The last time we spoke about mutual funds, we discussed equity mutual funds and provided a brief overview of the risk exposures in investing in equity mutual funds. Today, we’ll discuss the money market mutual fund, their risk exposures, when to invest in them and how to measure its performance.
A money market mutual fund is a collective investment scheme that invests specifically in short-term debt instruments such as T-bills, commercial papers, debentures and certificate of deposits. The idea behind money market mutual funds is to collect clients’ money into a pool of fund and invest them in instruments with duration not exceeding one year.
The advantage of a money market fund is that it can accommodate short term withdrawals whiles maintain value. Meaning, you can invest into it for the short-term relative to an equity mutual fund that requires you investing for the long term.
Just like any investment, the money market mutual funds have its peculiar risk exposures that require expert management. Credit or default risk remains top on the list. When a fund manager purchases the commercial paper of a corporate body, he/she lends out the funds to that institution. This means that if the institution goes bankrupt, the mutual fund will lose money. To prevent these possibilities, fund managers diversify or invest across several industries and employ varying asset allocation strategies to maximize return and minimize risk.
The best time to invest in money market instrument is when T-bills are trending upwards. In an era of rising rates, money market instruments do exceedingly well and vice versa. Also, the best way of measuring if your money market fund is providing superior returns is to compare it to the return on Treasury bills. If the return is less than treasury bills, then it’s worth questioning the fund manager. Always remember to seek professional advice when making investment decisions.