If we think about investing into “safe assets” in Singapore, we typically think of instruments like Singapore T-bills or Singapore Savings Bonds (SSBs). Of course, there is also the CPF Special Account (CPF SA) for those of us who want to put away money for retirement while still earning a yield.
Yet for a lot of investors looking for passive income, liquidity is an important factor. That means being able to easily buy and sell an asset if the need arises. Besides SSBs, most “risk-free” assets aren’t that liquid.
For those who do want a higher level of liquidity – while still receiving a decent yield – there are alternatives, such as money market funds (MMFs) and short-term, investment grade bonds. But with interest rates now falling, many people are asking if their yields will come down too.
So, what exactly are you investing in with MMFs and short-term bonds and what happens to them when interest rates fall?
Money Market Funds: More Liquid Fixed Deposits
An MMF, in the traditional sense of the term, is a product that invests into short-term deposits at major financial institutions. For investors in Singapore, a pure cash MMF will hold only Singapore Dollar cash deposits with varying terms of maturity.
These maturities will be short term in nature (no longer than one year) and the vast majority of them will be uber short term, so we’re talking about less than four weeks. This ensures that the provider of the MMF can roll over the deposits quickly and reflect the updated market yield for cash. These deposits are held across various banks or financial conglomerates – that typically need to have a minimum short-term credit rating – to minimise concentration risk.
It’s important to remember that even though MMFs are considered “safe” and conservative cash management tools, they are still set up as funds. As such, the capital deployed into them is not protected or insured by the Singapore Deposition Insurance Corporation (SDIC), like bank deposits are.
Given these funds invest into short-term deposits in Singapore Dollars, investors can view them as more flexible and liquid fixed deposits that you might purchase with banks – minus the SDIC protection. As there’s not much of an “active” component to overseeing the fund, the total expense ratios of cash MMFs tend to be relatively low – in the region of 0.10% to 0.20% per annum (p.a.) of the amount invested.
There are a few large MMFs in Singapore, with the two biggest being SGD Cash funds – Fullerton SGD Cash Fund A and Lion Global SGD Money Market. The yields of these SGD cash MMFs are currently in the range of 3.2% to 3.4% p.a. and there is little to no risk of capital loss in them. Investors can invest in these money market funds through Tiger Brokers, a brokerage licensed and regulated by the Monetary Authority of Singapore.
Short-Term Bonds: Higher Yield But More Risk
When looking at short-term, investment grade bonds, there are many funds out there that can provide higher yields than pure cash MMFs. Of course, with higher yield (i.e. higher returns), there comes a higher level of investment risk.
Many of these funds are typically investing in short-duration, investment grade bonds. While they are typically deemed conservative investments, that doesn’t mean they are “risk free”. Typically, investment grade bonds typically play a defensive role in any diversified portfolio.
That’s because bond prices traditionally rise when there’s a recession. The reason is because interest rates typically start to get cut when a recession is imminent (or obvious) for central bank policymakers. But with short-term bonds, investors aren’t exposed to “duration risk”, which is when interest rate moves have an outsized impact on the price of your holdings.
If you’re invested into bonds with long-term maturities (long duration) then you are exposed to any sudden moves in interest rates. That was what effectively brought down Silicon Valley Bank in the US in March 2023 – given the value of its portfolio of long duration, low-yielding bonds evaporated as the US Federal Reserve quickly hiked interest rates.
Within Singapore, there are many short duration, investment grade bond funds that help investors get a higher yield on their savings. Some of the biggest funds invest into investment grade bonds across varying short-term maturity dates, with an effective holding duration typically in the range of 1 to 1.5 years.
The yield on these bond funds will typically be higher than those found on SGD cash MMFs. For example, the UOB United Singapore Bond A Fund – one of the largest short duration bond funds in Singapore – is currently offering investors a weighted average yield to maturity of 3.73% (as of 30 September 2024). These bond funds typically have an “active” approach and, thus, also have higher expense ratios relative to SGD cash MMFs.
What Happens When Interest Rates Fall?
At the end of the day, both MMFs and short-term bond funds will see the same outcome when interest rates decline; lower yields. While the form of payments of distributions can differ, the lower yields result from the short-term nature of both instruments.
Where there is a difference is that short-term bond funds can see slight capital appreciation on falling interest rates. That’s due to the inverse relationship between interest rates and bond prices, i.e. when rates fall bond prices go up and vice versa. Meanwhile, SGD cash MMFs will just see a lower yield and there won’t be any compensation for investors on the capital appreciation side.
Overall, there is less drawdown risk for investors in short duration bond funds (versus long duration ones) but there is also less upside if interest rates fall. As a result, risk-averse investors who are concerned primarily with capital preservation – but also getting some yield – would prefer to be in shorter duration bonds.
Which Is Preferable For Investors?
Whether investors prefer cash MMFs or short-term, investment grade bonds is a very personal question. That’s down to the different characteristics of each instrument. The SGD cash MMFs are much more short-term and less vulnerable to a drawdown.
However, the yield in a falling interest rate environment will be less attractive. On the other hand, short-term bond funds require a higher level of investment risk but there is more upside potential on the capital appreciation side as interest rates decline – even if the average yield to maturity of new bonds within the fund also falls.
If you’re looking for more information on maximising your investment opportunities, you can join DollarsandSense at its first The Everyday Investor event where we will be speaking to everyday investors like yourself who will share on their personal investment journey. You can register here.
The post Money Market Funds Vs. Short-Term Bonds: What Are You Really Investing In & What Happens When Interest Rates Decline? appeared first on DollarsAndSense.sg.
