A money market fund (MMF) is an open-ended investment fund that holds short-term debt issued by governments, banks, and large corporations. MMFs play an integral role in the global financial system as pools of short-term funding for organisations such as governments, pension funds, insurers, companies, local authorities, and charities.
Money market funds have also acquired a secondary function as a cash reserve for ordinary ‘retail’ investors (that’s us!) chasing a better rate of interest than they can get from a bank account or cash ISA.
But is the higher yield potential of a MMF worth the extra risk that comes with them? We’ll aim to answer that question – and more – in this guide.
What are the main investment objectives of money market funds?
The primary investment aims of money market funds are:
- Stability
- Daily liquidity
- Credit risk diversification
- Returns aligned to the prevailing money market rate
Because MMFs are relatively stable investments they’ve been marketed to ordinary investors as ‘cash equivalent’ products.
However while money market funds are low volatility, their extra yield does come with additional risk strings attached.
Moreover, those risks are most likely to materialise during a period of heightened market stress, when ready access to cash is paramount.
Are money market funds considered to be cash?
Money market funds should not be thought of as cash. The Financial Conduct Authority (FCA) makes this point crystal clear in its Resilience of Money Market Funds paper:
As an investment, MMFs do not guarantee principal, and the investor must bear the risk of loss. MMF investments are equity liabilities, unlike bank deposits which are debt liabilities whose value is supported by equity capital.
It is true that money market funds are low-risk in comparison to equities and bonds.
But MMFs are riskier than cash because:
- They offer same-day redemptions to their investors
- But the majority of their assets are less liquid than cash and may not be immediately sold
This means there’s the potential for a liquidity mismatch if too many MMF investors make a ‘dash for cash’ during a market shock.
Under extreme conditions, money market funds can struggle to meet investors’ demands for their money back. That is exactly what happened during the Global Financial Crisis and the Covid crash.
It’s an extra dimension of risk for investors who think of their money market fund as a cashpoint.
What’s inside a money market fund?
It becomes obvious that money market funds aren’t just cash when we look at the list of financial instruments they typically invest in:
- Commercial paper (unsecured, short-term corporate debt)
- Corporate and sovereign floating and fixed-rate bonds
- UK Treasury bills (ultra short-term government debt)
- Repurchase and reverse repurchase agreements (short-term borrowing and lending in government securities via the repo market)
- Bank certificates of deposits (CDs)
- Cash deposits
This chart shows the break down of assets held by GBP money market funds:
Source: FCA. Resilience of Money Market Funds.
And here’s a typical list of the top ten holdings from a single money market fund:
Source: Vanguard. Sterling Short-Term Money Market Fund.
As you can see we’re not just talking about cash.
Do money market funds pay interest?
Money market funds do pay interest, but the rate is variable and not guaranteed. You won’t see an annual interest rate attached to a money market fund as if it were a bank account.
Typically, GBP money market fund interest payments resemble the Sterling Overnight Index Average rate known as SONIA.
The benchmark SONIA rate is supervised by the Bank of England. It is aligned to the overnight borrowing costs of banks.
You can check out the latest SONIA rate for yourself.
The next chart shows how SONIA has risen in the past year. Interest rate fans should notice that SONIA is closely tethered to the UK’s official Bank Rate:
Source: Bank of England.
Estimating money market fund interest rates
We can use SONIA to approximate the annual rate of interest available from a GBP money market fund.
However, SONIA can only ever be a rough guide to MMF income payments because:
- SONIA fluctuates daily
- Payouts from a money market fund are net of fees
So we must deduct all our investment fees from SONIA as part of our interest rate estimate.
For example, let’s say today’s SONIA rate is 3.92%.
From that you would deduct your following investment costs:
- The MMF’s Ongoing Charge Figure (OCF) – e.g. 0.11%
- Transaction costs (the fund’s underlying transaction costs, applicable spreads, and your broker’s dealing fees, if any.) – e.g. 0.01%
- Your broker’s platform fee – e.g. 0.25%
Your potential money market fund interest rate is thus:
3.92% – 0.37% = 3.55%
Money market funds are actively managed so some may beat SONIA periodically, or even over long periods of time. That’s hard to gauge with reasonable certainty, and isn’t guaranteed. Personally, I’d treat anything extra as a bonus.
Comparing your estimated money market fund interest rate against a bank account
Pop your estimated money market fund interest rate into a compound interest calculator such as this one. Match your inputs to the calculator’s fields like this:
- Initial investment = £1
- Interest rate = 3.55% yearly (or whatever is your estimated MMF annual interest rate)
- Years = 1 (this ensures the calculator gives us an annual compound interest rate)
- Compound interval = Daily
- Effective Annual Rate = 3.614%
The calculator’s Effective Annual Rate is the figure to compare against the Annual Equivalent Rate (AER) touted by your bank account. It gives us an apple-to-apples compound interest comparison.
Both rates assume you reinvest your interest throughout the holding period.
However you won’t get exactly this rate if you hold your money market fund for a year. Your MMF may not track SONIA perfectly. And SONIA varies daily in any case.
But at least this calculation provides a way of estimating if a money market fund offers any kind of interest rate advantage over a bank account.
Other money market fund yields
On a money market fund’s webpage you may see a percentage rate called something like ‘dividend yield’, or ‘net yield’, or ’12-month trailing yield’, or similar.
Such yields are typically calculated by summing up the last year’s worth of interest paid divided by the fund’s current price or Net Asset Value (NAV).
- If interest rates are rising then a trailing yield will probably underestimate your near-term income from the fund.
- If interest rates are on a downward trend then a trailing yield is likely to overestimate your expected income.
This assumes that your principal remains absolutely stable. We’ll explain why you can’t take that assumption to the bank shortly.
Note: your interest is automatically reinvested if you choose an accumulation fund.
