Can a Money Market Fund Actually Lose Money?

When business owners first hear about money market funds, the first question is almost always the same: “If I put in RM2 million, is there any chance I won't get RM2 million back?”

The honest answer is yes, it's possible.The probability is low, but it isn't zero. That has to be said first, or nothing after it means much.

What it is, and what it isn't

A money market fund is a unit trust. You are not buying a deposit; you are buying units in a fund, which then places the money in short-term bank deposits, short-term bills, short-dated bonds or their Islamic equivalents.

That makes it fundamentally different from an FD in three ways:

• No PIDM protection. PIDM covers bank deposits, not unit trusts;
• No guaranteed return. The annualised return in the marketing material is past performance, not a promise;
• The unit price moves. Usually only slightly, but in extreme conditions it can go down.

Where losses come from

Because the money sits in short-term, highly liquid instruments, day-to-day volatility is low. But “low” is relative. The main risks are:

• Credit risk: an issuer of a bill or deposit the fund holds gets into trouble and can't repay on time;
• Concentration risk: if most of the money sits with a few institutions, one problem has a large effect;
• Liquidity risk: in stressed markets, many investors redeem at once, and the fund may have to sell assets at poor prices or defer redemption payments as its documents allow;
• Interest-rate moves: the shorter the instruments, the smaller this effect, but it isn't zero.

This isn't theoretical. After Lehman Brothers collapsed in 2008, a long-established, large US money market fund that held Lehman's short-term paper saw its unit price fall to around US$0.97, then suspended redemptions and was wound down. That was the US market, and Malaysian regulation and fund structures differ, but the lesson carries: the words “money market” are not a guarantee.

What if the fund company goes under?

This is the other common question, and the answer is different.

Malaysian unit trusts generally have a trustee. The fund's assets are held by the trustee in the fund's name, separate from the management company's own assets. So trouble at the management company does not, in principle, mean the fund's assets are used to pay the company's debts.

But two risks need to be kept apart: the risk of the fund company and the risk of what the fund invests in. The trustee structure addresses the first. If a bill the fund holds defaults, unit holders still bear that loss. The specific arrangements are in each fund's official documents.

Six questions to ask before you choose

If you are considering putting part of the company's short-term reserve into a money market fund, get answers to these first:

• What did the worst months look like? Ask for the full history, not a few selected months;
• What does it hold? How much in deposits, bills and bonds, and at what credit ratings;
• How large are the biggest counterparties? High concentration deserves attention;
• What is the average remaining maturity? Shorter means lower interest-rate and liquidity risk;
• What do the redemption terms say? Cut-off times, settlement times, limits on large redemptions, and when redemptions can be suspended or deferred;
• Is the return net of fees? Management and trustee fees are usually reflected in the unit price, but confirm it, and check for sales charges or other fees on top.

A good fund can answer all of these, and most of it is in the prospectus and monthly fact sheet. If the answers aren't there, that is an answer in itself.

Which money does it suit?

Going back to the three layers from the first article: if a money market fund is used at all, it usually belongs in Layer 2, the short-term reserve, and only after you have confirmed Layer 1 operating cash is enough and know how much fluctuation you can accept. (Article 1: Your company has RM1 million. Why not put it all in an FD?)

Next week's payroll and supplier payments shouldn't depend on anything that needs to be “redeemed” first.

If this sounds familiar

If you want to know whether part of your company's short-term reserve suits a money market fund, or you have a fact sheet you can't make sense of, bring it and we can go through it together. The conclusion might be “a small portion fits” or “keep it at the bank for now.” Both are reasonable answers.

I work primarily on advisory engagement fees; if implementation involves a specific product and a commission arises, it is fully disclosed before you decide.

More questions? Read: Corporate cash management, 15 questions business owners ask most →

Registered Financial Planner (RFP) · JMarc
This article is general financial education. It is not investment advice and does not recommend any specific fund. Money market funds are not deposits, are not protected by PIDM, unit prices can go down as well as up, and past performance does not indicate future performance. Read the prospectus and related documents before investing.