Gill Marcus has thrown the cat amongst the pigeons for income investors. Despite the consensus view of economists that interest rates were likely to stay flat, the Reserve Bank Governor took the bold decision to raise interest rates at last month’s Monetary Policy Committee meeting. “We definitely think the Governor was reaffirming her commitment to fighting inflation with the latest hike,” says Stanlib’s Head of Money Market Investments, Ansie van Rensburg.

This has left income investors in a predicament. With interest rates at multi-decade lows in South Africa, people relying on the income from their investments for their livelihood have been enticed to fix their money for longer durations to take advantage of the marginally higher interest rates. But with the surprise move by the Reserve Bank, these investors may be worse off as their fixed deposit rates could be lower than what they could currently get on offer post the rate decision.

“We always inform clients that there is an appropriate time for different types of money market instruments in a portfolio, based on where we are in the cycle,” says van Rensburg, who has been managing money market funds for the past 17 years. “At the moment all we can do is stress the importance of remaining flexible and liquid, as it is very hard to call these things.”

There are three key differences between fixed deposits and money market funds investors should be aware of. The first relates to the diversification of risk. A money market fund is exposed to multiple debtors (counterparties), whereas when fixing money with a bank, your exposure is concentrated. “In a money market fund, you are essentially a holder of a pool of money market assets,” says Van Rensburg, “and that means if one of the underlying institutions in which the fund invests defaults, your risk is spread, and your loss will be negated by the diversification of the money. But if the institution you fix your money with fails, this could have dire consequences for you.”

The second key difference relates to just the type of situation we saw in January. Money market funds are limited with respect to how much interest rate risk they can take. “So to put it simply, the interest rate should reset every 90 days in a money market fund. So if we get caught by surprise, we can very quickly reset the rates in the fund to take advantage of the higher rates on offer,” says Van Rensburg. By van Rensburg’s calculation, people who had fixed their rates for one month would have lost the equivalent of 0.5% in lost interest, due to the unexpected hike. By contrast, the Stanlib Money Market Fund has reset to a higher rate.

The difficulty now lies in anticipating when more rate hikes can be expected. “I think it’s very difficult to get the timing right,” says van Rensburg. “Just consider the environment we find ourselves in. Inflation is at the maximum limit of the inflation band, and we have seen the rand depreciate by approximately 20% in the last year. The end of Quantitative Easing (QE) is also causing money to flow back to developed markets. We also have elections coming in April, and economic growth remains under pressure. So the outlook remains very uncertain, hence the need to stay flexible.”

The other benefit of a money market fund is that funds can be accessed within 24 hours. The same cannot be said of money in fixed deposits, which penalise investors for breaking them, if they are allowed to take the money out at all. Call accounts are just as flexible, but van Rensburg points investors to the difference of yields on offer. “For the retail investor, the current yield difference between a money market fund and a call account is between 0.5% to 1% (50-100 basis points) higher. For corporates, this probably translates to about 0.50% (50 basis points) higher than what’s available on call accounts. This may not sound like much, but on millions of rands over the course of a year, this can amount to quite a difference.”

It seems that in the current environment, common sense would suggest that the ability to remain flexible and be able to take advantage of rate increases when they present themselves, would be a good monetary policy to follow.