Cash and money market funds from all the major fund managers in Ireland are currently yielding rates of approximately 4% variable per annum. Meanwhile Irish banks are paying about 0.25% on demand deposit accounts. How is this happening and what are the implications for investors?
Cash and money market funds are typically managed by global financial institutions with billions to invest so they have access to the highest yielding corporate deposits across the Eurozone. These corporate deposits are designed for institutional investors who demand that the returns reflect ECB deposit rates which are currently 4%. Cash funds can also invest in short-term euro government and corporate bonds. Depending on their credit rating, these can also yield 3%-5%. So, the yields on cash and money market funds reflect a diversified blend of the rates available on euro corporate deposits, government bonds and corporate bonds. These funds are commonplace and popular in the USA, and they are beginning to gain ground in Ireland because of the attractive rates they offer compared to bank deposits.
Meanwhile, Irish banks set their deposit rates based on a variety of other factors, the primary one being the rate they need to pay to depositors to attract sufficient cash to lend out to customers in the form of mortgages and loans. Since the banks have significantly increased the interest rates they are charging on their mortgages and loans in recent months, you might assume that they would also need to offer higher rates on deposits. That is not necessarily true because it presupposes that they need to retain all their deposits in order to maintain their lending volumes. In fact, Irish banks are still awash with deposits so they can continue lending even if they lose some of their deposit book.
Inertia is a very powerful force in the universe and the world of finance is no different. Inertia is another reason why the banks don’t pay higher deposit rates. Individual Irish investors are innately cautious and have been slow to move from deposit accounts to cash and money market funds or other investments. So, the banks see no commercial imperative to increase deposit rates for personal investors and they are simply making a rational choice to maximise profits by paying as little as possible for deposit funds. On the other hand, corporate clients who tend to be better informed, and driven to maximise their own profits, have been much more proactive in moving the reserves off deposit. It has been widely reported that wealth managers have seen a surge in corporate clients moving their liquid reserves from deposit accounts to cash funds, money market funds and short-dated bonds. We have seen this trend repeated in Clinch.
It also helps that corporate investors pay a discounted tax rate of 25% on life-wrapped Irish cash funds instead of the normal tax rate on funds of 41%. The combination of higher interest rates and attractive taxation means that corporate clients can achieve ten times the return on their liquid reserves in a cash fund compared to a bank deposit.
These funds are also seen as a good risk management tool. Instead of having all your deposits with one Irish bank, cash funds allow investors to diversify their liquid reserves across a wide variety of financial institutions and bond issuers. The fund structures also allow investors to diversify from cash into property and equities if ECB rates reduce over the coming years.
Will the cash fund be crowned king? As long as Irish banks insist on maintaining ultra-low deposit rates, the attraction of cash and money market funds is only set to grow.