An income money market fund will pay out interest at the frequency indicated on the fund’s webpage.
Are money market funds taxable?
Yes, any interest or excess reportable income earned is taxable at your marginal rate of income tax as per normal cash savings.
Money market funds will often describe their income distributions as dividends. However they are taxed as interest.
There’s no tax to pay if you hold your money market fund in a stocks and shares ISA, or pension.
Your Personal Savings Allowance might also shield your MMF interest payments earned outside tax shelters from tax, depending on how much you have saved.
The Personal Savings Allowance enables non-taxpayers and basic rate taxpayers to earn £1,000 of interest tax-free. The amount is £500 for higher-rate taxpayers.
Low earners may be eligible to earn another £5,000 in tax-free interest using the little-known starting rate for savings.
Does your money market fund pay interest gross or net?
If your money market fund is registered as an OEIC or Unit Trust then check if it pays interest gross or net.
If interest is paid net then you’ll receive it with 20% income tax already deducted.
- So a basic-rate taxpayer has no more to pay. (Yay!)
- A higher-rate taxpayer owes another 20%
- A non-taxpayer is due 20% back (Double yay!)
This is only an issue if you’re holding the fund outside of an ISA or pension. It’s also not relevant if your fund pays interest gross – that is, with no tax already deducted.
Scan the fund’s webpage or other documentation for the info. Or contact the fund manager directly for clarification.
Capital gains tax (CGT) applies as usual.
If you invest in a foreign-domiciled money market fund then check its webpage or factsheet to ensure it has UK reporting fund status. If not, then any CGT liability must be paid at your income tax rate.
Money market funds tucked safely inside an ISA or pension are exempt from CGT.
Can money market funds lose money?
Money market funds can lose money. They typically invest in low-risk assets and are subject to close regulation. But you’re still not guaranteed to get back all the money you invested.
The clearest warnings come from the money market fund managers themselves.
BlackRock’s Cash Fund explicitly states the risk on its webpage:
Capital at Risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.
A Money Market Fund (MMF) is not a guaranteed investment vehicle. An investment in MMFs is different from an investment in deposits; the principal invested in an MMF is capable of fluctuation and the risk of loss of the principal is to be borne by the investor.
BlackRock goes on to list some of the risks that money market funds are exposed to:
Loss of Capital: an automatic share redemption may occur which will reduce the number of shares held by each investor. This share redemption will result in a loss of capital to investors.
Counterparty Risk: The insolvency of any institutions providing services such as safekeeping of assets or acting as counterparty to derivatives or other instruments, may expose the Fund to financial loss.
Credit Risk: The issuer of a financial asset held within the Fund may not pay income or repay capital to the Fund when due.
These risks are not merely theoretical. A huge and reputable US money market fund called the Reserve Primary Fund faced a run on its assets during the Global Financial Crisis in 2008.
Reserve Primary suspended redemptions and was eventually forced to liquidate its assets at a loss that impacted its investors.
The lessons of the Global Financial Crisis led to widespread reform of the $4.8 trillion money market industry both in the US and in Europe.
The MMF sector was again severely tested at the height of the Covid crash. Major institutional investors pulled their money as they scrambled to solve their own liquidity problems.
Money market funds subsequently faced massive redemption demands. And these were amplified by the unintended consequences of the previous round of reforms.
Fortunately, central bank action alleviated the pressure. Another wave of reform is now underway.
Cash crunch
The significant takeaway for ordinary investors is that – despite successive attempts by global regulators to strengthen money market fund resilience – what seems to be a low-risk vehicle in normal times can become unstable in extreme conditions.
The fact is that money market funds are not primarily designed to serve the needs of ordinary investors.
And the two most recent global crises illustrate that adverse feedback loops could restrict your access to cash at the worst possible time.
“Help! My money market fund is losing money” false alarm
If you do invest in a money market fund and you see an apparent capital loss shortly thereafter, check that you’re not being misled by the fund’s standard dividend payment operating procedure.
The following chart shows what looks like a repeating cycle of gains and losses by the Vanguard Sterling Short-Term Money Market Fund.
However, these share price fluctuations are just the regular monthly accumulation and distribution of interest from an MMF:
Source: Vanguard. Sterling Short-Term Money Market Fund.
Every month, the fund’s net asset value (NAV) rises above its £1 par value due to the accumulation of interest paid into the fund from its assets.
That accumulating interest temporarily fattens the fund’s value before it is distributed to investors.
The fund falls in value on its ex-dividend date. That’s when the interest payments are set aside by the management team in preparation for payment to shareholders.
Hence the apparent loss is entirely compensated for by the income you receive from the fund on its distribution date.
This cycle repeats as the money market fund continually harvests and pays out interest.
Note that despite the dramatic scale of peaks and troughs on the chart, the differences in NAV amount to a tenth of a penny on the pound.
(With all that said, your investment would be much more volatile if you held a MMF in a foreign currency as you’ll then be exposed to the gyrations of the FX market, too.)
Are money market funds safe?
Money market funds are not as safe as cash. The additional risk inherent in their operation subjects them to pressures and rules that don’t apply to a simple bank account product.
The Financial Stability Board (FSB) spells out the two main MMF vulnerabilities in its 2021 report Policy Proposals to Enhance Money Market Fund Resilience:
- “They are susceptible to sudden and disruptive redemptions”
- “They may face challenges in selling assets, particularly under stressed conditions”
A wide range of large financial institutions use money market funds for cash management.
But some money market fund holdings have relatively limited liquidity, especially when markets are stressed.
This means that MMFs cannot guarantee daily redemption under all circumstances.
The cost of liquidating harder-to-shift assets can rise during a market slump, or dry up completely. This creates an incentive for some money market funds and their investors to redeem early in a crisis – before the cost of doing so increases, or the regulations impose firebreaks on selling.
