With investor interest in exchange traded funds seemingly endless, fund sponsors are busy exploring every nook and cranny for new fund ideas. Over the past year, ETFs holding money market securities–Treasury, municipal, and corporate bonds that mature in less than a year–have sprung up to give investors a “cash-equivalent” ETF option. Money market ETFs have several attractions: they tend to offer higher yields than bank CDs and have lower expense ratios than most money market mutual funds. Like mutual funds, they pay interest once a month, and give investors access to a portfolio of bonds that would be impossible for an individual investor to assemble. Unlike money market mutual funds, there’s no minimum investment. For those who prize liquidity most (and who may have been spooked last September when the $23 billion Reserve Primary Fund set off a panic among investors when it halted redemptions for seven days after sustaining losses) shares in money market ETFs can be sold instantly.
Money Market ETFs’ Shortcomings
There are some downsides to money market ETFs, however, that make them less attractive. While the ability to sell shares in an ETF more quickly than a mutual fund may be attractive to some, it’s really most valuable to investors looking to dabble in highly volatile securities rather than relatively stable short-term paper. True, their expense ratios may be low, but expense ratios don’t include the commissions money market ETF investors have to pay when buying shares, fees that can add up quickly for those making regular deposits and withdrawals as is typical of money market funds. Investors who use a money market fund in place of their checking account may not appreciate the lack of check-writing capability. Furthermore, the much touted tax advantages of an ETF over mutual funds–their avoidance of long term capital gains that actively managed mutual funds sometimes incur–are less valuable for an ETF holding short-term fixed income securities that don’t vary much in value.