Using Mutual Funds for Cash Management Purposes

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 monies of multiple investors. Mutual funds are available for both fixed income and equity investments.

Short-term liquid fixed income 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 and investors of public monies should be aware of this risk.  Other non-money market fixed income mutual funds generally have a longer-term weighted average maturity and also have a fluctuating price or NAV.

The Government Finance Officers Association (GFOA) has endorsed the use of money market mutual funds by public cash managers in the past. Portfolio safety, liquidity, diversification, and professional management are desirable features of these investment vehicles; however, liquidity may be impaired by the floating NAV.

Risk Assessment. When analyzing risk, the following should be taken into consideration:

1. Local Investment Policy. State and local government cash managers should exercise prudence and caution when investing in short-term bond funds. Public cash managers should also check applicable statutes to determine if the use of money market mutual funds and/or short-term bond funds is permitted within their jurisdictions.
2. Fund Prospectus. Before investing, governments should review and understand a 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. Cash managers should continue to monitor these characteristics as they may change over time.
3. Restriction on Redemptions (Gates). Prior to investing in a money market mutual fund, cash managers should familiarize themselves with any restriction gates assessed against the fund which could impair the ability of an entity to withdraw monies from the fund on a timely basis in order to meet current liquidity requirements.
4. Fees. 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 mutual funds. Investors should assess the risk that the net yield (gross yield minus expenses) will be less than zero – in some cases it may be more beneficial to own the underlying securities directly.
5. Duration. Bond funds investing in shorterm 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 if short-term liquidity is a concern.
6. Holdings. Investors should review the specific holdings of their mutual fund at least monthly to know what underlying securities the fund owns. Prime money market funds that are AAA rated and hold A1+ paper may have foreign debt exposure that is not obvious.   In addition, Investors should review the NAV at least monthly. If the NAV varies below $0.995 (known as "breaking the buck"), investors should reevaluate their investments in these funds.  Governments should consider investing in money market funds that invest in US government securities, which have a higher level of safety and will not be subject to the floating NAV.