The FSB comments that:
Taken together, these features can contribute to a first-mover advantage for redeeming investors in a stress event and thus make individual MMFs, or even the entire MMF sector, susceptible to runs.
The FCA spell out how this contagion spread during the Covid Crash:
In March 2020, financial markets reacted to the unexpected effect on economic activity of the Covid pandemic and the public health measures introduced to contain its spread. This shock exposed underlying vulnerabilities in the financial system, which catalysed an abrupt and extreme dash for cash. As a result, financial markets experienced increased selling pressure, volatility and illiquidity.
MMFs also came under severe strain across major currencies, including in sterling, as investors quickly sought access to cash. Investors redeemed their units in MMFs to make necessary payments elsewhere, such as margin payments.
However, some investors may also have redeemed or made additional redemptions partly due to fear of being unable to redeem at a future date.
Some MMFs struggled to maintain the required liquidity levels as set out in law and regulations, which increased the perceived (and actual) risk of funds being suspended, which in turn may have increased investor outflows from some MMFs.
I think that conclusively answers the question: “Are money market funds safe?”
UK and European regulation can impose the following penalties on MMF redemptions:
- Additional liquidity fees
- Restrictions on the amount you can withdraw (known as ‘gating’)
- Suspending the fund
- A low-risk MMF must transform to a riskier type if it’s suspended for more than 15 days within a 90-day period
These penalties could make life more difficult for an ordinary investor who needs cash in a hurry.
As citizens, however, we should be reassured to see such measures that aim to protect the wider financial system from the systematic vulnerabilities of MMFs.
Money market fund classification
There are four types of money market fund available in the UK and Europe.
From the most conservative type to the least, they are:
Public Debt Constant Net Asset Value (PDCNAV) MMFs
- 99.5% of assets must be invested in public sector debt issued by central government, local authorities, and quasi-governmental bodies.
- Investors are able to buy and sell at a constant NAV price of £1 calculated to two decimal places. Volatility should be minimal under normal circumstances.
Low Volatility Net Asset Value (LVNAV) MMFs
- Can invest in private debt as well as public sector securities.
- Otherwise, liquidity requirements are as stringent as those that apply to PDCNAVs.
- The fund’s price is maintained at a constant £1 NAV under normal circumstances.
Short-term Variable Net Asset Value (STVNAV) MMFs
- Liquidity rules are looser than with the first two MMF types.
- Pricing is variable, meaning capital gains and losses are possible under normal circumstances.
Standard Variable Net Asset Value (VNAV) MMFs
- The least restricted money market fund type.
- Enjoys the wider liquidity bounds of a STVNAV but adds longer maturity assets to the mix.
- Variable pricing.
The FCA produced this table summarising the liquidity and maturity restrictions governing the four different money market fund types:
Source: FCA. Resilience of Money Market Funds.
- DLA = Daily liquid assets – the percentage of assets that can be disposed of in 24 hours
- WLA = Weekly liquid assets – as above but disposal is allowed within a week
- WAM = Weighted average maturity – the average time taken before the fund’s current holdings will be repaid by their issuer
- WAL = Weighted average life – the average time taken before the fund’s holdings will repay the amount invested. Similar to Macaulay duration for bond funds
Risk is all relative
Compared to the differences between, say, equity funds, all MMFs are so conservative that it’s like comparing four Mrs Thatcher clones by the colour of their headscarves.
However, the FCA draws out this key distinction:
As noted, evidence from major MMF domicile jurisdictions strongly suggests that in a large-scale market stress, private sector-backed MMFs suffer large outflows, while public debt backed MMFs receive large inflows. LVNAV MMFs invest predominately in private sector assets, while the PDCNAV must invest almost entirely (minimum 95.5%) in public sector assets. The evidence also indicates that public sector debt markets are less likely to become seriously illiquid in large market stresses than private sector debt markets.
Your money market fund provider may mention what type it is on the product’s webpage or somewhere within its documentation. (Burying the info somewhere within a 200-page prospectus is a favourite wheeze. World’s. Worst. Word search.)
You can find more detail about the money market fund classification system here.
Does the FSCS compensation scheme apply to money market funds?
If a money market fund provider defaulted then you’d be entitled to a maximum payout of £85,000 per authorised firm – including their sub-brands. Sadly, the restrictions of the FSCS compensation scheme means that limit is the most you’re entitled to. That’s regardless of how many investment funds you own from that provider. The £85,000 does not apply per fund.
Moreover, the FSCS scheme does not cover investments – including money market funds – that are domiciled outside the UK.
If you own investments in Ireland or Luxembourg then you’re subject to the statutory compensation scheme followed by those countries. This limits compensation payments to a meager €20,000.
Best money market funds
You can buy and sell money market funds from investment brokers like any other fund.
Not every broker makes it easy to find MMFs on their platform, however. Your best bet is to drop the name of your favourite money market fund into your broker’s search bar.
But how do you compare money market funds in the first place?
For money market ETFs, use justETF’s ETF screener switched to the money market category.
There’s only a handful of prospects. You can easily compare them using justETF’s tools.
Note that some of the products are synthetic ETFs that use a financial derivative called a total return swap to match the SONIA rate.
For a broader trawl, go to Morningstar’s Fund Screener.
Flip the screener’s Morningstar Category to GBP Money Market – Short Term or GBP Money Market.
Compare the characteristics of your candidate MMFs using Morningstar’s Investment Compare or the slicker FT Fund Compare.
Personally, I’d concentrate on:
- Long-term performance – Morningstar show up to 10-year annualised returns where available
- Fees – Money market funds are typically actively managed and costs vary a great deal
- Assets under management – big is beautiful
- 12-month yield – to gauge how generous previous interest payments have been
- MMF classification – this will require a deeper burrow into the fund documentation
Still want a money market fund?
