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How Safe Are Money Market Funds? Risk Assessment and Selection Criteria

2 min read

Executive Summary

Since the introduction of the first fund in 1972, institutional money market funds have gained a well deserved position in most corporate cash portfolios, thanks to their safety, constant share price, liquidity, and competitive yield.
But money market fund investing is not risk-free. In the last 15 years, at least one institutional fund has broken the constant $1 price and dozens more were bailed out by their advisors in the wake of defaulted securities, wrong bets on interest rates, and external risk factors.
A Moody’s survey series shows that, in the recent rising interest rate environment, the nation’s largest institutional funds have managed portfolio maturity risk conservatively. However, risk exposure to less liquid and non-traditional securities has increased dramatically.
The financial wherewithal of the advisor, average portfolio maturity, securities holdings, fund performance, and fund ratings are some of the relevant factors an investor may consider in selecting the appropriate fund to meet their safety, liquidity and returns goals.

Introduction

Since their creation three decades ago, money market funds have grown into a popular cash management tool and have found their way into almost every corporate cash portfolio. Having grown accustomed to their safety and liquidity, few investors consider credit risk as a major concern in selecting a money market fund.
For many cash reserve accounts, money market fund balances represent significant portions of the total investment portfolio, sometimes up to 100%. Furthermore, investors often consider, rightfully so, this portion of their investments to be the most liquid and to be available on demand. The objective of this paper is to caution investors that, while generally safe as an asset class, money fund investing is not without risk. Properly evaluating the credit risk of fund investing should be an integral part of a treasury department’s investment risk management practice.
The paper seeks to answer the following questions: what institutional money market funds are: why invest in them; whether the funds are really safe; whether they have gotten riskier over the years; and how investors should select a right fund.
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Lance Pan joined Capital Advisors Group in 2003. As Director of Investment Research and Strategy, Lance assesses the risk and relative value of asset classes and credits, creates advanced credit approval and surveillance procedures, issues credit opinions, and provides investment strategy recommendations. Lance oversees Capital Advisors Group’s Credit Committee.

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