Fund Spotlight: earn 5% on your cash with this £7 billion fund

A money market fund is a fund that invests in short-term, high-quality debt issued by governments, financial institutions, and highly rated corporates, as well as overnight bank deposits. These characteristics make money market funds a low-risk option and are often used by institutional investors and corporations to park un-deployed cash.

They have been around for more than 50 years, yet they have rarely gained as much attention from investors as they have in the past 18 months. Following the global financial crisis, a long period of low and falling interest rates emerged and investors were not being rewarded for holding cash or cash-like instruments.

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However, much has changed in the post-pandemic era when inflation skyrocketed, and major central banks hiked rates consistently throughout much of 2022 and 2023 to cool the pace of rising prices. On home soil, the Bank of England (BoE) took its main policy rate from 0.1% in November 2021 to a 15-year high of 5.25% in August 2023, where it has remained since.

It didn’t take long for yields of money market funds to rise and for these products to gain popularity with investors. The Royal London Short Term Money Marketfund, launched in 1999, received inflows of around £2.9 billion over the course of 2022 and 2023, boosting its assets under management (AuM), which now stand at around £6.9 billion. This is no surprise given investors can enjoy a current yield of 5.19%.

With consensus growing that rates will be cut this year, the question now is which central bank will move first and how much they will cut rates. This has led some investors to consider whether money market funds have already enjoyed their best days. This may well be true. However, trying to predict the path of future interest rates is no easy feat especially given how persistent inflation has been in recent times. It is unlikely central banks will be willing to risk cutting rates as quickly as they were raised.

Therefore, allocating part of a portfolio to money market funds may continue to be an important low-risk strategy for diversified investors. Yields of 5% will be available via other instruments and money market funds are not risk-free. However, the credit ratings of money market funds are typically very high meaning that the creditworthiness of the underlying securities is of very high quality, which should give investors some comfort.

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Investors seeking access to this area of the market may wish to consider the well-established Royal London fund, which has been managed by Tony Cole and Craig Inches since 2015. The fund’s objective is to preserve capital and provide income over rolling 12-month periods by investing at least 80% in cash and cash equivalents.

What does the fund invest in?

The fund is made up of a combination of money market instruments, covered bonds (which are more secure then regular bonds as they are backed by a pool of assets, like mortgages), corporate bonds, and government bonds. Investments will be screened to ensure they meet the fund’s predefined exclusions policy, which includes screening out tobacco, fossil fuels and armaments and ensures ESG considerations are factored in when considering the banks that make up most of the portfolio.

Money market instruments are straightforward investments, including short-dated cash instruments, such as certificates of deposits (CD’s), time deposits, and call deposits from a range of high-quality banks. These are all highly liquid short-term financial assets which are traded for less than a year. The allocation to these instruments is 69.7%. The managers believe that a well-diversified cash portfolio consisting of highly rated banking names can deliver the combination of security and income they seek. Many household names can be found in the top 10 list of issuers including Lloyds Banking Group (LSE:LLOY), The Goldman Sachs Group Inc (NYSE:GS), and BNP Paribas Act. Cat.A (EURONEXT:BNP).

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The government bond allocation (UK Gilts) is 17.4% making the UK government the fund’s top issuer. Geographically, aside from gilts, the fund’s largest allocation is to France (15.4%) and Canada (10.6%), with the remainder of the fund invested in issuers from other low-risk jurisdictions.

How has the fund performed?

The fund’s performance target is to outperform, after the deduction of charges, the Bank of England Sterling Overnight Interbank Average (SONIA) over rolling 12-month periods. SONIA reflects the average interest rate that banks pay to borrow sterling overnight from other lenders and is considered an appropriate benchmark for the fund’s performance.

In recent years, the fund’s performance has been in line with SONIA and has outpaced its sector peers. Prior to 2022, performance mirrored the zero-interest rate environment but performance has more recently seen an uptick as markets have adjusted to higher interest rates. If rates continue to stay elevated throughout 2024, the fund has the potential to continue delivering strong returns for investors.

Morningstar Total Returns (GBP) to 30/04/2024. Past performance is not a guide to future performance.

What are the risks?

Money market funds, like all investments, are not risk-free. Last year the Bank of England put pressure on these funds to significantly increase their holdings in liquid assets to enable them to withstand market volatility.

Liquidity risk is the risk of being unable to buy or sell assets without adversely affecting the price of the asset. Money market funds came under strain during the pandemic as investors withdrew money to meet their needs for cash. However, they did not have to gate. Increasing the proportion of liquid assets held in these funds should prevent this from happening in future.

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Another consideration for investors is if interest rates are to fall sharply. The yield available in money markets closely follows the path of interest rates. Therefore, a decline in rates means investors may have to look elsewhere to find high-yielding investments.

Why do we recommend this fund?

Money market funds are not designed to be the most exciting or high-returning products, but they do currently offer investors generous returns at around 5% with very low risk. For the risk-averse investor looking for steady returns, or simply those who are yet to decide where to invest a cash buffer, a money market fund can be a great vehicle to park cash.

With an ongoing charges figure of 0.1%, the Royal London Short Term Money Market fund is one of the cheapest money market funds available to UK retail investors. The fund also benefits from a stable management team and a strong track record. Management believes that the level of unpredictability in markets this year offers opportunities for active managers in this space to capitalise on going forward.

The fund features on ii’s Investment Pathways. 

Please find the latest factsheet here.