What Is a Money Market Fund?
A money market fund is a type of mutual fund. It focuses on investing in high liquid cash securities with high credit ratings. It is also known as a money market mutual fund. These funds mainly invest in debt-based securities with a short-term maturity (less than 13 months). Money market funds issue shares and are obligated to follow guidelines made up by the local regulators.
Breaking Down Money Market Mutual Funds
When you look at their key features, money market funds are like any other mutual fund. However, there is one major difference. It aims at maintaining a NAV (net asset value) of $1 per share. Investors receive any excess earnings in form of dividend payments. The investors are free to redeem or buy money market fund shares through banks, brokerage firms and mutual funds.
Money market mutual funds are popular for a few reasons, one of the main ones being the requirement to maintain a $1 NAV. Fund managers are forced to pay the fund investors regularly and this offers the investors a regular flow of income. It also simplifies the process of tracking and calculating the net gains that the fund generates.
Breaking the Buck
A money market fund may drop below the $1 NAV occasionally—this condition is called “breaking the buck”. It is brought about by the failure of the money market fund investment income to exceed investment losses or operating expenses. If the fund uses excess leverage, it may lead to capital risk and consequently, breaking the buck.
When this happens, regulators have to jump in and force liquidation. The first instance of breaking the buck was witnessed in 1994.
Cases of breaking the buck are not common. There was a crisis in 2008 that saw the SEC draft new rules to improve the management of money market funds and offer more resilience and stability.
Investment Options for a Money Market Fund
The following debt-based financial instruments are great for a money market fund investment:
- U.S treasuries
- Repurchase agreements
- Commercial paper
- Certificates of deposit (CDs)
- Bankers’ acceptances
Applicable interest rates determine these instruments’ returns.
Types of Money Market Funds
They are classified into different types depending on maturity period, invested assets and other attributes.
Prime money fund: this type of fund invests in commercial paper of non-treasury assets and floating-rate debt.
Government money fund: 99.5% of its total assets are invested in government securities, repurchase agreements (fully collateralized by governments securities or cash) and cash.
Treasury fund: this one is a variation of government money fund and focuses on investing in standard U.S treasury issued debt securities.
Tax-exempt money fund: fund investors are exempted from the U.S federal income tax. The exemption may also apply, to some extent, to state income taxes.
Institutional money fund
Retail money fund
Evolution of Money Market Funds
They were developed in the U.S in the early ‘70s. They quickly became popular because they made it easy for investors to buy a high-return pool of securities. Their popularity has been growing rapidly and today, they hold an estimated $3 trillion in assets.
Regulation of Money Market Funds
The SEC is in charge of money market funds in the U.S. It is responsible for drafting guidelines concerning the attributes and operations of a money market fund.