The pros of a money market fund are typically advertised as:
- More diversified than cash in bank
- May offer juicier interest rates
- No early withdrawal penalties (not entirely true as we’ve seen)
Yet having done the spadework on money market funds I can’t imagine why I’d choose one over a decent instant access savings account, except where tax comes into the equation and for some reason you don’t want to use a cash ISA.
There’s another narrow use case for someone who wants to earn a little more on cash that would otherwise be parked in a SIPP at derisory rates.
But I can’t see that the extra smidge of interest is worth it versus the additional risks you’re running with a money market fund.
If you want the simplicity and safety of cash then put your money in a bank.
Take it steady,
The Accumulator
Very comprehensive, thank you. Though I’m note sure if I am more or less confident on the Money Markets having read it! I feel like if I’m getting decent rate in cash then it’s not worth the risk v the relatively marginal reward?
Think I’ll just stick to easy access high interest, protected to £85,000, savings accounts for my cash. I like to sleep well at night.
Though I won’t need to be worrying about the £85,000 limit anytime soon, I do worry about reckless and incompetent government policymaking, and financial derivatives ‘wizardry’.
Thanks for this very timely article. I moved the cash in my Vanguard SIPP to their short term Sterling fund just this morning! This was because of their cut in rates. I’m reassessing that decision though, in the light of the above – I don’t think I really appreciated that there was risk involved. I wish there was a decent option for SIPP cash. I’m thinking now that a cash ISA treated as part of the overall asset allocation must be the way to go.
How interesting. Thanks for this in-depth review. It does sound like MMFs are far more common for ordinary investors in the US than over here but I agree with your conclusion that the extra risk probably doesn’t justify the reward.
That investopedia article doesn’t conclude with how much was lost by MMF investors – but it was something like 3% (source: https://www.sec.gov/comments/s7-03-13/s70313-331.pdf).
It seems strange to me that most banks can’t offer instant access savings accounts that can match the BoE base rate/SONIA rate.
The swines!
Great article thanks…in the position that my SIPP (AJB) doesn’t allow NS&I investments or any simple retail saving products which I would prefer, so have a reasonable slug in Lyxor’s Smart overnight CSH2 fund. Not the biggest fund, but seems to have a demonstrable track record over a good length of time and also through a few of the wobbles you mention in the article. Plan to see what it looks like after a month in there, see if its performance and see if it stacks up with the extra risks
High interest bank account ie Tesco and instant access cash ISAs ie Skipton BS now offering almost 3% interest rates
Safer? No tax problems also if cash savings in an ISA
xxd09
Annoyingly, JustETF categorises some of the MMFs under “Active ETFs” instead of the default “Long-only ETFs”. By default, if you click on “Money Market” you’ll only see 4 funds and miss the aforementioned CSH2 as well as QUID and MIST. The Active/Long-only selection can be changed at the bottom of the option on the left hand side.
I’ve been thinking about this lately. It’s generally a lot easier to switch funds within a S&S ISA than it is to drag a Cash ISA from provider to provider…which seems primative.
AJ Bells “cash savings hub” is another interesting model, alongside the various super apps now following this model.
Thank you, food for thought. I have a decent chunk of my house deposit savings allocated to an MMF in my Lifetime ISA. I agree that the extra risk is probably not worth it vs savings in a bank, but I’d currently only get 1% on cash in the LISA…
I have a S&S LISA instead of a cash one because I’m still several years away from buying, which means I’m happy to take some risk (currently half in risky assets). I’m betting on two horses anyway because I’m wary of breaching the £450k limit, so the LISA may end up supplementing my pension.
I too have been pondering this recently and like the look of the Royal London OEIC. The rate is very close to the Sonia rate with near enough instant access. To get close to that rate with conventional savings accounts you need notice or a, fix of between 6 months to a year roughly. 0.5% extra on a full 85k is, over £400.
I gusss it depends on the risk side of things…
1. If you have cash in conventional easy access then you’re covered for spending, ad-hoc opportunistic investing etc, should there be an issue getting it out of a mmf.
2. The capital loss from a mmf is rare and low – I think I read something like 0.2%
Fixed rates have peeked, and look to be declining. Easy access is likely to get a, small boost on the next rate hike, but I sense an mmf will still be on top of both.
I still, however, haven’t taken the plunge just yet though!
Think you are majorly overstating the risks here, are you able to point to a single instance of capital loss in a UK MMF? No.
‘Gating’ shouldn’t concern anyone – it is there to protect you as an investor. ‘Emergency cash’ – say, 3 months worth of spending, should be in a bank account, absolutely. I don’t know anyone advocating that this should be in a fund. Longer term cash (that you may have a horizon of 6-12 months for) imo can reside in a MMF and the extra 60bps of return you get – and ability to hold in an S&S ISA/SIPP – more than compensates for the extra risks
As alternative parking places for surplus £ cash, you could also consider short dated UK government or corporate bond funds e.g.
IGLS iShares UK Gilts 0-5yr UCITS ETF
ERNS iShares GBP Ultrashort Bond UCITS ETF
IS15 iShares GBP Corporate Bond 0-5yr UCITS ETF
Please refer to the relevant factsheets for top 10 holdings for risk appetite as well as projected yield to maturity as a good indication of the expected effective return.
I agree with Barry. I have cash in my current account to meet intra-month expenditure, cash in my Marcus account to meet household emergencies, and money awaiting investment in Royal London Short Term Money Market Class Y Income GBP (about 2% of my portfolio). I have looked at the graph on Morningstar for 2008 and 2020. There appear to have been two small down spikes in 2008, each of which was recovered the next day, and no issues at all in 2020. Yes, there is some risk, but it should be negligible compared with the risk of my portfolio as a whole. It appears to be worth it for an extra 1% or thereabouts.
