Pros and Cons of Cash Management funds and why I like them

A couple of weeks ago, I wrote an article about the options for deploying cash in an environment of falling interest rates.

To give you a little bit more background on that topic, falling interest rates is usually a response to central banks increasing the supply of credit available in the financial markets, to prevent companies from going bust if they lack access to credit (or capital).

Now, there were a few options presented in that article, but I wanted to share a bit more about cash management funds and why they are my preferred method of deploying cash.

Cash management funds are funds that deploy your cash into highly liquid (i.e. easily converted back to cash), ultra-safe (i.e. low chances of losses) instruments that generate yield.

These instruments can range from holding actual cash, to money market funds and short-term bond funds as they move along the risk spectrum. These instruments are all considered low risk investment options.

Pros of cash management funds

  • Earn a higher interest on your idle cash compared to bank deposits
  • Flexibility of deposits, withdrawals and transfers, with no lock-ins
  • No pre-qualifying conditions
  • Low risk of capital losses

Earn a higher interest on your idle cash compared to bank deposits

Bank deposit yields have fallen drastically. For example, DBS Multiplier has revised its rates a number of times this year and from August 2020, will be cutting its interest rates significantly. UOB One account holders too.

In fact, across the board most banks are offering less than 1% yields p.a. on your deposits in your high yield saving accounts.

For those who have money in fuss-free accounts with no conditions, then your expected interest rate is about 0.5% (e.g. CIMB FastSaver).

Cash management products can offer slightly higher yields than bank deposits, with annual yields ranging from between 1% to 2% as of today.

Flexibility of deposits, withdrawals and transfers, with no lock-ins

This is an underrated feature that I really appreciate cash management funds for. The beauty of how they are set up is that you don’t have to lock up your cash for a period of time.

When you don’t lock up your funds you have full flexibility in choosing what to do with them in the near future.

That means if you’re an investor waiting for the market to correct, you can cash them out at any time (with a short time lag) and invest into stock markets.

If you need access to these funds, for example in an emergency, then you can also flexibly cash them out without penalties and early termination fees.

There’s also no need to commit to a fixed savings schedule like in some endowment plans.

Let’s say you’re trying to save $200 a month – an Endowment plan fixes that schedule for you but penalizes you for failing to save or for terminating the plan early.

With a cash management product, you save – on your own terms – through a scheduled transfer, without fees, termination charges, or any kind of limitations upon you.

Flexibility is the key word here – you are in charge of your money, not the company.

No pre-qualifying conditions

They also come with no pre-qualifying conditions – no need to credit salary, or lock in your cash for 3 years, or have your interests capped at $10K, or anything.

When there’s no pre-qualifying conditions, it opens up the options for more people to access these products.

For example, my company doesn’t credit salary as SAL but as a GIRO payment instead – so I don’t qualify for the higher tier of interest for any of those high yield bank accounts that require salary crediting.

I am sure many of you also don’t want to be restrained by the option of meeting X amount of credit card spend or make X amount of GIRO transactions each month.

Low risk of capital losses

Cash management funds are extremely low risk. They are not risk free, but their risk are actually considerably low compared to many alternatives.

The risks may come from a few places – one might come from the borrower defaulting on the short-duration bond.

This is usually low, because the monies are usually loaned out to high quality companies (see the underlying fund holdings for the actual composition) with a short loan maturity , with loans expiring in weeks or months instead of 20 years.

I want to be clear though, that there is a risk associated in all investments, including putting your money in a bank – where the money might be lost if the bank goes bust, or not covered under SDIC insurance.

This is known as counter-party risk. When investing through a fund, where they diversify their sources of loans, the risk might even be lower.

Cons of cash management funds

Well, are they that good that they do not have cons? I think it’s also important to understand that there isn’t free lunch in this world. So what are their drawbacks?

  • Sensitivity to interest rate changes
  • Counterparty risk

Sensitivity to interest rate changes

Because they are so flexible, they come with one limitation, their rates can change with time, depending on market conditions.

In other words, when market interest rates go down even further, you can expect to see your yields on your money parked in cash management funds fall as well.

The yields you see are not guaranteed and are just a projection of the annualized ammortized yield of the fund’s holdings.

Counterparty risk

I mentioned this above, and maybe I should mention it again here.

Because of its inherent diversification, there are many more counter parties involved in a cash management product, so the risk is spread out more. However, if any deposits loaned out to those companies or institutions are defaulted, then there is a risk of losing that portion of the investment.

The risk is small and unlikely, and the cash funds have their assets ring-fenced by custodians so that fund managers cannot simply just use your money, unlike bank deposits – which sit on the bank’s balance sheet as a liability to the bank, they can access those funds because it’s on their books.

Overall thoughts

I think I’ve stated my preference for cash management products over the alternatives in the market quite clearly.

I am not a big fan of anything that locks my money up because I appreciate the ability to rapidly redeploy the cash into something else if necessary – remember, cash is a short-term instrument. If you don’t need to use the cash in the short term, invest it instead.

Interest rates have fallen so drastically that there’s not much further it can fall. Hence, if you lock your money up in a 3-year endowment plan yielding 2% then when interest rates reverse their trend, you’ll be stuck with that really bad deal.

Disclaimer: This is not financial advice.

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  1. Yup, have been using the underlying funds since the late-1990s. Those days they actually imposed 1% sales charges (commissions), but luckily yields were also much higher then.

    The MAS criteria to be classified as MMF is rather stringent. Long running MMFs like LionGlobal’s & Philips’ went thru 2008 GFC without a hitch.

    With the low-yield environment, providers are packaging short-term bond funds into the mix (which are not MMFs) e.g. UOB SGD Fund or Fullerton Short Term Interest Rate fund or Nikko Shenton Short Term Bond Fund. These can go down quite a bit & take months to recover.

    E.g. about -5% during the peak of Covid economic shock in late March;

    about -10% during GFC major financial dislocation & took many months to recover.

    But during good times, they can yield 4+% annually, similar to CPF-SA.

    1. I am not sure if it’s a fair comparison given our lack of liquidity and demand in SGD bond and money markets. If you’re comparing just money market funds exclusively, my opinion is the Fullerton Singapore Bond Fund (AUM: $250M) is way too small compared to the largest retail equivalent in US, VMFXX, which has an AUM of $250B.

      So we should expect lower selection of instruments, lower yields, higher fees and lower performance over the long term. But the alternative is taking FX risk and buying into more liquid US money market instruments, or buy a hedged version with higher costs.

      Overall, I think it’s still in-line with what we should expect – we should look at it from a cash management product perspective (cash +MMF+ST bonds) to evaluate and weight the trade offs in terms of risks, interest rate and price volatility.

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