Page 129 - Profile's Unit Trusts and Collective Investments 2021 issue 2

Understanding Asset Allocation

year. The yield for any month can therefore be compared to the rate that was offered by a one year
fixed deposit which paid interest monthly in arrears. (Note that both historic yields and indicative
short term yields are available on www.fundsdata.co.za, updated daily. The latter can be found by
clicking on the Home menu button and selecting Money Market Yields.)
The performance of money market instruments and fixed interest products is obviously
dependent on the level and trend of interest rates in the economy.
Under normal economic conditions, long-term interest rates are higher than short-term
interest rates (eg, a one year fixed deposit pays higher interest than a savings account to
compensate investors for tying up their money for extended periods).
In a weakening economy with falling short-term interest rates (resulting from attempts by
monetary authorities to stimulate the economy), long-term rates may drop below those of short-term
rates as investors compete to lock in favourable long-dated rates (known as an inverted yield curve).
Underlying investments
The money market features a number of different types of instruments. The two main types are
interest-bearing investments and discount instruments.
An interest-bearing investment pays a periodic rate of interest to the holder. An example is a fixed
deposit, which pays a pre-defined rate of interest on an amount of money which must be invested for
a fixed period (30 or 60 days, for example). A call deposit, by contrast, can be withdrawn at any time
(ie, the depositor can “call” for his money on short notice), but pays a variable rate of interest. At any
point in time, call deposits will usually offer a slightly lower rate than fixed deposits.
Call deposits are favoured by investors who may need their money in a hurry. They are also
favoured by asset managers who think that interest rates are about to rise, because the variable rate
of the call deposit will go up as interest rates in the market go up. An asset manager who believes
that interest rates are about to decline might opt instead for a fixed deposit, “locking in” a higher
rate in the expectation that call rates will fall.
A discount instrument works a little differently to an interest-bearing instrument. The latter
involves a fixed capital amount on which interest is paid. A discount instrument, by contrast, is
sold at a “discount” to its face value; the larger the discount, the greater the effective interest rate.
By way of simple example, if a three month banker’s acceptance with a face value of R1m is sold for
R970 000, the buyer will make a profit of R30 000 when the instrument becomes payable,
equivalent to interest of 3.09% over three months or 12.37% p.a. (12.94% compounded).
Most discount instruments can be traded (ie, the instrument can be sold to another party
before it becomes payable). This is true of some interest-bearing instruments, like NCDs, but not
true of ordinary fixed deposits and call accounts.
The main underlying instruments of money market funds can be divided into government loans
and commercial loans (see table below).

GOVERNMENT
Treasury Bills These are effectively short-term loans to the Reserve Bank, and are repaid with
interest after periods of between 90 and 180 days. Treasury Bills are issued
weekly on a tender basis.
Bridging Bonds These are short-term loans to lesser government bodies like the Landbank,
and Parastatal Bonds Eskom and the Development Bank of Southern Africa. They are used to finance
short-term cash flow requirements.
COMMERCIAL
Bankers’ Acceptances A bank acceptance is the most common instrument in the money market. It is a
bill of exchange drawn on and accepted by a bank. It can be traded in the
money market.
Negotiable Certificate of A negotiable certificate of deposit, or NCD, is a fixed deposit receipt issued by
Deposit a bank that is negotiable in the secondary market.
Commercial Paper and Commercial paper and debentures are loans to companies. They are usually
Debentures issued with a maturity of more than a year, which is too long for money market
funds, but as negotiable instruments, they can be bought back in the secondary
market when they are close to expiry and meet the one year maturity limit of
money market funds.

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Profile’s Unit Trusts & Collective Investments — Understanding Unit Trusts