[Song Seungseop's Financial Light] Why Did the Wealthy Move Funds to MMF?

Better Returns Than Savings and Free Deposits and Withdrawals
Funds Moving to MMF Amid Unstable Bank Conditions
Careful Review Needed of Investment Returns, Management Scale, and Assets

Editor's NoteFinance is difficult. It is entangled with confusing terms and complex backstories. Sometimes, you need to learn dozens of concepts just to understand a single word. Yet, finance is important. To understand the philosophy of fund management and consistently follow the flow of money, a foundation of financial knowledge is essential. Therefore, Asia Economy selects one financial issue each week and explains it in very simple terms. Even those with no financial knowledge can immediately understand these 'light' stories that illuminate the 'light' on finance.

Since last year, the rapid interest rate hikes and the bankruptcy of major banks earlier this year have engulfed the financial market in uncertainty. The deposit interest rates of banks, which boasted high returns, have also begun to show signs of gradually declining. As a result, high-net-worth individuals have started moving their substantial funds deposited in banks to other places. One of these is the Money Market Fund (MMF).

Better returns than deposits, with flexible withdrawals and deposits

Net Asset Trends of US MMF from the 1990s to the Early 2010s. Source=Korea Development Institute

MMF is an ultra-short-term financial product in which asset management companies collect customers' money and invest it. When customers put money into an MMF, the asset management company invests it in products such as CP (Commercial Paper) or CD (Certificate of Deposit) to generate returns. They also seek profits by investing in short-term government securities. Although it is a fund, it features relatively free withdrawals and deposits, and its returns are higher than those of savings and time deposits. You can even earn returns based on performance by putting money in for just one day and then selling it.

MMF was developed in 1971 by Merrill Lynch, the largest securities firm in the United States. MMFs grew during the first oil shock in 1973. At that time, as oil prices rose sharply, inflation surged, and advanced countries like the U.S. raised benchmark interest rates significantly. People who invested in long-term bonds suffered heavy losses. In contrast, MMFs, which invest in short-term bonds with a so-called 'hit-and-run' strategy, were less affected by interest rate fluctuations and gained tremendous popularity.

MMFs were first introduced in Korea in September 1996. At that time, short-term interest rates in Korea were rapidly rising, causing instability in the money market. Therefore, the Korean government wanted large financial institutions to manage short-term funds stably. The media and academia also had high expectations that as MMFs became more active, funds that had been flowing into unstable short-term financial products in the secondary financial sector would be absorbed by large financial institutions. In fact, due to relatively high interest rates and free liquidity, MMFs were popular even among ordinary people.

Funds moving from unstable banks to MMFs

[Image source=EPA Yonhap News]

MMFs are once again attracting attention in the financial sector. Enormous funds have suddenly poured into MMFs. According to major foreign media, funds inflowing into U.S. MMFs last month reached $367 billion (approximately 485.87 trillion KRW). In Europe, the amount was about 17.7 billion euros (approximately 25.6 trillion KRW), the largest scale since November last year. Korea's MMF net asset total reached 211 trillion KRW on February 6, marking the highest record for the first quarter. Compared to 159.7 trillion KRW in the first quarter of the previous year, it shows how quickly it has grown.

Why have so many funds flowed into MMFs? Because banks are unstable. Last month, Silicon Valley Bank (SVB) went bankrupt, and Credit Suisse experienced a liquidity crisis. It was a time when a global financial crisis was looming. Investors who had deposited large assets began withdrawing money from shaky banks and placing it in the short-term financial market. There is also the aspect of temporarily entrusting funds to MMFs with good returns until other investment options are found.

This atmosphere acts as a bigger negative factor for smaller regional banks. If customers lose trust in small and medium banks and move their funds to MMFs, these banks have to offer higher interest rates to retain customers. For small and medium banks, this means increased losses. When liquidity was abundant, they could accept huge deposits even at low interest rates, but now, if they cannot offer attractive rates, they must watch funds outflow.

Carefully examine investment returns, fund size, and assets

There are also aspects that MMF investors need to be cautious about. The U.S. federal government has currently reached the legally allowed debt ceiling as of January. Discussions are underway to raise the debt ceiling, but Democrats and Republicans are strongly clashing. If the bill does not pass by July, there are concerns that a default could become a reality. In this case, given that most funds are invested in U.S. Treasury bonds, investors in U.S. MMFs would suffer significant losses.

Besides this, when investing in MMFs, investors should always carefully check the investment returns, fund size, and managed assets. If the fund size is small, the possibility of a fund run increases, and there is a higher risk of withdrawal restrictions. Depending on the managed assets, investors may not achieve the expected returns.