity investment in mind.
Research information provided by Equinox.co.za
This article was first published in the 1st Quarter 2002 edition of Personal Finance magazine See what's in our latest issue