Money market funds are an effective option for investors looking to deploy capital for short durations. These funds are ideal for goals where low volatility and relatively steady capital appreciation are important.
Money market funds invest in high-credit-quality, highly liquid marketable securities with limited duration risk. Portfolios are well-diversified, reducing the risk of concentration. As these are open-ended funds, one can withdraw money at any time, subject to an exit load if applicable.
Such funds invest in money market instruments with a maximum tenure of one year. “This allows them to lock-in higher yields available in higher maturity papers due to the usual steepness of the yield curve,” says Amit Somani, deputy head, fixed income, Tata Mutual Fund.
Money market funds align returns with prevailing short-term interest rate trajectories. This structure works well when policy rates are expected to remain steady and can also adjust relatively quickly if short-term rates move higher.
Higher returns than liquid funds
Money market funds invest in instruments with maturities of up to one year, while liquid funds are restricted to securities with maturities of up to 91 days. This allows the former to access slightly longer duration instruments and a wider investible universe, which translates into a modest yield pickup.
Nirav Karkera, head, Research, Fisdom, says the incremental return comes from taking marginally higher duration risk rather than higher credit risk. “Under normal market conditions, the return differential between money market and liquid funds is generally expected to be in the range of 25 to 50 basis points, although this can vary depending on the interest rate environment,” he says.
Portfolio quality
Before investing in these funds, investors must focus on portfolio quality and liquidity rather than chasing marginally higher yields. Investors must review the quality of the underlying portfolio, particularly the credit profile of the instruments held.
“It is important to check the fund’s average maturity and duration, as these influence how sensitive returns may be to changes in interest rates,” says Aditya Agarwal, co-founder, Wealthy.in, a wealth management platform.
Holding period
The ideal holding period for a money market fund should typically be three months to one year. “This time-frame allows the fund to ride out minor interest rate fluctuations and aligns with the maturity profile of the underlying instruments, ensuring the investor captures the full accrual yield,” says Aditya Agrawal, chief investment officer, Avisa Wealth Creators.