Prior to the recent market volatility in March and April 2020, it was generally believed an “At Call” account with a bank was very similar to an investment in a “Cash Fund”. Both essentially gave the investor a cash like return – right?
However, the more astute investors probably noticed that returns on Cash Funds were usuually higher and so were therefore tempted by what appeared to be a free or at least a better priced lunch. Like most situations in financial markets, there is “no free lunch” and the recent market volatility exposed some key differences.
Under an At Call account, monies can be withdrawn without penalty at anytime whereas in a Cash Fund, investors redeem through selling units in the fund. These units need to be sold at the prevailing market price to be fair to all investors entering and exiting the fund with the price of the units varying with market conditions.
The price varies because most Cash Funds do not hold entirely cash as their assets as they typically look to provide an enhanced return to their investors above the cash rate (after any fees paid). This is only feasible if part of the fund is invested in securities and other investments that are higher yielding than cash. The greater the “enhanced return” sought, the greater the percentage of assets in the fund that are riskier than cash. The securities providing these enhancements typically have varying terms to maturity and as such are subject to market pricing.
In a low interest rate environment when there is high market volatility, it is possible for the interest accrued during any one month on a Cash Fund to be less than the market price movement and if this market price movement is downwards, then the Cash Fund can record a overall lost during the month.
However, it is rare for a Cash Fund to record multiple successive monthly losses because this would require the securities held to lose significant value in multiple successive periods. The securities held are typically of high quality and so are unlikely to default so it is generally purely a mark to market issue for investors. It is far more common a sharp fall in value one month is followed by a rise in the next.
Such a situation occurred in a popular fund in March and April where the unit value fell 0.23% in March and rose by 0.22% in April. The fund also made distributions (re-invested as additional units) of 0.11 % in March and 0.04% in April, but the March loss was greater than the distribution so an overall loss of 0.12% was recorded. This was then followed by a 0.26% gain in April as there was both positive income and positive mark to market gains. Overall returns were positive when the two months were combined.
Another factor that comes into play for Cash Funds is if they cannot meet the variations in normal inflows and outflows via simply varying their cash holdings. If this is not possible, they need to buy and sell securities. There are obviously brokerage costs on these purchases and sales and so to be fair to all investors these costs need to be passed onto those investors entering or exiting the funds as it is their actions that are causing these costs to be incurred.
The imposition of entry and exit costs was imposed on investors in this popular fund mentioned during March and April with 0.09% being charged to exit the fund from 25 March onwards which was subsequently revised to 0.02% being charged to enter the fund and 0.05% to exit the fund from 20 April onwards. Prior to the recent volatility there were no entry and exit fees charged. As shown above these fees can be significant and can amount to close to a whole month’s return on the fund in this current low interest rate environment.
The bottom line for conservative investors is to recognise that while Cash Funds pay higher interest than At Call accounts, they can also make negative returns occasionally and there might be frictional costs imposed (or changed without notice) for entering and exiting in times of market volatility. These risks do not exist in At Call accounts. However over the longer term, holdings in a Cash Fund tend to outperform; hence it is a case of balancing the what are essentially penalties for immediate liquidity in a Cash Fund vs the greater longer term yield as compared with an At Call account.