Not so long ago there was a useful article about generous interest rate on cash held in Vanguard account. Someone from Vanguard must have read that article because they are cutting rates on cash to 2.2% lol
The 1 year gilt yield has just breached 4%, so not a bad option to buy and hold an individual gilt to maturity for those with a SIPP.
And the 2 year is close behind on about 3.9%
No pesky fees either, apart from trading cost.
To be nitpicky, sorry…
“Capital gains tax (CGT) applies as usual in the unlikely event you make a significant capital gain from an MMF. ”
CGT applies (outside of an ISA or SIPP) if you exceed the Annual Exempt Amount on your *total gains*, and includes the MMF gain whether by itself it’s “significant” or not, right? I don’t think you can carve out individual assets and exclude their individual gains as de minimis? (Happy to be wrong on this of course!)
So if I have £13k of capital gains from other assets, and a £100 gain from an MMF (not that unlikely, after all I might have bought just after the XD date and sold just before the next one), that £100 is taxable along with the rest of my gains.
I don’t think this will be all that material – especially not relative to the advantages, when instant access bank savings are lagging Bank Rate so badly – but worth keeping in mind.
The Fidelity Cash income units do pay monthly distributions, which helps reduce the size of the gain you could run up, but that fund seems to be a bit off the pace in terms of yield.
“You typically receive interest with 20% income tax already deducted if your money market fund is registered as an OEIC or Unit Trust”
Wasn’t the deduction at source abolished in 2017?
HMRC notes: https://www.gov.uk/government/publications/deduction-of-income-tax-from-savings-income/deduction-of-income-tax-from-savings-income
The corresponding legislation: https://www.legislation.gov.uk/ukpga/2017/10/schedule/5?view=plain
@LondonInvestor, that’s interesting thanks for adding that, seems ‘cleaner’ that way – means everything is gross rather than some sfuff gross some net.
@ D – thank you for that. Will update the justETF section with your find.
@ londoninvestor – that is nitpicky! 😉 Still as a Grade-A nitpicker myself, I do agree. My defence is that sometimes in the throes of a 3,500 word article I end up simplifying the finer detail 🙂
On the net tax point – thank you very much for that, really good info. I did check a couple of sources that suggested net tax was still a thing but I didn’t know about that specific piece of legislation. It makes sense that investment funds wouldn’t pay net if they didn’t have to and I noticed that the Vanguard money market fund pays gross. I’ll do a wider trawl and update in the next day or so if nobody appears to be paying net.
If any other readers with OEICs or Unit Trusts in taxable accounts knows whether their distributions are being taxed gross or net please let us know in the comments.
@TA – thanks! Also, in my earlier comment I mentioned Fidelity Cash, but of course the Vanguard fund you mention in the article itself is another example that pays dividends monthly.
The Royal London fund which many of us are looking at pays twice-yearly however: so its NAV moves around enough that some investors will want to give CGT a bit of thought.
“SONIA can only ever be a rough guide to MMF income payments. That’s because the rate fluctuates daily and you must also deduct your investment fees.”
I don’t think this is correct for most funds – which historically track
SONIA net of fees. For example, the Royal London Short Term Money Market KIID explicitly states that, “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.”. The historical net performance shows that it has indeed closely tracked the compounded SONIA with an annual deviation of only -0.02% over the last 5 years. You can similarly compare other funds net performance (from the fund KIID) to the compounded SONIA to see how well it tracks when fees are taken into account, e.g. for the last 5 years, average annual net return deviation from compounded SONIA was: Lyxor CSH2 +0.08%, Abrdn +0.02%, RL -0.02%, L&G -0.08%.
(Obviously the net performance figures do not include platform holding fees, so there’s still that to account for – but if that’s an issue and your platform charges a percentage of your holdings then consider switching to a fixed-fee broker like iWeb).
@ C – Unless I’m misinterpreting you, we’re saying the same thing. Deducting your investment fees from the SONIA rate is the same as a fund’s SONIA rate net of fees.
I’m not saying you should take the fund payout and then deduct fees from that. I’m saying you deduct investment fees from the SONIA rate to produce your own SONIA net of fees.
I’ve updated the text so it’s clearer.
To your second point – yes, as most money market funds are actively managed some will periodically outperform SONIA. Even passive funds beat their benchmarks sometimes to the extent that their holdings deviate from the index and experience variable performance.
Personally, I’d treat that as a bonus when it happens as it’s not guaranteed but you might want to weight your interest rate estimate differently. It’s a point worth mentioning though so I’ve updated the text.
Thanks for your thoughts all useful clarifications and apologies in advance if I’ve got the wrong end of your stick 🙂
@TA Re your overall conclusion…
“Yet having done the spadework on money market funds I can’t imagine why I’d choose one over a decent instant access savings account”
…might I ask, do you have a sense of what spread between instant access savings rates and Bank Rate / SONIA would be high enough to tempt you into a MMF?
Personally I wouldn’t bother for like 10bp, but right now the best instant access savings (according to MoneySavingExpert) pays 3.15% – that’s Bank Rate minus 85bp, which is pretty unappetising IMO.
In fact, an article I’d love to read is about the dynamics of the retail savings market. It’s been quite common in recent-ish times for instant access savings accounts to pay above Bank Rate. One explanation offered has been that retail savers tend to be “sticky”, and so even supposedly instant-access deposits are a more stable source of funding than the money markets. What has made that pattern reverse in the current environment, i.e. why isn’t an institution outbidding 3.15%, hoovering up retail customers’ savings and lending them out short-term for 4%-ish? Is it the shape of the yield curve? Regulatory factors? Capital/reserve requirements? I’d be really interested to find out!
@ londoninvestor – that’s a really interesting question and I guess much depends on each individual’s personal position and preferences.
