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The fundamental difference between money market and income unit trusts

Aug 17 2018 21:04

A Fin24 user wants to know what the fundamental difference is between a money market unit trust and an income unit trust.

He writes:

What is the fundamental difference between a money market unit trust and an income unit trust?

They publish different returns and costs, but is the difference expected growth (low) in an income fund against very little growth in a money market unit trust.

I’m looking to make a sizeable lump-sum investment for a period of five years, which will need to generate a monthly “income”/drawdown to support an elderly parent – and these seem to be a low risk and cost-effective possibilities.

Francis Marais, a senior research and investment analyst at Glacier by Sanlam, responds:
The fundamental difference would be liquidity and risk which goes hand in hand with return.
Money market investments are priced to 100. So, you gain very little in terms of growth. Hence your investment return is typically made up of interest, but this also means that your capital is safe.

These investments have very little interest rate risk. They are very liquid, but due to this lower risk and higher liquidity, the interest rate on offer tends to be lower than those on offer in your “income funds”. These funds typically invest in short dated floating rate securities issued by the big banks.
The term income funds can be used in a number of ways. However, income funds are traditionally classified into two broad categories: SA Interest Bearing Short Term Funds or SA Multi-Asset Income Funds.
Collective Investment Schemes classified as Interest Bearing Short Term Funds invest exclusively in a combination of bonds, money market instruments and other interest-bearing instruments. They are not allowed to invest in asset classes such as equity or property.

These funds tend to give you an “enhanced” cash-like return, so they try to produce returns in excess of what you would normally receive in a traditional money market fund.

In order to do this, they utilise a bit more risk, by investing a bit more in credit instruments (credit risk) and slightly longer dated instruments (term or duration risk).

Capital protection

Capital protection is, however, very important as well as liquidity. It is important to note that, unlike in money market funds, your unit price is not priced at 100 and hence you may experience some capital losses.
Collective Investment Schemes in the SA Multi-Asset Income space also invest in a variety of interest bearing instruments, bonds, money market instruments, but may also include some exposure to equity (maximum 10%), which typically tends to be in the form of preference shares - although other funds might use actual equity - and property (maximum 25%).

It, therefore, uses more riskier types of asset classes, but the portfolio manager can choose amongst a wider opportunity set and manages risk actively through diversification.
Unfortunately, the names of the funds can be quite misleading, and all the funds tend to have their own unique characteristics within a category.

For instance, some money market funds might offer a very attractive yield, but if you look through its holdings, they might contain slightly riskier credit instruments, or they might push their maturity limits.

The same applies for funds in the Interest Bearing Short Term category. Here it is especially important to understand how the manger constructs his portfolio.

In the Multi-Asset Income category some funds might be comfortable to use more property or equity or even invest a portion of their fund offshore, while others are managed much more conservatively.
It is, therefore, vital that you speak to a qualified financial adviser. This is to ensure that you understand, not only the risk and return objectives of the underlying funds, but also your own risk and return objectives so that you may ultimately choose the right fund for your specific requirements.

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