Question: What are money-market funds? What are the pros and cons of investing in such funds? When should one invest in such funds? Are they available here in the UAE, and if not how do I invest in such funds?

Answer: Money-market funds invest in short-term debt securities such as commercial paper, certificates of deposit, bankers' acceptances, and federal and provincial treasury bills (T-bills) — all generically known as money-market instruments. This means the money you invest in a money-market fund is used for short-term loans to various companies and government bodies.

A money-market fund is the ideal place for money that will be needed in the near future, to keep an emergency cash fund, or to park your money while seeking more attractive investment opportunities. If interest rates are high, and the stock or bond market is looking unsettled, you may want to let the money sit until things calm down.

These funds generally pay two or three percentage points higher rates of return than savings accounts, and are generally extremely safe because of the short-term nature of the investments held. If safety of capital is your number one concern, you should choose a fund that invests exclusively in Treasury bills.

Government T-bills

This is as risk-free as you can get because the government stands behind the T-bills in the fund's portfolio. However, as money-market funds move away from government Treasury bills to provincial Treasury bills and debentures issued by major corporations, the risk increases but it is still extremely small.

The main difference between the assets held in money-market funds and bond funds is the term to maturity. Some money-market securities mature in as little as 24 hours, while others mature in 90 days or several months. You need to keep in mind that the longer the maturity, the less quickly the fund manager will be able to exchange investments for ones with higher interest rates, should rates rise.

If you think interest rates are heading up you may want to put your money into a fund with shorter-term maturities. When the fund manager invests at the higher rates, the higher yields are passed on to you.

However, ever since last year's market meltdown, money funds have been under siege due to the actions of Reserve Primary Fund which had invested in suddenly worthless Lehman Brothers commercial paper.

The fund "broke the buck" by allowing its net asset value to fall below the normally fixed $1 per share, which led to panic as frightened investors began pulling their savings out of these funds. In the end, the federal government stepped in to offer a temporary guarantee for the $3.6 trillion (Dh13.2 trillion) in money fund assets.

The US Securities and Exchange Commission has proposed money fund rule changes that include higher credit quality and shorter maturities. But the most controversial notion, which is not in the proposed rules but was offered up for public comment, is a so-called floating NAV, which would mean that a fund's net asset value per share would be free to move up and down, instead of being pegged at $1 per share.

Entry into money-market funds can be obtained directly via the internet or alternatively through a regular or lump sum savings policy.

As with most investments, it is important to identify both your short-term and long-term objectives, as well as any other factors important to you, and you should consider consulting an independent financial adviser in order to achieve this.

 

The writer is Chartered Insurance Broker, Sales Training Manager, Nexus Insurance Brokers. If you have any questions, please email to advice@gulfnews.com