My personal thinking goes something like this:
My overriding reason for holding cash is because I want access to highly liquid assets to pay living expenses – come hell or high water. Hence safety is paramount for me in this part of my portfolio.
The bulk of my portfolio can then be invested in riskier assets. However, I’d prefer those assets to be more distinctive from cash than a money market fund.
An MMF seems like an unnecessary shade of grey to me. Moreover, institutional use of money market funds create unnecessary risks for me as a retail investor.
Thinking about the problem of liquidity from an ’emergency cash’ perspective, I want at least one year’s spending available. Ideally more than that.
Whenever I dig into a farrago like the liquidation of the Reserve Primary Fund, investors are inevitably left in limbo for over a year. Same with brokers that fall into administration.
So if I’m living off my portfolio, I want more than a year’s spending cash available from the safest possible source.
If I was still living off a salary then I always assumed I could be out of work for over a year – though I used insurance to cover that scenario.
Sorry, this is a bit rambly but my gut tells me: no amount of marginal gain from a money market fund is enough to shift my cash out of the bank – given its strategic role.
If I want a higher interest rate on cash then I have plenty of options as a retail investor e.g. promotional accounts such as 5% on a Barclays Rainy Day fund or fixed rate savings – especially those that allow a limited number of penalty-free withdrawals.
The riskier parts of my portfolio are then positioned further down the yield curve.
So I don’t really see a role for money market funds for me.
I’d be interested to know your approach to the same question if you have the time.
I’m not London Investor, obviously, but my tuppence worth:
1. Living expenses, emergency fund etc is held in easy access
2. Cash not needed for the above is in either easy access, or fixed rate accounts
As 2. covers quite a few years worth, at current projections, my options are:
A. Increase the amount invested in risky assets, say equites
B. Think of some other investments which generate better returns than those in option 2. but are less risky
I don’t feel comfortable with increasing my risky allocation right now, but I’d like to have the option to – say if there was a big dip in the market. The MMFs seem to fit that bill – a smidge more risky than cash, but less volatile (considerably) than say bonds, gold, etc.
I take the point about regular savers etc – but the 5% or so on offer requires quite a bit more leg work than just investing in an MMF, if you had a decent chunk of cash. Obviously you’d need several of these regular savers, shunting cash all over the place with carefully planned regular payments etc.
I’ve probably missed something here which is probably why whilst this seems a logical and sensible move, I’ve not done it yet!
@TA thanks, really illuminating! I can start to see how we’re coming at this from different angles.
For me, it starts with an asset allocation view: at the top level, I split between equities and fixed income in the way which I think will maximise my SWR. (Obviously plenty to talk about there, but that’s a whole separate article :)). I rebalance to that every quarter.
Given the extremely low QE-driven interest rates through the 2010s, the priority for the fixed income allocation has been to keep IR risk low, i.e. to overweight short-duration assets. (Since autumn 2022 I have started to drip a bit into gilt funds and take on more duration and hence rate risk, but that’s still in fairly small doses – I’m still concerned about ‘unknown unknowns’ as we exit the QE / ZIRP era, and that was true even before Truss and Kwarteng!)
So, what are those short-duration assets? That can be fairly tactical and flexible, and in fact for most of the last few years, the savings market has often been more attractive than bonds. So there’s a little bit in short-duration bond funds (particularly in the SIPP where alternatives are limited), but more in bank deposits (instant access, fixed-term and regular savers). Now, though, something has happened in the savings market that makes instant-access deposits significantly less attractive compared to wholesale money market rates.
There are still a few decent regular saver accounts, but the amounts are always pretty limited, so that leaves quite a bit of the fixed income portfolio needing a home. Fixed term deposits are also OK, but there’s a need for more liquid cashlike assets (a) to pay the bills of course, and (b) to be “dry powder” for rebalancing into equities if there’s a stock market dip. Recently, money market funds have become an attractive place for those. Up to a point of course – I wouldn’t go “hand to mouth” with them, and I still have enough in the bank for all reasonable living expenses.
I don’t think I would really bother with MMFs if the yield was only a few basis points above instant access savings (and prior to this year, I didn’t bother.) But there is the side benefit of not having to constantly check the savings market, watch out for providers cutting rates etc.
Regarding risk, the Reserve Primary Fund etc I understand where you’re coming from, but I’m comfortable with funds that hold basically government debt plus bank commercial paper (like the Vanguard screenshot you showed) – I don’t think this is the same as the 2008 scenario where the “safe” assets were CDO tranches and such. But I guess in practice I agree with you, since I wouldn’t have so much in MMFs that waiting a year to get the money out would be a terrible crunch.
I am retired with lots of income and plenty of cash in my Marcus account. I have also got a load of cash looking for a home. Equities currently 63%. I am happy with that.
The yield curve is currently flat with a small sag in the middle. You cannot get a higher rate than a money market fund from conventional gilts. The market thinks that UK interest rates will rise further and then fall away. The Vanguard economists have recently said that they do not think that will happen as fast as the market expects. Having lived through the 1970s, I am not keen to rush money into bonds.
I have two term accounts maturing later in the year and, at current prices, I would buy low coupon index linked gilts, and more equities if the market dives. My money market fund holding will fund my ISA and £3,600 SIPP contributions in the next financial year, with money left over for any opportunities that arrive. An attractive NS&I Index Linked Savings Certificate launch, perhaps.
Thank you for the in-depth review. For my part, I use iShares GBP Ultrashort Bond ETF (ERNS) for a near cash holding. Well diversified (137 holdings), liquid (£713m assets), 65% AAA, 4.6% YTM, duration 0.34, and – crucially – extremely low volatility, even at times of acute market stress.
