Introduction
Money market funds are a high-liquidity investment option for temporarily parking your money. This guide will help you understand how money market funds work - the players are involved, what they do, and how they generate returns from your money.
Key Players in the Money Market Fund Industry in Kenya
Issuers are companies and institutions that need to raise money. They offer securities on the public market e.g. shares/equities, bonds and bills.
Fund managers use money from money market funds to purchase these securities. In return, they earn management and performance-based fees. For example, ICEA Lion Asset Management is a fund manager that manages the ICEA Lion Money Market Fund.
Assets are held in a custodian bank, and the legal title to these assets is held by trustees on behalf of investors.
Finally, the Capital Markets Authority ensure provides regulatory oversight.
| Key Players in Money Market Funds and their Roles | |
|---|---|
| Participant | Roles |
| Fund Managers | Manage investments |
| Regulatory Authorities | Ensure investor protection, and enforce market rules |
| Issuers | Provide securities for investment |
| Custodian Banks | Hold securities and settle transactions |
| Trustees | Hold legal title to MMF's assets on behalf of investors |
| Source: Kiihela | |
How Money Market Funds Generate Returns
Money market funds invest in short-term, low-risk instruments in order to provide liquidity, safety, and a modest return on investment. Fund managers determine the best mix of investments that will yield good returns. It is a delicate art that aims to maximise returns while protecting the fund from volatility in any one sector or investment type.
There are several investments that are available to fund managers:
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Treasury bills (T-bills) are short-term debt securities that mature after 91 days, 182 days, or 364 days. They are issued by the Kenyan government.
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Government bonds are long-term debt securities with maturities ranging from 2 to 30 years. They offer higher yields than T-bills.
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Corporate bonds are issued by companies. They offer higher yields then government bonds, but come with additional risk.
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Commercial paper is issued by companies looking to raise funds quickly. They offer high yields in a short period of time, but are riskier.
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Certificates of deposit are time deposits offered by banks. They provide a fixed interest rate for a specific term.
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Repurchase (repo) agreements are short-term loans. Securities are sold with an agreement to repurchase them at a higher price at a later date. Used to raise funds quickly.
Conclusion
While you’re never going to directly invest in any of these securities, it’s crucial to understand how money market funds are structured and managed. This helps you understand the risk involved with investing your money.
| Levels of risks in money market funds | ||
|---|---|---|
| Level | Characteristics | Investment Type |
| Low Risk | Safest investments, provide security and stability, lower returns | Treasury bills, government bonds |
| Moderate to High Risk | Higher yields, added credit risk, balance of risk and reward, potential for high rewards | Corporate bonds, commercial paper |
| Variable Risk | Risk depends on issuer’s stability and specific terms | Certificates of deposit (CDs), repurchase agreements (repos) |
| Source: Kiihela | ||
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