Friday May 2, 01:53 PM
Avoid This Investment
By Jane Baker
If you err on the side of caution, you may be feeling less than comfortable with the idea of investing in the stock market. And you wouldn't be alone. Investors have been deserting shares in their droves, with many heading for security by pouring
millions into Money Market funds.
Money Market Funds
So, what is a Money Market fund? Essentially, these are unit trusts which aim to provide you with an income from risk-free, short-term cash and cash-like holdings. By cash-like holdings I mean things like bank deposits, certificates of deposit*, very short-term fixed interest securities and floating rate notes**.
Most Money Market funds require relatively low minimum investments -- typically around £500. They are also pretty low-charging, usually with no initial charges and an annual management fee between 0.25% and 0.50%.
So in short, Money Market funds are cheap, accessible and low risk. In these turbulent investment times, what could be better?
The Risks
If I was paying an annual fee for a Money Market fund, I would expect the fund manager to beat the return available from conventional, high street savings accounts. What else would I be paying the manager for?
But the truth is most Money Market funds aren't performing better than traditional savings accounts. Far from it, in fact. Just take a look at their past performance track record:
Performance Of Money Market Funds
Period 1 Year 5 Years 10 Years Money Market Funds
% Growth 3.80% 15.70% 41.20% Source: Investment Management Association, IMA (Milan: IMA.MI - news) . March 2008.
Over the past 12 months, the average Money Market fund has produced a return of just 3.80%. A market-leading savings account would easily have beaten that. Even over the last decade, average growth of 41.20% is rather lacklustre.
The problem is some funds are taking more risk than others, which drags the averages down. Conventional Money Market funds invest in deposit accounts and short-term, high-quality debt. But, more recently, some funds have taken to investing in riskier assets such as lower-grade corporate (company) debt and longer-term loans with the aim of generating a better return.
While these debts may offer higher yields, defaults are occurring more frequently and with less liquidity (yet another repercussion of the credit crunch) performance has suffered.
Worse still, the most popular Money Market fund -- Threadneedle UK Money Securities -- has produced an appalling return of -3.9% over the last 12 months. This is worrying since these funds are supposed to protect your capital.
But, in fairness, this fund is an anomaly as the only one in the sector to produce a negative return over the last year.
That said, even the top performer for the year -- the Fidelity Moneybuilder Cash ISA fund -- only produced a return of 5.5%. Then, again this falls short of the more competitive savings accounts.
So for a supposedly near risk-free return, a margin of 9.4% between the best and worst performing funds is alarming to say the least. Many investors, who have turned to Money Market funds as a safe haven, aren't even aware that they can actually fall in value.
Not Such A Great Deal
So taking the scope of returns into account, Money Market funds actually seem quite expensive in terms of running charges. What's more, the investment strategy of some funds is hardly low-risk and they are all exposed to some degree of market volatility.
On top of all that, it's difficult to determine the quality of the debt instruments your money is being invested in.
Money Market funds in the US have been feeling the impact of the subprime debt crisis for some time now, with falling interest rates putting pressure on returns. Could it soon be a similar story over here?
With a number of market-leading, easy access savings accounts -- including Abbey, Alliance & Leicester, Birmingham Midshires and Kaupthing Edge -- paying interest rates of 6.5% without taking any investment risk at all, I feel Money Market funds have little to offer right now.
This article was inspired by research carried out by Moneyspider.com.
*Certificates of deposit = A time deposit (i.e. a deposit with a specified maturity) made at a bank which pays fixed or floating rates of interest. The lender receives a certificate that a deposit has been made which can then be sold in the secondary market whenever cash is needed.
**Floating Rate Notes = Bonds and other debt instruments which carry a variable (i.e. floating) rate of interest, usually linked to a reference rate such as the LIBOR.
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