Many South African investors make use of money market funds. According to the latest unit trust statistics, there is R438bn saved in these products.
Absa’s decision to close its money market fund has, however, raised concerns about whether these products are safe. The bank made it clear that its reason for closing the unit trust is that most investors thought that their money was guaranteed by Absa.
This is not the case in a money market fund. These are unit trusts rather than bank accounts, so they are not the same as having your money deposited with a bank.
So what are the risks?
That doesn’t mean, however, that money market funds are risky. They are very low risk investments, suitable for many people who need somewhere to keep a sum of money for short periods of time. These funds should earn interest at a higher rate than you might get from a deposit at your bank.
How a money market unit trust works is that the manager of the fund invests in a range of short-term money market instruments. These are deposits at banks, or bonds issued by the government, banks or other creditworthy institutions.
In other words, even though the money in the Absa Money Market fund wasn’t guaranteed by Absa, it was all still guaranteed by somebody. The risk of losing money is therefore low.
Low risk, but not no risk
There have, however, still have been instances of money market funds losing money. The most well-known recent example is that a number of these funds had invested in instruments issued by African Bank before it collapsed in 2015. Investors had to take some losses when this happened, although they were very small.
Part of the reason that the losses were not severe was because money market funds have diversified portfolios. They won’t only invest with one bank. So, if there is a bankruptcy, it only affects a part of the fund.
This is the strength of money market unit trusts. The manager is able to build a portfolio that can generate a decent rate of interest while managing the risk. That is why they have become a very popular option.
Know what you need
Nevertheless, these funds may not be suitable for everyone. Before investing in anything, you should at least understand the potential return, and the cost and tax implications. You need to be able to compare these with other options in the market.
You also need to know how long you are staying invested. If you want to transact every day, you would probably be better off in a bank account. If you don’t need the money for a few years, you could look at a different kind of unit trust that takes a little more risk. This will at least ensure that your money grows in line with, or ahead of, inflation.
As always, understand what you are investing in so that you can appreciate whether it is the best option to meet your needs.
If you were invested in the Absa Money Market fund and want to understand your options, or if you have any questions about money market unit trusts generally, seek professional advice.
Disclaimer: The information provided herein should not be used or relied on as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your professional adviser for specific and detailed advice.