Higher interest rates in recent years have led to a pick-up in demand for money market funds as investors attempt to mitigate the erosion of purchasing power through inflation.
A money market fund is a type of fund that invests in debt securities which carry short maturities and minimal credit risk with the objective of giving you a higher return than cash.
These funds are typically made up of short-term debt from governments, banks, and companies with strong balance sheets and investment-grade credit ratings. This means they offer more stable returns compared to other bond funds.
Why consider these funds now?
Given their low risk, these types of funds can be a good place to park your money. It may be the case you are planning to spend some of your savings soon or are unsure what to invest in. A money market ETF allows you to earn a little interest every day until you decide to use the cash somewhere else.
With interest rates at decade highs, these types of funds are becoming more popular and can be seen as a substitute for a savings account at present. Although the annual rate of interest is not guaranteed (given the Bank of England may decrease these within the next 12 months), it is most likely a higher interest rate than most UK bank accounts, at present the Lyxor Smart Overnight Cash (although accumulating) has an annual rate of nearly 5.00%.
Most UK money market funds track the SONIA (Sterling Overnight Index Average) rate. SONIA is based on actual transactions and reflects the average of the interest rates that banks pay to borrow sterling overnight from other financial institutions and other institutional investors. In its true form the benchmark tracks the base interest rate by the Bank of England.
Important things to consider
Although money market funds do provide a level of return on your cash savings, their performance and risk are far inferior when compared to stocks. This may make them unsuitable for growing your savings in the long-term.
Liquidity is paramount with these types of products, so whereas a bank account may set you a fixed term to keep the deposits in for it to honour the rate of interest, with a money market fund there is no set period of subscription.
Even with higher interest rates, these products should not be used to park cash for a short period of time (less than a month for example) as the execution will still be subject to a spread. Money market interest rates are also subject to fluctuations as the Bank of England progresses with their policies.
Although low risk, a money market fund is not a risk-free investment. There is always the risk that you get back less than you invested.
The ETFs on our platform are also synthetically backed meaning the underlying holdings replicate the performance of the SONIA rates but are not necessarily linked to it directly. This does bring a level of counterparty risk, however default events in these types of products are rare.
It is also important to note that money market funds are not covered by the Financial Services Compensation Scheme (FSCS) in the same way as a bank account.
What ETFs are available for me on InvestEngine?
At present, we have two money market funds on our platform. The Lyxor Smart Overnight Cash (CSH2) at a cost of 0.07% TER and over £515m of assets under management, and the Xtrackers GBP Overnight Rate Swap (XSTR) at a cost of 0.15% TER and over £64m of assets under management.
Source: InvestEngine & Bloomberg
Date of data: 13/02/2023
Important information
Capital at risk. The value of your portfolio with InvestEngine can go down as well as up and you may get back less than you invest. ETF costs also apply.
This communication is provided for general information only and should not be construed as advice. If in doubt you may wish to consult a professional adviser for guidance.
Tax treatment depends on personal circumstances and is subject to change, and past performance is not a reliable indicator of future returns.