Oran Hall | Money market funds meant to preserve capital

Money market funds are meant to be the most conservative of the mutual funds and unit trusts.

Their primary investment objective is capital preservation, which is best achieved by short-term interest-bearing securities, which tend not to experience price changes, or very little if they do. Some Jamaican funds, it seems, are not preserving capital at the level expected.

Although the offering document of Jamaican funds states that they are low risk, and conservative, and aim to preserve the capital of investors, some of the types of instruments in which they state that they invest seem to suggest that the managers have an interest in giving returns out of line with the stated investment objectives of the funds.

This is contrary to what informed investors expect in that low-risk investments give relatively low returns.

While diversification is important in reducing the risk of a portfolio, in a money market fund, diversification is best achieved by the issuer of the instruments, the type of instrument and the maturity of the instrument, for example. The story that the offering documents tell is that some funds set out to invest in instruments that aim to generate capital appreciation. Some aim to generate income, but from bonds, which may lose value if interest rates increase.

Some funds are described as Jamaican-dollar funds, but some invest in foreign currency-denominated instruments to derive gains if the value of the local currency depreciates. The major challenge here is that the value of the fund is at risk of falling when the value of the Jamaican dollar appreciates, thus exposing investors to the risk of their capital not being preserved.

The Financial Services Commission, which regulates collective investment schemes, which include unit trusts and mutual funds, does not explicitly require them to state what percentage of a fund is to be invested in any asset class. The reasonable expectation is that the fund managers are prudent in how they build the portfolios, ensuring that the bulk of the assets of a fund is invested in the appropriate securities.

Generally, it is out of character for a money market fund to experience fluctuations in its unit price. Considering that the vast majority of such funds reinvest all of the income they earn in the fund, it is hard to understand why any fund should experience any such fluctuation.

Surely, the management fees and investment fees they incur cannot be so high that they erode the value of the income that the fund earns periodically? Yet, I know of unit values of money market funds rising and falling.

As would be expected, the funds invest in money market instruments, such as certificates of deposit, treasury bills, commercial paper, short-term bonds, denominated in Jamaican currency. But some also invest in the US, British, Canadian, and Caribbean currencies. Given that they do not publish a breakdown of the portfolios, it is not possible to say the extent to which this is done.

The same can be said of medium-term and long-term bonds, which do not have the capacity of the shorter-term instruments to retain their price as their prices move inversely to changes in interest rates. Although these instruments tend to mature at face value, any change in their price before then is reflected in the value of the fund and the unit or shares of unit trusts and mutual funds, respectively.

There are other types of instruments that some money funds allow themselves to invest in based on what their offering document says. They include securitised mortgages, preference shares – and stocks of companies that pay good dividends. Stocks! Their characteristics give rise to questions about them being ideal for money market funds, and in the case of ordinary shares, their ability to preserve the value of the investor’s principal.

It seems that in a competitive market like ours, there is a strong emphasis on generating superior returns. The reality is that the funds that generate such returns by investing in more risky securities, even relatively small amounts, risk eroding the value of the principal that investors trust them to preserve. Perhaps this approach is a contributor to the relatively wide differences in the performance of the money market funds in the Jamaican market.

Although investors should take some responsibility for becoming familiar with the objectives of each fund and the strategies it uses to achieve them before making an investment decision, the onus is on the collective investment schemes to set up funds that are true to the names they give them.

Oran A. Hall, author of Understanding Investments and principal author of The Handbook of Personal Financial Planning, offers personal financial planning advice and counsel. Email: finviser.jm@gmail.com