Money market funds have emerged as an alternative for individuals parking their funds for a short duration, typically three to six months. These funds are attracting conservative investors seeking better yields without significant risk as they provide a combination of safety, liquidity, and relatively stable returns. Also, given the recent volatility in the markets, some long-term investors are viewing money market funds as an interim solution.
In October, money market funds received net inflows of Rs 6,248 crore, the second highest in the debt-oriented schemes. These funds allow investors to maintain liquidity and stability in the short term while strategically identifying and allocating their funds to more suitable long-term investment options as market conditions evolve. This adaptive approach enables investors to navigate the current market uncertainties while positioning themselves for long-term success.
Nirav Karkera, head, Research, Fisdom, says that within the spectrum of short-term investment options, money market funds offer flexibility by deploying funds in instruments maturing up to one year. “This stands in contrast to other categories, such as ultra short-term and low-duration funds, which have specific duration constraints ranging from 3-6 months and 6-12 months, respectively. Money market funds, therefore, provide a versatile solution capable of adjusting its duration dynamically based on market conditions,” he says.
Returns expectations
Money market funds invest in short-term debt instruments of maturity of up to one year and typically invest in T-bills, commercial paper and commercial deposits. Investors prefer them because the underlying debt papers are of highest quality and give slightly better return than liquid fund and overnight fund and in case of any market corrections they can deploy it in equity to take advantage of it. These funds offer a safe avenue for short-term investments, often seen as an alternative to bank deposits.
Pankaj Kumar, partner, Alpha Capital, a registered investment advisor, says bank fixed deposit rates for less than one year are very less when compared to yield to maturity (YTM) of money market funds. “For example, SBI FD rates for less than 1-year ranges from 3-5.9% whereas money market debt fund YTM is 7.4%. So, investors get a better yield in the money market fund compared to FD,” he says.
Similarly, Sonam Srivastava, founder and fund manager, Wright Research, says money market funds are attracting investors due to their higher returns compared to traditional savings accounts. “While money market funds do not promise high returns like stocks, they aim to offer stability and consistency, making them suitable for conservative investment strategies or short-term financial goals,” he says.
As money market funds primarily invest in short-term, low-risk debt instruments, they enhance the safety of the funds, making them attractive to risk-averse investors. They also offer high liquidity, allowing easy redemption of their funds.
Soumya Sarkar, co-founder, Wealth Redefine, says these funds often diversify their portfolios into various short-term instruments, reducing the concentration risk associated with investing in individual securities. “The diversification contributes to risk mitigation and enhances overall fund stability. The ease of investment, available through systematic investment plan or lump sum contributions makes money market funds accessible to both retail and institutional investors,” he explains.
What to look before investing
While money market funds are generally safe, they are not risk-free. Investors must consider the fund’s credit risk, interest rate risk, and liquidity risk. They must assess the fund’s portfolio quality, the manager’s expertise, and the overall economic environment, as these factors can impact the fund’s performance and the safety of the capital invested.
Investors should carefully examine the specific commercial paper, certificates of deposit, and short-term bonds held by these funds when investing. Despite primarily investing in low-risk instruments, money market funds are not entirely immune to credit risk. In the event of a security issuer defaulting or undergoing financial distress, it can impact the fund’s performance.
While money market funds are generally highly liquid, there are instances, especially during market turmoil, where certain securities in the fund may become less liquid. This could impede the fund’s ability to promptly meet redemption requests, posing a risk to investors. “Money market funds are vulnerable to changes in interest rates. If interest rates rise, the returns on new securities in the fund may surpass those of existing holdings, potentially impacting the fund’s overall yield and share price,” says Karkera.