A variety of forces have encouraged large inflows into money market funds, for example in the US. We talk to Aviva Investors, which runs a series of funds in the sector, about what's driving growth and why potential for expansion remains high. The sector is not without its risks and challenges, however.

The failures of Silicon Valley Bank, Signature Bank and First Republic, not to mention the dramas at Credit Suisse, have forced people to re-think where they hold money. At the same time, rises in interest rates to levels not seen since before 2008 have lit a fire under money market funds. 

The MMF sector is enjoying something of a renaissance.

According to one definition from BlackRock, a money market fund is a type of mutual fund, typically holding cash, government securities or repurchase agreements collateralised by government securities. Some MMFs can hold government securities, but also those issued by banks, corporations and non-government bodies. In the US, another form of fund are those linked to municipalities that hold municipal securities; earnings are typically exempt from federal tax. Standard MMFs have a minimum investment horizon of three months and offer the opportunity of yield uplift.

The US has by far the largest sector. Total money market fund assets increased by $16.70 billion to $6.02 trillion for the week ended 7 February (source: Investment Company Institute.)

Growth has been strong.

“That is a staggering amount of money,” Alastair Sewell, liquidity investment strategist, Aviva Investors, told this news service in a recent call. 

Alastair Sewell

The problems at a string of banks in 2023 re-awakened people to counterparty risk on a scale not seen since the 2008 crash. It reminded them that they must spread risk. And, at the same time, higher rates meant that there was less of an urgent need to put cash to work when the risk-free rate from US Treasuries, for example, was in the region of 4 per cent – above inflation.

“Real yields became positive and that is going to resonate with asset allocation. The question now is: `How much risk do you want to take to beat inflation?’” Sewell said.

The money markets funds' industry in the US dates from the 1970s. Europe’s sector is smaller, not helped by still being fragmented along national lines. In Europe, for example, most such funds (89 per cent) are domiciled in France, Luxembourg and Ireland (source: ESMA). At the end of 2021, the European Union’s MMFs sector stood at around €1.4 trillion. These funds vary by type in the range of assets they are allowed to hold. Another measure, from the London-based Institutional Money Markets Association, said there were €967 billion ($1.035 billion) in such funds at the end of November 2023 – rising from €40 billion in 2000. According to the UK’s Financial Conduct Authority, sterling-denominated MMFs stood at about £280 billion ($351.5 billion) at the end of 2021. The UK sector is significant, but has catching up to do.

In a May 2022 paper about the risks and benefits of MMFs, the FCA said that they are mainly used by investment funds, pension funds, other non-bank financial institutions, non-financial corporates, local authorities and charities. Individual UK retail investors do use MMFs, but they account for a relatively small proportion of MMF assets. 

Global shocks can rattle the sector. The FCA noted, for example, that in 2020 when the pandemic struck, MMFs were hit by redemptions as investors rushed to get cash. “Investors redeemed their units in MMFs to make necessary payments elsewhere, such as margin payments. However, some investors may also have redeemed or made additional redemptions partly due to fear of being unable to redeem at a future date. Some MMFs struggled to maintain the required liquidity levels as set out in law and regulations, which increased the perceived (and actual) risk of funds being suspended, which in turn may have increased investor outflows from some MMFs,” the FCA said. 

Besides encouraging international policymaker co-operation, the regulator suggested requiring funds to hold more liquid assets, making it less of a strain to meet redemptions.

The benefits of MMFs are several, the UK regulator said: “MMFs historically offered higher yields than bank accounts that also offered instant access to cash. MMFs also allow investors to diversify counterparty credit risk, and outsource much of the risk management associated with investing with many different counterparties.” 

Get educated
Aviva Investors’ Sewell thinks the UK-based wealth sector needs to be more informed about what MMFs can offer.

“There’s demand from investors to put money into fixed deposits, such as for six months through to a year,” he said, noting the possibility that UK interest rates may have already peaked. “The downside of these deposits is that the money is locked and not immediately accessible.”

The “cash drag” an investor suffers by holding cash for a period of time when rates were very low isn’t such an issue now, he said. 

“This is a priority business area for us at Aviva Investors,” Sewell continued. The firm is adding people and other resources in the space. 

More needs to be done in the UK. In the US, money market funds are an established part of the retail and wealth landscape, but these funds are “relatively underused” in the UK. “That’s a disservice, and I hope this is something that can change. It is cultural – there’s just more acceptance in the US,” he said. To an extent, continental Europe also “gets” MMFs a bit more, such as in France, he said.

But there are signs of change: “In the past year, we have seen more interest from wealth platforms and IFAs,” he said. “The pace and scale of rate rises was so fast and far that people are catching up. IFAs are rediscovering the product,” Sewell said.

“We are starting this year with the highest interest rate level in developed markets for more than 15 years. We got conditioned to really, really low rates…we now expect them to remain relatively high,” Sewell said.

“Old ideas [about cash] aren’t fit for purpose any longer,” he added. 

Handy facts:
-- Investors often use MMFs as a cash management product. Investments in an MMF aren't guaranteed.
-- Under UK and EU law, any MMF marketing document must indicate, among other matters, that the MMF; is not a guaranteed investment, that an investment in MMFs is different from an investment in deposits, that the MMF does not rely on external support for guaranteeing the liquidity of the MMF or stabilising the net asset value per unit, and that the investor bears the risk of loss of the principal (source: FCA).
-- Many investors use MMFs as part of their cash management strategies because MMFs offer “same day liquidity.”
-- Most UK MMF investors use sterling MMFs, although a number of large corporates and financial institutions based in the UK also use MMFs denominated in other currencies, including US dollars and euros. In Switzerland, the MMF sector operates.
-- Non-financial companies use them to manage their cash balances. The Bank of England reckons that around half of FTSE 100 companies use them.
-- The vast majority of sterling MMF exposures are to banks (over 90 per cent of their assets).  
-- MMFs also have limits on the weighted average maturity (WAM) and weighted average life (WAL) of their assets.
-- According to the FCA report of 2022, UK investors predominantly use sterling MMFs domiciled in the EU (see chart below).