Banking on Money Market Funds Could Be the Smart Choice
- Starlight Adviser
- Oct 6, 2024
- 4 min read
Cash Reserve Preservation: All that glitters may not be Gold...
by Starlight Wealth, as featured in the Sunday Times, 6th October 2024 (edited)
The deposit market in Ireland finally got what it wanted: a bit of competition and choice. We have gone from fulminating over the lack of any deposit interest from the domestic banks to having a selection of competitive rates from neobanks, as well as the introduction of money market funds.
What a difference a year makes. We’ve gone from a choice between nothing, nada, and zip, to being offered rates that better reflect what’s available in wholesale markets. But there is more to deposits than the advertised financial return.
Rainy day money, nest egg, life savings - the different names we give deposits reflect their importance and the low tolerance for risk associated with them. That’s why the two most important factors to consider are safety and return. A failure when it comes to the first makes the second redundant, so quality of institution and diversification come before consideration of interest rates.
Safety First.....Mind the Gap!
When you deposit your cash in a bank, it stops being your money and becomes an unsecured loan to that bank. Therefore, treat your deposit as you would any other investment in terms of risk. The first thing to consider is how well your money is protected.
Many of the neobank offerings prominently feature their foreign government guarantees, even though mandatory regulatory warnings are not meant to be used to market products. That said, the guarantees are real, whether German, Dutch or Lithuanian. However, the neobanks are all unrated by the major ratings agencies, although some highlight the credit rating of the countries that provide their deposit guarantee (very naughty, in my opinion).
The message is: “Don’t worry about the quality of the bank – it’s guaranteed by the government!” Any bank lending officer will tell you the path to hell is paved with loans to questionable businesses with “strong” guarantors, so tread carefully here.
I’m an optimist by nature, but when looking at any investment you have to consider the worst case scenario. Most readers will remember the refrain of “Burn the Bondholders!” repeated throughout the banking crisis. Bondholders were seen as institutional and overseas – and therefore expendable - whereas the depositors were seen as domestic, and therefore untouchable.
But imagine that, instead of borrowing from institutional bondholders, one of our domestic banks had built up a massive deposit book by offering amazing online rates to rate tourists from continental Europe. Do you think Ireland would have been as eager to enforce and enlarge the deposit guarantee scheme to protect them once everything went wrong? Me neither. Now consider that scenario with today’s passported neobanks. Ireland is still paying for its banking crisis. Few countries have the appetite to repeat our errors.
Diversification - A Sensible Approach for Your Cash
So institutional quality is a key consideration. But you should also, as with any type of investment, consider diversification among quality providers, even when it comes to something as safe and vanilla as bank deposits. Trust me: you’ll sleep better. Diversification leads me to money market funds.
Money market funds invest in high-quality short-term securities and near-cash instruments that are highly liquid. They are long established in the US as an alternative to savings accounts, with nearly 25 per cent of the entire cash deposit base sitting in them, split between commercial and retail. If Ireland followed the US model, some €39 billion of our €157 billion deposit base would be diversified in money market funds. In the US they are seen as the safer investment: every time the market is worried about recession, war or a stock market crash, inflows to money market funds increase. For example, when Silicon Valley Bank failed in 2023, $538 billion left the US bank deposit system in eight weeks and flowed into money market funds.
For larger sums, a money market fund is the natural home thanks to the inbuilt diversification and liquidity. Unfortunately, I think the product isn’t fully understood. It is important to note that not all money market funds are equal. Some will be made up entirely of government bonds, whereas others can hold up to 50 per cent of their portfolio in mid-ranking corporate bonds.
Making your way through the different types can seem arduous, but it is worth it. Under European regulation, all money market funds must hold more than 20 per cent of their assets in weekly maturing instruments. This means that 20 per cent of the fund is available for distribution to investors every week unless reinvested. Imagine if any bank saw 20 per cent of depositors withdraw their savings in one week? Not even the strongest could withstand that.
Alex McKnight has nearly 30 years’ experience in institutional investment management gained predominantly in London and New York, is a former Chief Investment Officer, and is a co-founder of Starlight Wealth, a wealth management firm that draws on the founding teams’ diverse knowledge and international experience to offer insightful financial advice and innovative and relevant investment products to the Irish market.
Starlight Wealth's Starlight Smart Reserve comprises a curated model portfolio of EU-regulated short-term Money Market Funds designed for clients seeking a demand deposit alternative that generates an institutional rate of return on their cash that exceeds prevailing retail bank deposit rates.
Starlight has reviewed c.300 MMFs and only selected ‘Short-Term’ MMFs with the highest credit quality, all managed by leading global investment institutions.
It is available to individuals, companies and pensions.
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