Investment 101: Can Your Money Market Fund Lose Money?

Money market funds are often called “safe havens” or “parking bays” for your money. But are they really without risk?

Remember inflation

The truth is: there is no risk-free option. Even leaving your money under the mattress carries the risk of having very little buying power after 20 years. Likewise, depending on your tax situation, your money market investment may not be keeping up with inflation on an after-tax basis.

When investors ask about safety, they generally mean “Can I lose money?” And as SA money market funds remain steady at a unit price of R1, investors can be forgiven for thinking that their capital amount remains stable, which would be true on any normal day.

Not a day like any other day

But there are days in the investment industry, such as 10 August 2014, when it’s hardly business as usual. What happens to a money market fund when a big institution like African Bank is placed under curatorship?

In a best case scenario, the money market fund will have no exposure to the specific institution, in which case investors lose neither interest, nor capital.

If the fund manager did have exposure, the extent of the damage depends on the size of the exposure on the day before the write-down. Money market funds are highly regulated and closely monitored by the Financial Services Board. Managers must limit the portion of the fund that’s invested in a specific investment instrument.

What if your fund manager did invest in a “bad” investment?

Often, when an institution is placed under curatorship, the value of its debt instruments (what your fund manager invested in) is written off – either fully or partly. The instruction to write down (and how to write down) usually comes from the Financial Service Board. With African Bank, the write-down was firstly taken from the interest that the relevant funds earned on that day from their “good” investments. This means that, on their statements, investors will see a sharp drop in interest for the month of the write-down, relative to other months.

If the size of the write-down is bigger than the interest earned by the good investments of the fund, the manager will have to cancel units in the fund to keep the unit price at R1. For example, if Joe Soap had 10,000 units of R1 each on the day before the write-down, and 1% of the net asset value of the fund has to be written down because the interest earned on the day cannot fully absorb the write-down amount, Joe Soap will have only 9,900 units of R1 each on the day after the write-down. He would have lost his interest for the day, as well as R100 of his capital.