Understanding Money Markets And Mutual Funds In Kenya

There has been a vibrant discussion on social media about money markets, mostly concentrating on which fund is paying the most interest. I believe that before looking at the returns of an investment, it helps to understand the investment – this makes you a savvy investor. This is an introductory post to mutual funds (of which money markets are part of). Please ask any questions you have in the comments section and I will do my best to respond.

Mutual funds are defined as:

A mutual fund is an investment vehicle made up of a pool of money collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and other assets. Mutual funds are operated by professional money managers, who allocate the fund’s investments and attempt to produce capital gains and/or income for the fund’s investors. A mutual fund’s portfolio is structured and maintained to match the investment objectives stated in its prospectus – Investopedia

 

Mutual funds are part of what we call collective investment schemes, managed by licensed fund managers, and regulated Capital Markets Authority. The Authority does have prescribed practices for one to operate a collective investment scheme – you can access those here.

In Kenya, there are many types of mutual funds, but this post introduces the three most common types for individual investors: money market funds, dividend funds, and balanced funds. These funds require an investment amount as low as KES 2,500 to start, though the limits depend on the specific provider.

Money market funds

These are the best-known type of mutual funds. Money market funds are open-ended mutual funds that invest in short term government securities, commercial paper, and negotiated fixed and call deposits. Money market funds pay interest of between 4% and 10% annually depending on the fund manager. This interest is credited to your account on a monthly basis. They will allow you to access your funds subject to a 3-5 day notice period and withdrawals attract a charge of between 1-1.5%.

Government securities – These are instruments through which the government borrows from the members of the public. In Kenya, there are of two types; treasury bills (these are short term – between 30 to 360 days), and treasury bonds that are medium to long term (between 2 years and 30 years).

Commercial paper – This is unsecured short term notes, issued by corporations, typically to finance their short term cashflow needs. Maturities on commercial paper are negotiated and are rarely for longer than 270 days.

Fixed and call deposits – These are deposits held with commercial banks

Money market funds are by nature low risk, and are best suited for the following:

• An avenue to accumulate savings for Investment
• Emergency fund or nest egg
• Non-monthly expenses such as insurance, school fees etc

As a rule, only invest in money market funds that offer deposit protection (meaning, whatever happens, you get your returns back). It is also important to be cautious when a money market fund offers rates that are significantly higher than the market average. This is because, when it comes to the short-term, there is very little a fund can do to differentiate its returns from the rest – if a fund is offering returns that are 3% upwards higher than its peers, it may be pursuing an aggressive investment strategy that may put your investment at risk.

Finally, be clear on the withdrawal terms before investing. Most will require a 3-5 day withdrawal notice before you can access your funds.

Dividend funds

This is a class of mutual funds that invests in:

• Publicly traded stocks that have a good track record of paying dividends
• Government instruments
• Money markets
• Commercial paper
• Moderate risk corporate bonds

The goal of the investments dividends funds make is to generate a decent dividend and/or interest income that is credited to investors’ accounts on a quarterly basis.

Dividend funds are medium-risk because while the government instruments, money markets, and commercial paper can be perceived to be safe, the other two types of investments (stocks and corporate bonds) carry some risk. They also have a moderately high rate of return of 12-15%.

When investing in a dividend fund, it is important to know the following:

•  The fund’s performance track record. If possible, get a 5-7 year performance record and seek explanations where the fund underperformed
• The make-up of the fund’s portfolio, that is the percentage of funds they invest in each of the categories above. We know for example that corporate bonds for private companies have not performed very well in the recent past and for this reason fund that is over-exposed in corporate bonds will not perform very well.

Make comparisons of the two metrics above across funds, and choose the one you are most comfortable with. If need be, consult an advisor.

A dividend fund is well suited for your medium-term savings and investments.

Balanced funds

As the name suggests, these funds invest in a mix of traded stocks and government bonds. Unlike the two above where you invest in a pooled fund, balanced funds operate as trading units, and you invest by buying a unit in the fund.

Instead of receiving periodical interest income like the other two, you realize the gains on your units by selling them at a price that is higher than your buying price.

The price of the units solely depends on the performance of the balanced fund – for example if the stock market performs well, the unit price goes up.  For this reason, timing is important when it comes to making the investment – it is always better to invest when the stock market isn’t performing so well, and to play your exit at the right time.

As with all investments that carry some risk, do not panic when the market underperforms and your units start losing value. Take advantage of a down market to acquire more units and balance off the price. The market operates in cycles, and if you are patient you should be able to make some money.

Balanced funds are medium to high risk, meaning there is a chance you could make losses on your investment, but they in term pay reasonably high rates of return – sometimes close to 20% per annum.

A balanced fund is ideal for long-term goals such as retirement investments, or long-term education investments.

There are other types of mutual funds that we have not discussed in this post:

Equities funds – these invest strictly in stocks

Fixed income funds –  These invest in treasury and corporate bonds only

Managed funds – These are retirement funds that are managed by fund managers.

Some of the Companies dealing in mutual funds in Kenya

British American Asset Managers

UAP Old Mutual

Sanlam Investments Limited

CIC Insurance

ICEA

Zimele

Stanlib

African Alliance

Photo credit:rawpixel