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Home Investments

Role of money market funds in a diversified investment portfolio

Denis Kipruto by Denis Kipruto
October 14, 2024
in Investments
Reading Time: 3 mins read

As Kenya’s financial landscape evolves, investors are increasingly seeking ways to diversify their portfolios while balancing risk, liquidity, and returns. One vehicle that has gained significant traction is the money market fund, particularly in an environment where traditional savings accounts offer limited returns.

As bank deposits increased by 18.0 percent to KES 5.9 trillion by December 2023, many clients were focused on building cash reserves despite the low interest rates offered by banks. However, for those seeking better returns while still maintaining liquidity, money market funds present an attractive alternative.

The primary advantage of money market funds is their ability to offer investors higher interest rates compared to traditional bank accounts, all while maintaining a low-risk profile. These funds are designed for short-term investments, providing a stable option that minimizes volatility and preserves capital. For investors with exposure to long-term growth assets, money market funds serve as a complement to their overall strategy, providing a buffer against market downturns. The liquidity of these funds means that investors have ready access to their money when needed, a key feature that makes them suitable for emergency funds and short-term savings goals. This is particularly important when faced with unexpected expenses, as it prevents the need to take on debt during financial emergencies.

In times of market volatility, money market funds also offer a safe place to “park” funds temporarily. Investors may not want to commit all their available cash into riskier investments like equities or balanced funds, especially when market conditions are uncertain. Money market funds allow investors to phase their money gradually into the market, mitigating the risk of significant losses if the market experiences a decline shortly after an investment is made. Unlike attempting to time the market, this approach prioritizes capital preservation while still positioning the investor to take advantage of future opportunities.

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Moreover, money market funds provide greater flexibility compared to fixed deposits. In a fixed deposit account, investors are typically locked in for a set period, and early withdrawals often come with penalties. Money market funds, on the other hand, allow investors to access their funds at any time without incurring penalties. This ease of access is a significant benefit, especially for individuals who may need liquidity at short notice. Additionally, because money market funds are structured as unit trusts, they offer diversification by investing across multiple banks and financial instruments, reducing the concentration risk that comes with holding a fixed deposit in a single bank.

In terms of performance, money market funds have historically outperformed regular savings accounts. In the past year, the oversupply of short-term government Treasury Bills in Kenya led to a rise in their interest rates, reaching 15.0%. This presented a lucrative opportunity for money market funds, especially those that held an overweight position in Treasury Bills. Investors in these funds saw better returns compared to those in traditional cash accounts. Even in periods where money market funds do not significantly outperform, they still offer the benefit of diversification and immediate access to cash, which makes them an appealing option for cautious investors.

For those considering how to structure their investment portfolios, it’s important to assess risk appetite and investment goals. Money market funds may not be the ideal vehicle for individuals with a high risk tolerance or those seeking long-term growth, as these funds are designed to preserve capital rather than generate significant gains. However, for conservative investors or those looking for a balance between risk and return in the short term, money market funds provide an excellent solution. They offer a low-risk, highly liquid investment option that generates returns above inflation, making them suitable for investors focused on maintaining their capital in the face of market uncertainty.

Essentially, money market funds play an integral role in a diversified investment portfolio, especially for investors in Kenya. By offering liquidity, stability, and competitive returns, these funds provide a reliable option for short-term savings and emergency funds, as well as a safe harbor during periods of market volatility. As the financial markets continue to evolve, money market funds will remain a valuable tool for both individual and institutional investors looking to preserve capital while earning better returns than those offered by traditional bank accounts.

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Denis Kipruto

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