Money market fund

A money market fund (MMF) is a mutual fund that can be used like a savings account. Generally, they buy federal and provincial government treasury bills (T-bills) and other financial instruments with less than a year to maturity. Investors should be aware that MMFs are not guaranteed deposits.

How they work
Money market funds don't make loans. They buy them. Generally, they buy federal and provincial government treasury bills (T-bills) and other financial instruments with less than a year to maturity. Those other instruments include commercial paper, by which corporations directly go into the market to bridge their payroll and other payment obligations until their receivables come due — in other words, while waiting to get paid. (Think GE here, and how all the accounts payable and receivable are matched, not in real time, but over time). There are also banker's acceptances, which are short-term credit investments created by non-financial firms and guaranteed by a bank as to payment. Acceptances are traded at discounts to face value in the secondary market. They are commonly used in international transactions. They are much like commercial paper except that they bridge international payments and domestic receivables. They substitute the bank's credit worthiness for that of the firm, which may be unknown in an international transaction.

Challenges
Money market funds face a number of challenges. Foremost is their high management expense ratio (MER). In a low-interest environment, a 1% MER leaves little on the table and half of that — a 50-basis-point fee — doesn't leave much either. A quick glance at Globefund.com's inventory of MMF funds indicates that fewer than half charge 1% or less.

The second is a crisis of confidence should they "break the buck." Traditionally, US MMFs have had a net asset value (NAV) fixed at $1 per unit (Canadian MMFs are traditionally $10 per unit). Earnings either bought new units or were paid out to investors. Until the fall of 2008, only one MMF had ever broken the buck — that is, let its NAV fall below $1. But, with the Lehman Brothers bankruptcy, a number of US MMFs ran into difficulties.

Third, in Canada, a number of MMFs held non-bank asset-backed commercial paper (ABCP) — various short-term receivables, such as mortgage, credit card and auto loan payments — that were difficult to trace to a particular borrower or bank. That same non-bank ABCP was used to back both MMFs and high-yield savings accounts offered by a number of financial intermediaries, most prominently National Bank and Dundee Bank. At issue here was not so much the commercial paper, but the guarantees should the issuer of the paper default. Because of peculiar wording in the counterparty contracts, the foreign guarantor banks were not required to pick up the tab for a liquidity crisis (i.e., nonpayment of interest due) that constituted a default.

Alternatives
High-interest savings accounts from discount brokerages have developed into a popular alternative due to their attractive rates of return and lack of fees such as a MER.