Using Mutual Funds for Cash Management Purposes (2003, 2006 and 2012) (TIM)
Background. State and local government cash managers may benefit from investing public monies through mutual funds. Mutual funds are SEC-regulated investment instruments that pool and jointly invest of monies of multiple investors. Mutual funds are available for both fixed income and equity investments.
Short-term liquid mutual funds that maintain a weighted average maturity of 60 days or less and have a stated aim to maintain investor shares with a constant one dollar ($1) Net Asset Value (NAV) are called money market mutual funds. While these funds seek to maintain a constant or stable NAV, this is not guaranteed. Investors of public monies should be aware of this. Other non-money market fixed income mutual funds generally have a longer-term weighted average maturity and have a fluctuating price or Net Asset Value.
The Government Finance Officers Association (GFOA) has endorsed the use of money market mutual funds by public cash managers through the GFOA's model investment legislation for state and local governments. Portfolio safety, liquidity, diversification, and professional management are desirable features of these investment vehicles. The safety of assets, which is the foremost objective of public cash managers, may be impaired by market price risks associated with short-, intermediate-, and long-term bond funds.
Recommendation. The GFOA recommends that state and local governments restrict their use of mutual funds for cash management purposes exclusively to money market mutual funds and short-term bond funds. Public cash managers should check applicable statutes to determine if the use of money market mutual funds and/or short-term bond funds is permitted within their jurisdictions. Further, GFOA recommends that governments review and understand the fund's prospectus and statement of additional information to determine:
- Portfolio composition;
- Risk characteristics;
- The duration and weighted average maturity of the mutual fund;
- The reputation and experience of the investment company;
- The performance history relative to appropriate benchmarks;
- Total expense ratio;
- Philosophy, strategies, and portfolio policies;
- If the fund is rated by a nationally recognized rating agency; and
- Whether the fund can meet the compliance requirements of the government’s approved investment policy, for example, minimum ratings, maximum sector allocations, or specific criteria such as social investing.
Cash managers should continue to monitor these characteristics as they may change over time.
Further, during extremely low interest rate environments, mutual fund expenses may exceed yield. While fees are included in all mutual funds, these fees should be considered when investing in longer term mutual funds. Investors should assess the likelihood that the net yield (gross yield minus expenses) will be greater than zero--in some cases it may be more beneficial to own the underlying securities directly.
GFOA recommends that governments consider money market mutual funds that are invested in Treasury, federal government agency, or first tier categories and possess the highest ratings available from at least one nationally recognized rating agency. Short-term bond funds should receive the highest credit quality ratings and the lowest risk ratings available. State and local government cash managers should exercise prudence and caution when investing in short-term bond funds.
Bond funds investing in short- and intermediate-term instruments, with a varying NAV, may be legal and appropriate investments in some jurisdictions when monies are not needed for near-term disbursement. However, mutual funds of an intermediate or long-term duration should be avoided by investors of short-term funds needed for liquidity purposes.
As further precautions, investors should, at least quarterly, review the specific holdings of their mutual fund to know what the funds own. Prime money market funds that are AAA rated and hold A1+ paper may have foreign debt exposure that is not obvious. Also, all money market funds are required to disclose NAV monthly. Investors should at least quarterly review the NAV, which should remain close to $1.00. If the NAV varies below $0.995 (known as “breaking the buck”), investors should take appropriate action. This could include withdrawing all or part of the entity’s shares in the fund.
- GFOA Best Practice, “Managing Market Risk in Investment Portfolios,” 2007 and 2009.
- An Introduction to Investment Advisers for State and Local Governments, Second Edition, Sofia Anastopoulos, GFOA, 2007.
- A Public Investor's Guide to Money Market Instruments, Second Edition, edited by M. Corinne Larson, GFOA, 1994.
- Investing Public Funds, Second Edition, Girard Miller with M. Corinne Larson and W. Paul Zorn, GFOA, 1998.
Approved by the GFOA’s Executive Board, January, 2012.