@ londoninvestor, Labyrinth93, Geoff – thanks all – it’s interesting to see how we all come at the same problem from different angles – risk tolerance, stage of life, financial capacity, market beliefs, and engagement levels all playing a prominent role. We share many of the same concerns but naturally our dials are at slightly different settings 🙂
Pardon my ignorance, but what could be an example reason for a charity to raise funds in MMFs? I thought charities funds came from…charity?
Thanks all.
> MMFs play an integral role in the global financial system as pools of short-term funding for organisations such as governments, pension funds, insurers, companies, local authorities, and charities.
Think of a charity like any other financial organisation – revenue comes in (e.g. from charitable contributions) and needs to be stored before it’s paid out again in salaries, rent, capital investment, good works etc
Some charities draw down on money market funds to, for example, pay wages at the end of the month
Isn’t a potential advantage of a swap based fund like CSH1 that you receive a capital gain rather than interest so as long as you are within your CGT allowance you can get the “interest” free of tax outside an ISA?
Hi Grant, I can’t see a CSH1 out there but CSH2 uses a total return swap and pays dividends so you’d pay tax as usual on that income.
Yes sorry, CSH2 is what I meant. I didn’t think it paid dividends but willing to be corrected.
The ETF’s webpage says:
Dividend policy – capitalisation
In other words, some component of the total return is reinvested income.
https://www.amundietf.co.uk/en/professional/products/fixed-income/lyxor-smart-overnight-return-ucits-etf-cgbp/lu1230136894
Re CSH2, normally the term ‘unfunded’ would be a bit scary, as in unfunded pension, but the fact that this is UCITS and backed by physical securities has me asking whether this is actually less risky than some of the other options for parking any new profits I may make over RPI, which is my preferred decumulation method.
Excess reportable income for CSH2 are listed on kpmgreportingfunds.co.uk
Curiously, for the last reported year (YE 31/10/21) it’s 0 but non-zero for all preceding years. I guess this is some artefact of the ZIRP era?
@D Indeed, that looks like the effects of ZIRP + Covid. Bank Rate was 0.1% for that whole year, so I guess the charges would have more than swallowed up the income from the fund’s assets.
1. From the comments above I understand any gains of CSH2 would be treated as income for a retail uk tax payer – ie income tax is due at the marginal rate – is that correct?
2. Is the excess reportable income on the website https://www.kpmgreportingfunds.co.uk/Fund/SingleReport?reportId=a8a5ea27-31a4-402d-bd4d-bc763c4970a9 in GBP/unit?
3. Is the excess reportable income in point 2 taxed as income in addition to the gain in point 1?
Thanks for any clarification!
Reminds myself of why I only hold income units in a taxed fund. Partial answer to 1 and 3 is given by good explaination here https://www.justetf.com/uk/news/passive-investing/how-etfs-are-taxed-in-the-uk.html
Excess reportable income is taxed as interest income if CSH2 counts as a bond fund, dividends if not.
“The fund is actively managed and invests in a diversified portfolio of financial instruments and repurchase agreements, in an environment of strict risk and liquidity monitoring.” – Not sure if this counts as a bond or equity fund.
However you can ofset the ERI against any capital gain – the purchase price is raised by the ERI.
That’s right. And it will be taxed as a bond fund, even if some of the underlyings are derivatives and repos rather than literally bonds.
The HMRC manual (IFM13320) says: “Where an offshore fund holds more than 60% of assets in interest-bearing **(or economically similar)** form, any distribution or excess of reported income is treated as a payment of yearly interest”.
Anyone have any thoughts on if the risk profile has changed with MMFs with the current banking liquidity stress. I see lots of talk of significant inflows with associated reductions in bank deposits (notably in the US). I appreciate the risk may have always been there and we’re maybe just more aware of counterparty risk now, but I would appreciate anyone’s thoughts.
I don’t have the technical knowhow to examine their listed holdings with any depth of understanding of their relative risks…
https://www.ft.com/content/032523bc-3b92-4b94-b6b8-ebbe1d606b2c
It appears the FT’s comments section has started discussing a simliar topic on their latest article: Money market funds swell by more than $286bn as investors pull deposits from banks
Is the interest on the MMF paid out monthly, ie if you hold the fund for say a week you wouldn’t receive the interest? Thanks
@Marc some pay monthly (e.g. Vanguard), some pay six-monthly (e.g. Royal London). (There are funds which pay daily, but I doubt those are available to retail investors since the cost of paying a bunch of small distributions every day must be significant).
The price of the fund includes accrued interest, so if you held the fund for a week that didn’t include a interest payment date, your return would come from your selling price being higher than the buying price. If you look at the price chart of the Vanguard fund (in the “Help! …” section of the post), you’ll see how this works.
Can you give some examples of Public Debt Constant Net Asset Value (PDCNAV) MMFs?
@Dot one example of a sterling PDCNAV is: BlackRock ICS Sterling Government Liquidity Fund. That one actually is kind of available to retail investors – it’s the underlying fund behind (formerly Transfer)Wise’s “Assets” product.
I can’t find the excess reportable income for CSH2 anywhere! Should be available on the Lyxor site but I can’t see it… Anyone have any clues?
Anyway, too much palaver at tax return time – I’m selling! Short term gilts with low coupon seem a better deal tax-wise for higher rate taxpayers (at the expense of volatility and less flexibility) and currently paying around 4% yield to redemption and virtually tax free.
FWIW – just got the excess reportable income data for CSH2 directly from Lyxor – it’s £0.00 for the last period – end of reporting period 31 Dec 2021, distribution date 30 June 2022. However, I’m not sure how one uses that and the data for next reporting period & distribution date (December 2022 and June 2023) for a short term holding. I have read that “relevant investors are subject to tax on the excess reportable income of a reporting fund if they hold the investment on the last day of the fund’s reporting period.” My immediate assumption is therefore that if you don’t hold the shares on the last day of the reporting period, you don’t have income, and thus don’t have to declare it on tax form or pay income tax on it (i.e. it’s a capital gain) – but that sounds wrong. And the person buying on 30 December would be shafted for a year’s tax (unless the fund uses equalisation)! Or does the deeply discounted securities clause mean you have to put it down as income anyway? Happy to have any advice here! SG
I’m struggling to understand what it means by “Capital gains tax (CGT) applies as usual”. Is this implying it’s possible to use a MMF to pay 20% CGT on gains rather than interest at my marginal rate?
