What is a Money Market Fund?
Investing

What is a Money Market Fund?

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Franc's cash fund (which we suggest for short term investment) is the Allan Gray Money Market Fund which we chose (amongst other reasons) because of its consistent good performance. Now, what exactly is a money market fund? Well read on and hopefully we can explain this to you.

Can I get a loan please?

Most people understand what it means to borrow money from a bank (a loan) and then pay interest on it. The amount borrowed (loan capital) has to be paid back either all at the end or in installments every month. So as a simple example, you borrow R1,000 from the bank at an interest rate of 10% per year - you owe the bank R1,100 at the end of the year assuming you made no payments to them during the year. This R1,100 comprises of the R1,000 loan capital repayment as well as interest of R100.

How much do you need?

Now, switch the above scenario around and see yourself as the bank or lender! There are lots of entities out there looking for money to fund their operations - the SA government (read this for a recap of where the government gets its money from), local banks as well as large South African companies, all borrow money. One of the places they borrow from is the money market. This term is a generic term used to describe the virtual "market' where large scale short term (12 months or less) borrowing and lending occurs. This borrowing happens similar to how you borrow from the bank (just at a much much larger scale).

So the borrower (let's use MTN as an example) will go to the "market" saying how much it wants to raise and what interest its willing to pay. They should have a good idea if investors are happy with the interest rate otherwise they won't get any takers. Then Allan Gray, on behalf of its clients in their Money Market Fund, may decide to lend MTN some of what it needs. So effectively, if you are invested in the Allan Gray Money Market Fund, you are lending large entities money! You can access this product because Allan Gray is aggregating your money together with thousands of other people's money and therefore has enough scale to make these large amounts available for MTN and others like it to borrow.

Risk vs reward

Generally the longer the term of the loan, the higher the interest rate. Also, the higher the perceived risk, the higher the interest rate. Allan Gray's portfolio managers have to decide on who to lend to in order to maximise the returns to the end investor (you and me) without taking inappropriate risk and always having money on hand to pay out investors who need their money back. So the interest that you earn on the fund is the interest MTN and the like have paid. It is very rare (but not impossible) for the borrowers not to be able to repay the loan. This is called a capital loss and occurred a few years ago when African Bank defaulted on its loans. This can be a disaster if this borrower makes up a large portion of who the fund lends to but this is why riskier investments should be much smaller in the fund as the chances of them defaulting are greater. Have a look at the table below to see who is borrowing money from the AGMM fund.

Who is borrowing money from the AGMM Fund as at 30 November 2020

Money market fund investments are great for short term investment in that they very safely give you a good return without losing access to your money like you would in a term deposit or fixed deposit. Often the returns can be even better than a fixed deposit because you are getting commercial returns (as a retail investor) because your money is being pooled with other peoples money to get scale. Don't let money sit idle in your bank account earning nothing, put it to work in our cash fund!

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Sebastian Patel

Sebastian is an investment actuary with more than 15 years of financial services experience. Outside of Franc he likes sports, traveling and trying out new wines (as long as they're Shiraz!).

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