Money market fund

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Cash management

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. Most funds buy Canadian instruments but some specialize in US dollar money markets.[1] Investors should be aware that MMFs are not guaranteed deposits, i.e. there is no CDIC or Assuris coverage.

This article first briefly explains what money market instruments are, then summarizes some history about MMFs, including issues during the global financial crisis. The article then mentions some examples of MMFs and presents alternatives in the cash and cash equivalents asset class.

How they work

Money market funds, as their name indicates, buy money market instruments. These are debt securities such as federal and provincial government treasury bills (T-bills) and private sector financial instruments with less than a year to maturity.[2] Securities law further specify that the "dollar-weighted average term to maturity" of a MMF must not exceed 180 days.[2]

The private sector 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. They substitute the bank's credit worthiness for that of the firm.

History

Origin

Money market mutual funds appeared in the US in the 1970s.[3][4] They became significant in Canada in the late 1980s, but still much less so than in the US, relative to deposits at banks.[5]

The global financial crisis

US funds

An issue that was encountered during the global financial crisis was the possibility that the net asset value (NAV) of a fund could decrease below the usually stable value, so called "breaking the buck."[6] Traditionally, US MMFs have had a 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.[7] But, with the Lehman Brothers bankruptcy, a number of US MMFs ran into difficulties.[8]

Ultimately "the US governement decided to intervene by providing unlimited insurance to all money market fund depositors", thereby stopping the run.[3] A MMF fund called the "Reserve Primary Fund" features prominently in this story. Its investors eventually received 99 cents on the dollar, but the liquidation process took 16 months.[4] It appears that certain MMFs had taken more risk than was advisable in an attempt to attract more assets based on higher yields relative to competitors.[4]

Canadian funds

During the same period, in Canada, a number of MMFs held non-bank asset-backed commercial paper (ABCP)[9], the market for which froze in August 2007. Non-bank ABCP consisted of short term debt obligations issued by limited purpose trusts manufactured by non-bank financial corporations.[10][11] Traditionally, the assets backing the notes were various high-quality short-term receivables, such as mortgage, credit card and auto loan payments.[10] But by August 2007, non-bank ABCP had evolved into something else; problems included:

  • Some 'conduits' (limited purpose trusts) were issuing non-bank ABCP with exposure to credit-default swaps, collateralized debt obligations, other leveraged derivatives, or the US subprime mortgage market.[10][12]
  • It was difficult to find public information about which note held what; sometimes the notes were issued before the assets were purchased.[10]
  • There was a timing mismatch between the short term ABCP and the longer-term assets backing the notes.[12]
  • There were serious issues with the "Canadian-style" liquidity backup arrangements[10][13][14]

Despite all this, before the crisis, most of the ABCP was given the highest rating by the only credit rating agency that did rate it.[15] Other agencies did not want rate it:

  • S&P had warned in 2002 that the liquidity backup arrangements used by Canadian ABCP provided "no benefit at all against the range of circumstances that a conduit needs to manage liquidity pressures", were "almost meaningless" and did not meet international standards.[13]
  • Moody's had provided similar warnings in 2002[14]

After the non-bank ABCP paper market froze, Morningstar reported that 24 Canadian MMFs held non-bank ABCP, for $1.14 billion exposure.[16] One MMF from the National Bank had 38% of its assets (or $298M) in non-bank ABCP.[17] The bank "stepped in and volunteered to acquire all of the ABCP held by National Bank Mutual Funds and its Altamira Mutual Funds".[16]. A particular fund from another sponsor held 80% of its assets in non-bank ABCP.[17] The ABCP market was eventually restructured.[10][15][18]

Low rates and high fees

With the low interest rates that prevailed between 2008 and 2021 (e.g., see T-bill yields), money market funds were considered outdated by many in Canada. In a low rate environment, their high management expense ratios (MERs) left little on the table for the investor. This meant that some funds actually lost money after fees[19], which is obviously not the desired result.

A 2010 report by FAIR Canada cited "insufficiently clear disclosure about current fees and returns; safety and an implied guarantee; habit, convenience and inertia; and lack of financial advisor incentive" as reasons why Canadians were not switching out of MMFs more quickly.[20] At the time this report was written, Canadians held $56B in MMFs. In September 2021, after more than a decade of low rates, the amount was still $27B.[21]

Back in fashion

With quickly rising interest rates since late 2021, MMFs are back in fashion, and by July 2023 they held $44B in the traditional mutual fund structure, plus $22B in exchange-traded funds (see below).[22]

Examples

For investors purchasing MMFs through a discount brokerage, D-series or F-series funds have the lowest MERs. Avoid expensive A-series funds. Canadian dollar MMFs recently discussed on the Financial Wisdom Forum include:

  • BMO95142
  • CIB237, CIB238
  • TDB2913, TDB2914

Alternatives

Money market funds should be compared to other cash-like or cash equivalent products by the prospective investor.

