What are money market instruments and when are they needed in a portfolio?

The money market is loans and deposits for a period from one night to a year. The FinEx line includes an ETF that refers to money market instruments — fund

US government Treasury bonds, US T-Bills, are some of the most reliable financial instruments in the world. These short-term securities are denominated in US dollars and have a maturity of up to 1 year. Securities with maturities up to one year are classified in the money market.

T-Bills does not have the highest rate of return — about 0.03% in USD as of September 2021. Buying T-Bills is close to buying dollars or opening a short-term bank deposit in dollars, but instead of a bank — the US government.

All assets of the FXMM ETF are made up of T-Bills with maturities ranging from 1 to 3 months. Which specific issues to buy is determined by the Solactive index. When we buy an FXMM ETF share, we are, as it were, buying a set of several types (issues) of T-Bills.

If the fund simply invested in T-Bills, then the fund’s share price in dollars would remain almost unchanged, while the price in rubles would follow the dollar rate. However, the FXMM ETF is not just a portfolio of US bonds.

The FXMM ETF is a portfolio of US dollar-protected bonds — ruble hedging. It is because of the hedging that the fund behaves like a short ruble bank deposit and not like a bundle of dollars.

What does “protection against changes in the dollar exchange rate” mean?

For example, knowing the current prices, we can agree to make some kind of sale and purchase transaction in the future, or exchange interest payments, or agree that one of the participants will pay the other the difference in price.

Let’s say we have a thousand dollars and today it costs 56,000 rubles. In a year, the dollar exchange rate will change and our thousand may rise in price or fall in price by tens of thousands of rubles. Hedging allows you, as it were, to fix the rate for the required period.

With today’s price of our dollars at 56,000 rubles, we can conclude a contract for their sale in a year at a price of 61,000 rubles. The selling price in a year is not known because someone knows (or is trying to guess) the future dollar rate. The future price of RUB 61,000 is today’s price plus the difference in interest payments. In other words, the forward rate.

The contract for the sale of the dollars we have with a due date in a year is similar to the placement of today’s ruble price of these dollars on a bank deposit for the same period. We kind of sold dollars today for 56,000 rubles and put them on a deposit for a year in order to get 61,000 rubles in a year.

If we place our dollars in a deposit at interest, and a buyer with rubles places in rubles, then the amount in rubles will increase significantly over the year, but in dollars it will remain almost unchanged. This will happen because the rate on ruble deposits is several times higher than on dollar deposits. The benchmark is the rates of central banks: the key rate of the Russian Central Bank is 6.75%, while the similar rate in the United States is 0.25%.

By concluding a contract for the sale of dollars in a year, we want to receive for them not only the current price in rubles, but the interest that would have accumulated over the year on the amount of the sale in rubles. In turn, we give interest on the dollar deposit. But the interest rates are different and this is called the interest rate difference. It is the difference in rates that most determines the future price of our thousand dollars.

The work of FXMM can be summarized as follows:

We buy FXMM ETF shares for rubles; dollars are immediately bought for our rubles and at the same time a contract is concluded to sell these dollars at a higher ruble price the next day; and for the time before the sale of dollars, US T-Bills are bought with them. Then the operation with the purchase of dollars and their sale under the contract is, as it were, performed every night.

Thus, T-Bills are used to store the fund’s assets, but the reason for the change in the value of the fund’s assets is precisely the yield from ruble hedging. The fund keeps assets in US T-Bills and receives the profitability of the Treasury bills market, but is protected from their rise in price or depreciation in rubles, plus it receives a ruble yield due to the difference in rates.

On the chart, we see that the ruble value of assets per share of the FXMM ETF does not depend in any way on the dollar exchange rate and at the same time is growing steadily due to the difference in hedging rates in our favor:

At FXMM, hedging occurs overnight and is repeated every night — this reduces the risk of long-term changes in interest rates and makes the growth of assets smoother.

The money market is loans and deposits for a period from one night to a year. The FXMM ETF is filled with bonds with maturities ranging from 1 to 3 months — these bonds are classified as money market instruments. Ruble hedging interest accrues every night, so FXMM shares are essentially a money market instrument. This is a tool that is as close as possible just to money (but with interest income), it is not for nothing that the name of the fund in English includes the phrase «Cash Equivalents» — the equivalent of money.

For independent work in the money market, an amount of 10,000,000 rubles or more is required, and one FXMM share costs about 1,700 rubles. Therefore, FXMM is practically the only instrument on the Moscow Exchange that allows a private investor with a small capital without risk to receive income on money not borrowed in stocks or bonds.

From the beginning of 2021 to June 23, the FXMM ETF showed a yield of 4.11% per annum, minus the fund’s commission.

FXMM ETF can be compared to a ruble deposit, but there are important differences: the term and the rate. Usually, a bank deposit can be opened for a period of three months or more. The rate on the deposit and the amount of interest at the time of repayment are known in advance.

In the FXMM ETF, interest is calculated every night, and the rate differential the fund receives from the foreign exchange hedging (forward premium) depends on market conditions, which are constantly changing. Therefore, the rate is known only at the time of the conclusion of contracts for the next night.

You can estimate the profitability of FXMM for the coming days by the quote of the instrument

You can also focus on the rates of short ruble bank deposits.

The fund’s commission is 0.49% per annum. When the fund shares are sold through a Russian broker, individuals are charged with personal income tax in the amount of 13%. Excluding the fund’s commission and personal income tax, the yield from the beginning of 2017 to June 19 was 9.19% per annum.

The FXMM ETF is the least risky FinEx fund available on the Moscow Exchange and is labeled risk 1 on a scale from 1 (minimum risk) to 7 (maximum risk). The risk scale is the same for collective investment funds operating under the legislation of the European Union (UCITS).

The FXMM ETF is considered low risk because its price fluctuates within a very narrow range. When you invest in such a fund, you can be sure that you will be able to withdraw your money without loss in a week or a year.

If we talk about medium and long-term investments, then buying FXMM ETF shares can be a stabilizing factor in the investment portfolio along with cash.

Typically, a portfolio of securities consists of stocks, bonds and cash. Stocks generate higher returns in the long term, but their price can decline significantly in the short term — this is a high risk. Bonds bring moderate yields and a stable flow of payments, their price can also decline, but not as much as stocks — this is an average risk. Cash is the least risky part of a portfolio because, excluding inflation, the price of money is constant.

If we talk about the ruble portfolio, then due to the stability of the price, the FXMM ETF is the equivalent of cash. That is why the name of the fund contains the words Cash Equivalents.

In the short term, FXMM ETFs provide a return on the free money in the brokerage account. For example, if the market situation is not conducive to buying stocks and bonds, then free money can be sent to the FXMM ETF and receive a ruble yield. FXMM ETF shares can be sold any day and money back when needed.

The FXMM tool is in demand by many participants in the financial markets — from experienced traders to novice investors. It is part of the low-risk portfolios of Simple Investments and Financial Autopilot services.

To buy and sell shares of the FXMM fund, you can contact any bank or financial company that provides brokerage services.

This and other materials in the Normal Money channel do not constitute an individual investment recommendation. Investing involves risk.

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