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The money market is for interest-earning securities, which tend to have maturities of up to one year and generally maintain their value during that time.
This is the class of financial instruments that gives its name to money market unit trusts and mutual funds. Why then does the performance of such funds vary so widely in the Jamaican market as shown in the attached table?
There are several reasons for the variation in fund performance, including the following: the instruments selected, the level of income they generate, the percentage of the fund invested in each type of instrument, the level and timing of inflows into the fund, corrective action taken with regard to past performance, the savviness of the manager, and the extent to which non-money market instruments are included in the fund.
There are several types of money market securities, including treasury bills, Bank of Jamaica certificates of deposit, repurchase agreements or repos for short, and commercial paper. Long-term bonds due to mature within a year also qualify.
Although there are short-term instruments with maturities of one year, there are others that may mature in 30 days, 90 days, 270 days, or some other time. The rate on each issue is determined by the market conditions at the time of the issue, so the shorter the term of each instrument, and the higher the proportion of very short-term instruments in the fund, the more the return is likely to fluctuate in a volatile market as maturing funds are reinvested.
It is possible for more than one fund to invest in exactly the same instruments yet give different returns. This is so because of the difference in proportion of the portfolio that each invests in the various types of securities, each of which may give a different return, so, for example, the return on commercial paper may be superior to that on repos.
In fact, it is possible, and it does happen, for one type of instrument with the same term to give different returns. For example, the fund could buy repos of the same term from two different sources at different rates, 5.0 per cent and 5.2 per cent, depending on what is happening in the market.
How much cash is in the fund at any time also has the potential to affect its performance because cash does not earn interest. Because of this, a very significant inflow into the fund just before a public holiday or weekend could conceivably cause the fund to have a strong build-up of uninvested money. Further, as new units are created, there could be a negative effect on the unit value given the inability of the managers to put the money to work immediately and the higher number of units used to calculate the net asset value.
A fund that does well in one period may not necessarily repeat that performance in the following period. How well corrective action is taken can make a big difference. Given the short-term nature of the instruments in these funds, managers may have some room to make meaningful changes in the portfolios, market conditions allowing.
The savviness of the investment manager is important to the performance of the fund because the manager has to be able to read the market and know when and how to make important decisions regarding what to buy and sell and when as well as in what amounts within the limits set by policy.
The reality is that our money market funds do not limit their investments to money market instruments. The offering document of each mutual fund and unit trust includes an outline of its investment policy, including the instruments into which it is to invest.
The statements about eligible investments range from just a mention about investing in money market instruments to mentioning a wide range of instruments, including bonds, preference shares, and ordinary shares. Yes. Ordinary stock.
Some Jamaican-dollar funds also allow for investment in currencies other than the Jamaican dollar to benefit from the depreciation of the value of the Jamaican dollar, but the market can also go the other way and affect the fund adversely.
The funds are very clear that their primary investment objective is capital preservation, but the low yields of some and fluctuations in their unit prices raises the concern about whether the strategies they engage are really aimed at yielding this objective.
People who buy money market funds tend to be the most conservative investors, interested in the preservation of their capital first and returns afterwards.
There is a trade-off: low returns for low risk. Yet, some collective investment schemes seem to be very keen on generating the highest returns for investors in a competitive market although such an approach puts investors at a higher level of risk than would be expected.
What managers should aim to do is to get the best returns at the level of risk that is in line with the risk tolerance of the risk averse investors who find money market funds attractive.
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Oran A. Hall, author of Understanding Investments and principal author of The Handbook of Personal Financial Planning, offers personal financial planning advice and counsel.
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