4 Questions Treasurers Should Ask Before Investing in a Money Market Fund

Feb 14, 2025

Ensuring the safety and liquidity of cash is paramount for treasury teams. With over $3.8T of the world’s institutional cash1 sitting in Government MMFs alone, MMFs are a common investment option for treasurers. However, not all Money Market Funds are created equal, and there are underlying risks that should be evaluated to ensure they match the treasury function’s risk tolerance.

Before committing capital, it’s essential to ask the right questions to fully understand and weigh the fund's risks, returns, and structural details. Several key factors can affect performance and risk exposure, from the counterparties involved to the type of securities held. This post will walk through the critical questions that treasurers should consider when evaluating Money Market Funds.

What category of Money Market Fund is Most Suitable for Our Company’s Needs?

With a variety of Money Market Fund options available, understanding the differences between them can significantly narrow down the search for the right fund.

Different types of Money Market Funds come with varying levels of risk and return profiles. Treasury funds tend to be the safest, as they’re focused on short-term U.S. government securities, while prime funds offer slightly higher yields but also greater risk due to their exposure to a larger pool of securities, like corporate debt and commercial paper. Government funds invest in securities backed by the U.S. government or its agencies (e.g. Fannie Mae), while Municipal funds invest in short-term municipal debt for treasurers seeking tax advantages. 

Each type of fund has its advantages and disadvantages, and it’s important to assess which is the best fit for your liquidity and risk needs.

What Counterparties Does the Fund Expose Our Company To?

One of the most important considerations when evaluating a Money Market Fund is the exposure it creates to various counterparties. Although MMF investors hold shares of the fund rather than the underlying assets themselves, they are still exposed to the risks of those securities. Prime funds will tend to expose treasurers to more securities that use leverage (compared to the other fund categories mentioned above), but even Treasury funds will include repurchase agreements (repos), a form of short-term borrowing.

When a MMF purchases these securities, it’s indirectly taking on the risk that the issuer or counterparty might not be able to meet their obligations. This risk is particularly important because, during times of financial stress or market volatility, these have lead to liquidity and solvency challenges.

Credit Rating and Its Impact on Counterparty Risk

Treasurers should closely examine the credit rating of the underlying securities in any Money Market Fund. The credit rating, typically provided by agencies like Moody’s, S&P, or Fitch, offers a snapshot of the likelihood that the issuer will fulfill its obligations. Treasurers should be cautious about investing in funds with a significant amount of lower-rated securities unless the higher yields are deemed acceptable for the organization’s overall risk profile.

Exposure to Repurchase Agreements (Repos)

In a repo transaction, one party sells securities to another party with an agreement to repurchase them at a later date—often overnight. Repos are essentially collateralized loans, where the lender (the MMF) provides cash to the borrower in exchange for securities, which act as collateral. There’s always a risk that the borrower could fail to repurchase the securities, resulting in the fund having to liquidate the collateral at potentially unfavorable terms, or worse, the collateral could lose value. The counterparty involved in the repo transaction is key to understanding the risk, as funds are exposed to the possibility that the borrower might default on the agreement.

Counterparty Risk in Periods of Market Stress

Treasurers may disregard these risks because most of the time the market is not under stress, but Treasurers need to be prepared for unexpected shifts. In periods of financial or market stress, counterparty risk becomes even more pronounced. Treasurers who experienced the 2008 financial crisis can attest to the fact that many money market funds suffered significant losses due to the sudden deterioration in the creditworthiness of their counterparties. The primary example is when the Reserve Primary Fund “broke the buck” in September of 2008. The Fund had held around $785 million in Lehman Brothers' commercial paper, accounting for about 1.2% of its total assets, and when Lehman Brothers went bankrupt, it caused the Fund’s NAV to drop below $1. Worried shareholders quickly withdraw, exacerbating the problem and leading the Reserve Fund to freeze redemptions for several days.

Funds that invest in highly liquid and low-risk assets, such as Treasury bills or highly rated government-backed securities, will likely be more resilient in times of stress. On the other hand, funds that rely more heavily on corporate debt or repos may face greater volatility.

Reviewing the Money Market Fund’s Annual Reports

A fund's annual reports often include details about the types of securities it holds, including the issuers of these securities, and any counterparties involved in repurchase agreements. Reviewing annual reports to get a sense of the counterparty risk is an important step in the evaluation process.

How Do the Fund’s Management Fees Affect Take-Home Returns?

Money market funds typically charge several fees that impact your take-home returns, particularly in a low-rate environment. These fees are typically deducted from the fund’s assets, reducing the overall returns.

The expense ratio covers the total cost of managing the fund, including management fees, administrative costs, potential 12-b1 fees, and other operational expenses. It’s charged annually as a percentage of the fund's assets.

Evaluation

Understanding the fee structure, comparing net returns, and weighing the costs against the potential benefits of the fund are all essential steps in making an informed decision. For treasury functions with large cash reserves and the expertise to manage their investments, it may even be worth considering direct investment in the underlying assets to avoid fund significant management fees. 

What is the Reputation and Financial Stability of the Broker-Dealer Offering the Fund?

The broker-dealer facilitating the purchase and sale of shares in the Money Market Fund plays a crucial role in executing transactions and maintaining liquidity. A broker-dealer with a solid track record and strong financial standing is less likely to face disruptions that could affect the fund’s operations. Additionally, evaluating the broker-dealer’s compliance with regulatory requirements can offer reassurance about their adherence to industry standards, especially in times of financial stress.

Making Informed Decisions for Better Treasury Cash Management

It’s essential to make informed decisions by considering the full range of factors that impact fund performance. From selecting the right category of MMF to understanding counterparty risks, evaluating fees, and ensuring the stability of the broker-dealer, each element plays a role in determining how well the fund aligns with your treasury needs. By asking the right questions and carefully analyzing the fund’s structure and potential risks, treasurers can optimize their investment strategies, enhance liquidity management, and safeguard their organization’s capital.