HISAs

Main article: High-interest savings accounts

High-interest savings accounts from discount brokerages have developed into a popular alternative to park cash due to their potentially more attractive rates of return and lack of fees such as a MER. You can never get a negative return in pre-tax nominal terms with a HISA, and they are protected by CDIC.

Cash ETFs

Main article: Cash ETF

Cash ETFs pool funds from many investors and deposit them with Canada's major banks. These ETFs are not guaranteed by CDIC but might yield a bit more than directly purchased HISAs.

T-bill funds

Certain money market mutual funds hold only highly liquid Canadian T-bills and tend to have "T-bill" in their name. This avoids any investment in exotic products like the non-bank ABCP mentioned above.

Money market ETFs

Exchange-traded funds (ETFs) that invest in money market instruments are increasingly available. They are similar to money market mutual funds, but their shares/units are purchased on stock exchanges through a discount broker. The MERs are in the 0.1-0.2% range[23], including fee waivers. Money market ETFs compete directly against cash ETFs and may be available at certain brokers where cash ETFs are blocked from purchase.[23]

Examples of money market ETFs recently discussed on the Financial Wisdom Forum include:

  • iShares Premium Money Market ETF (CMR)
  • BMO Money Market Fund ETF Series (ZMMK)
  • Horizons 0-3 Month T-Bill ETF (CBIL)

See also

Further reading

References

  1. ^ Ontario Securities Commission, Money market fund, updated June 2, 2017, viewed June 4, 2023.
  2. ^ a b Ontario Securities Commission, National Instrument 81-102 Investment Funds, Money Market Fund, January 3, 2019, viewed November 20, 2021.
  3. ^ a b Kacperczyk M, Schnabl P (2013) How safe are money market funds? Quarterly Journal of Economics 128:1073-1122.
  4. ^ a b c Fisch JE (2018) Tales from the dark side: money market funds and the shadow banking debate. Research Handbook on the Regulation of Mutual Funds, pp 228–246
  5. ^ Bordo MD, Redish A, Rockoff H (2015) Why didn’t Canada have a banking crisis in 2008 (or in 1930, or 1907, or ...)? Economic History Review 68:218–243, also available as a NBER working paper, viewed August 25, 2023.
  6. ^ Wikipedia, "Breaking the buck."
  7. ^ Diana B. Henriques, "Filing Accuses Reserve Fund Executives of Lying", New York Times, January 15, 2009.
  8. ^ Diana B. Henriques, "Professional Money Fund Is Closed by Putnam", New York Times, September 18, 2008.
  9. ^ Michael Gregory, CFA, Senior Economist, BMO NesbittBurns, "The ABCs of Canadian ABCP."
  10. ^ a b c d e f Carhart J, Hoffman J (2009), Canada's Asset Backed Commercial Paper Restructuring: 2007-2009. Banking & Finance Law Review 25:35-58
  11. ^ Diane A. Urquart, undated, Retail Owners Were Sold Very High Risk Savings Vehicles as If They Were Safe as T-Bills, viewed Septemebr 6, 2023.
  12. ^ a b Ben-Ishai S, Lubben SJ (2011) A Comparative Study of Bankruptcy as Bailout. Brooklyn Journal of Corporate, Financial and Commercial Law 6:79-102
  13. ^ a b Standard's and Poor, Leap of Faith: Canadian Asset-Backed Commercial Paper Often Lacks Liquidity Backup, August 1, 2002, viewed September 6, 2023.
  14. ^ a b Moody's Investor Service, Alternatives for Structuring Liquidity for Asset-Backed Commercial Paper Programs: Conduit Issuer Ratings and Pure Liquidity Support, February 26, 2002, viewed September 6, 2023
  15. ^ a b Leanne Williams, ABCP Crisis: the Canadian Solution, International Corporate rescue 5:370-373
  16. ^ a b Investment Excutive, Non-bank ABCP held by 60 investment funds, says Morningstar Canada, August 26, 2007, viewed August 26, 2023.
  17. ^ a b Benefits Canada, Liquidity Crisis Eases in Paper Market, August 27, 2007, viewed August 26, 2023.
  18. ^ The ABCP crisis and its (somewhat) happy ending, The Globe and Mail, September 12, 2011, viewed August 26, 2023.
  19. ^ Bloomberg, High fees are putting some money market funds in the red, January 8, 2021, viewed November 11, 2021
  20. ^ FAIR Canada, FAIR Canada Issues Report on Money Market Funds: Canadians Losing Out on $300 – $500 Million, March 11, 2010, viewed November 20, 2021.
  21. ^ Investment funds institute of Canada, IFIC Monthly Investment Fund Statistics – September 2021, viewed November 21, 2021.
  22. ^ Investment Funds Institute of Canada, IFIC Monthly Investment Fund Statistics – July 2023, viewed August 25, 2023.
  23. ^ a b Investment Executive, Interest in money-market ETFs heats up as yields rise, June 13, 2023, viewed August 25, 2023.

External links

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