What are Money Market Funds?

These are funds that invest primarily in short-term, low-risk money market instruments, such as treasury bills, certificates of deposit, promissory bills and short-term corporate and government bonds. These funds aim to provide investors with a stable return and low volatility, but offer a more attractive return than traditional bank deposits. Last week in the United States, for example, they offered a 4.28% yield at 7 days, compared to 2.6% at the end of 2022, according to EPFR

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Illustration tirée du dernier point hebdomadaire de BofA

Illustration from BofA's latest weekly update

What are their characteristics?

Liquidity: They offer investors a way to keep their money in a highly liquid investment, allowing them to withdraw funds quickly without incurring significant penalties or fees. Low risk: These funds invest in short-term, low-risk financial instruments, making them less exposed to market fluctuations and potential losses than longer-term or riskier investments. No guarantee: However, these investments do not fall under the category of FDIC-guaranteed deposits.

Who owns them?

Institutional Investors: Corporations, banks, insurance companies, pension funds, and asset managers among others. Individual investors. Governments and public agencies. Foundations and non-profit organizations.

How do they operate?

MMFs typically experience inflows of new money:

When investors are concerned about financial market volatility or increased economic uncertainty, they tend to look for safer, more stable investments like MMFs. When short-term interest rates rise, the returns offered by MMFs may become more attractive to investors seeking low-risk investment options.

On the contrary, they can go flat:

When investors are willing to take on more risk because the economic and/or financial environment allows it. If short-term interest rates fall, the returns offered by MMFs may become less attractive compared to other investments.

What is happening right now?

Over the past two weeks, MMFs have seen massive inflows of funds (nearly $300 billion). This is due to a shift of funds from the banking system to MMFs, especially at the expense of medium and small banks. This phenomenon of inflating MMFs traditionally accompanies rate hikes, but the movement has been accelerated by recent risk aversion. Indeed, investors have preferred to redirect their funds into these products, often hosted by large institutions, and out of the coffers of smaller banks, which are currently considered riskier. The main beneficiaries are Vanguard, Fidelity, BlackRock and JPMorgan Chase. Goldman Sachs, Charles Schwab, Federated Hermes, Dreyfus (BNY Mellon) and Morgan Stanley

What are the risks?

This situation further weakens the regional banks, which are losing deposits. However, MMFs are not totally safe investments, since they are not guaranteed by the FDIC. In any case, the amounts at stake exceed the guarantee for traditional deposits. Nevertheless, the main risk is a massive withdrawal in case of a panic about the soundness of the financial system. In 2008, the US Treasury Department was forced to launch a temporary guarantee program for money market funds. The coverage was triggered if the net worth of a fund in the support program fell below $0.995. BofA recommends keeping an eye on the evolution of these products in the context of rapidly changing monetary policy.