I’m interested in putting some money into a MMF, say the Royal London one, but I am really struggling to understand how I could account for the gains on my self assessment. I gather that the gain would be classed as interest rather than a capital gain.
Let’s say I bought:
1st February bought 10000 units @ 103.82p
15th February bought 10000 units @103.97p
1st March sold 10000 units @ 104.13p
How do I calculate the tax payable? Since this is going to be in a taxable account, should I buy the income version for ease of tax calculation, or does it not make much difference? Since interest seems to be accrue daily through an increased unit price, when does tax become due?
I’ve been investing for 5 years and comfortable with calculating capital gains as a s104 pool etc.
Thank you
@Chris if you’re buying the accumulation version of the RL fund, it works in the same way as other accumulation funds. The reinvested dividend is subject to income tax, but you can add it to your base cost so it reduces your capital gain (or increases a capital loss).
(The “dividend” for a money market fund is treated as interest for tax purposes, like bond funds but unlike equity funds.)
See Monevator’s guide at: https://monevator.com/income-tax-on-accumulation-unit/
Are income units easier for tax purposes? Maybe a bit, but you still have equalisation to deal with in the first distribution you get, so IMO it ends up making not too much difference.
You might end up with a small capital gain or loss – for example if you buy just after an ex-dividend date, and sell just before, you’ll probably end up with a capital gain; if you do the reverse you’ll end up with a loss. But it’s going to be pretty small. (Say the fund yields 4% and pays out twice a year: if you bought immediately after XD, then sold immediately before, you’d expect roughly a gain of roughly 2%.)
@student grant – can you please elaborate on your comment “ Short term gilts with low coupon seem a better deal tax-wise for higher rate taxpayers”
Where do you find any Short term Gilt w a yield of 4%? Been looking for a while w/o luck. Thanks
@Rivarama
GB Govt 0.125 Jan31’24 currently 4.27% YTM on Interactive Brokers (0.125% coupon is taxable, rest is tax free capital gain)
GB Govt 0.25 Jan31’25 4.24%YTM, slightly higher 0.25% coupon.
£1 buying cost on £1000 to factor in slightly reducing these yields.
Anyone got any thoughts on this offering from Wise for businesses? https://wise.com/gb/business/interest
It looks like they are offering a bank account with the facility to put the balance into a MMF. The differential in return for a company is quite big, because banks don’t offer good rates to companies. The best instant access rate that I can find for a company is currently 3.1% (Aldermore). Wise is offering 4.54% on GBP, so an extra 1.5%. I’m tempted.
That rate is net of their fees.
For the GBP interest, they use https://www.blackrock.com/cash/en-gb/products/251026/blackrock-ics-sterling-gov-liquidity-premier-acc-fund. This is Irish domiciled and I can’t see it in the list of reporting funds, so I guess this means no ERI. Though this help page does seem to talk about ERI:
https://wise.com/help/articles/5OEcpk4Svl3OWY7I2JiPvr/using-wise-interest-in-the-uk?origin=related-article-4vA3EJSQTbRlgQTQpoVQUo
In practice, I’m not sure it matters for a company as the tax on gains and income is the same (unless the income is a dividend).
@IvanOpinion it is a reporting fund: search for it in the HMRC list by its ISIN (IE00B43PVC83) to avoid complications with abbreviated names and so on.
Ah, thanks. Though, as I say, I’m not sure it makes a difference for a company.
A snag with Wise is that they charge £45 to open an account. That’s quite a difference from savings accounts. It swallows the extra interest benefits unless you are investing for a while or a big sum.
I think that instead of Wise Interest, I’m going to DIY it. I’m going to open an account for the company with Interactive Brokers and buy a MMF direct. That way I save the 0.29% annual fee that Wise would charge and the £45 account opening fee. From what I can see, IB will only charge me €5 transaction fee to buy the fund and the same to sell it.
Is there any inherent advantage of the offshore MMFs over the UK versions? For instance, are they taxed more favourably or can they minimise costs in some way?
Thanks for the amazingly detailed article as always
1) From HMRC tax standpoint, are the distributions of money market fund (Assuming distributing funds in Taxable account) treated exactly as bank interest ? Do you get to use tax free personal savings rate of £5000 and/or tax free savings income of £1000 for basic rate taxpayers / £500 for high rate taxpayers ?
2) If answer to (1) is YES, then are distributions from US Money market funds also treated the same way in UK ? I have some savings in VMFXX : Vanguard Federal Money Market Fund in the USA in taxable account. When I declare it in UK can I declare it as bank interest ?
Appreciate if anyone can kindly respond
There are a couple of excellent Blackrock papers about the stress MMFs experienced in 2020 in the US and Europe. These would deserve to be linked to in your article. It is interesting to note the differences in US and Europe’s MMF regulations. The US is clearly separating MMFs for institutional investors from MMFs for individual investors. Not so in Europe.
https://www.blackrock.com/corporate/literature/whitepaper/viewpoint-lessons-from-covid-19-us-short-term-money-markets-july-2020.pdf
https://www.blackrock.com/corporate/literature/whitepaper/viewpoint-lessons-from-covid-19-the-experience-of-european-mmfs-in-short-term-markets-july-2020.pdf
Is there any way to see the answers of participants to the questions the FCA asked in their public consultation? I would be interested to see that, or at least a summary.