What are money market funds and how do they work?

Key takeaways:

• What are money market funds? Low-risk pooled investment funds that invest in high-quality, short-term debt securities such as Treasury bills, commercial paper and certificates of deposit to preserve capital, provide liquidity and generate income.
• How do money market funds work? Money market funds invest in diversified portfolios of short-term debt securities. Many aim to maintain a stable net asset value (NAV) while offering daily or T+1 liquidity.
• What are the benefits and risks? Money market funds offer capital preservation, diversification and daily liquidity, but returns are linked to short-term interest rates and capital is not guaranteed.

Table of Contents:

• What is a money market fund?
• How does a money market fund work?
• Benefits of money market funds
• Risks of money market funds
• Different types of money market funds
• Money market funds vs bank deposits
• Business use cases
• Access MMFs with MillTech
• FAQ's

 

Holding short-term cash is a reality for most businesses, whether it’s to cover day-to-day operations, support liquidity buffers or manage temporary surpluses. Deciding where to keep that cash, however, isn’t always straightforward. Traditional savings accounts offer security but often low returns, whilst riskier investments may not be suitable for funds that need to remain readily accessible.

For many corporate and institutional investors, money market funds have become a practical tool for navigating today’s interest rate landscape. This guide takes a clear, structured look at how money market funds work and what they can – and can’t – offer, helping you understand their role within short-term cash management.

 

What is a money market fund?

A money market fund (MMF) pools investors' money into a portfolio of high-quality, short-term debt securities, including government bills, commercial paper and certificates of deposit. As a low-risk mutual fund, MMFs aim to preserve capital, provide daily liquidity and generate a modest yield, making it a popular choice for short-term cash management.

Unlike a traditional bank deposit, a money market fund invests across a diversified range of short-term securities rather than holding cash with a single institution. This approach helps reduce concentration risk while keeping cash readily accessible for investors.

 

How does a money market fund work?

Money market funds pool investors' money into a diversified portfolio of high-quality, short-term debt securities issued by governments, banks and companies. These investments mature in less than one year, helping to preserve capital, provide daily liquidity and generate income.

Money market funds commonly invest in:

• Treasury bills: Short-term government securities such as UK Treasury bills (T-bills), issued at a discount and redeemed at face value.
• Commercial paper (CP): Short-term, unsecured debt instruments issued by companies to meet working capital and other short-term funding needs
• Certificates of deposit (CD): Fixed-term deposits issued by banks that pay interest and can be traded on the secondary market prior to maturity.
• Sale and repurchase agreements (repos): Short-term secured lending arrangements in which securities are sold with an agreement to repurchase them at a set date and price.
• Short-dated government and corporate debt: High-quality investment-grade securities, including floating-rate notes, that help diversify the portfolio while maintaining liquidity.

Because these investments are short-term and high quality, money market funds are generally considered low risk*. Their short maturities help reduce sensitivity to interest rate changes, while regular maturities provide the liquidity needed to meet investor redemptions.

Investors earn returns from the interest paid by the underlying securities. In the UK, sterling MMF yields generally follow the Bank of England’s Bank Rate and SONIA (the Sterling Overnight Index Average), based on overnight sterling transactions. When short-term rates change, MMF yields usually follow with a lag as existing holdings mature and are reinvested.

Many money market funds aim to maintain a stable net asset value (NAV) of 1.00 in their base currency (for example, £1.00, €1.00 or US$1.00 per unit), although this depends on the fund type and applicable regulatory framework.

 

What are the benefits of money market funds?

Money market funds (MMFs) are widely used by businesses, institutional investors and treasury teams to manage surplus cash while preserving capital, maintaining liquidity and generating income.

• Capital preservation: Money market funds prioritise the safety of the principal by investing in high-quality, short-term, low-risk debt, making them well suited to cash a business needs to hold securely and access when required.
• Diversification: Rather than holding cash with a single bank, money market funds diversify investments across multiple issuers and short-term instruments, helping to reduce concentration and counterparty risk.
• Competitive yields: Money market funds aim to earn income from prevailing short-term rates, typically yielding more than a corporate deposit account, though returns vary with market conditions.
• Daily liquidity: MMFs usually offer daily access to cash, subject to dealing cut-offs, making them well suited to balances that need to stay readily available.
• Professional management: Experienced portfolio managers actively monitor credit quality, liquidity, maturity profiles and regulatory requirements to help ensure the fund remains resilient and aligned with its investment objectives.

What are the risks of money market funds?

• Lower return potential: Money market funds are designed for stability rather than long-term capital growth. As a result, they typically generate lower returns than higher-risk investments such as equities or longer-duration bonds.
• No government protection: Unlike bank deposits, money market funds are investments and are not protected by government deposit guarantee schemes such as the Financial Services Compensation Scheme (FSCS). Although they invest in high-quality assets, capital is not guaranteed.
• Management fees: Some money market funds charge management fees, which are deducted from the fund's assets and can reduce overall returns, particularly when interest rates are low.
• Sensitivity to interest rates: Money market fund yields closely follow prevailing short-term interest rates. When central banks reduce interest rates, the income generated by the underlying investments also falls, which can reduce overall returns.
• Credit risk: Although money market funds invest primarily in high-quality issuers, there remains a small risk that an issuer could default or experience financial difficulties. Diversification and regulatory investment limits are designed to help mitigate this risk.

 

What are the different types of money market funds?

Money market funds can be structured in different ways depending on how their net asset value (NAV) is calculated and maintained.

In the UK and Europe, the three main types of money market fund are Constant NAV (CNAV), Low Volatility NAV (LVNAV) and Variable NAV (VNAV).

• Constant NAV (CNAV): Aims to maintain a stable NAV of 1.00 in the fund's base currency (for example, £1.00, €1.00 or US$1.00 per unit).
• Low-volatility NAV (LVNAV): Aims to maintain a stable NAV of 1.00 per unit, provided the underlying assets do not deviate by more than 0.2%. This is the most common structure for sterling institutional money market funds.
• Variable NAV (VNAV): Uses market-based pricing to value its assets, so the NAV fluctuates with market conditions.

 

Money market funds vs bank deposits for businesses

 

	Money market fund	Deposit account
Definition	A type of mutual fund that invests in high-quality, short-term debt instruments.	A deposit account offered by banks or building societies to store money securely.
Returns	Variable and linked to prevailing short-term rates, after fund expenses.	Fixed or variable depending on the product, provider and term.
Risk level	Low risk, but not risk free. The fund’s income and value may change, and capital is not guaranteed.	Low risk; deposits are protected up to £120,000 per business under the FSCS in the UK.
Access	Usually same-day access depending on the fund and dealing cut-off times.	Instant access for easy-access savings accounts.
Protection	Not covered by FSCS; regulated by the FCA as an investment product.	Covered by the FSCS up to £120,000 per institution.
Best for	Investors seeking higher returns on surplus cash with low risk and daily liquidity.	Investors prioritising security and immediate access to their money.

 

When might a business use MMFs?

Businesses typically use money market funds to manage surplus cash that is not needed immediately but must remain readily accessible, while seeking to earn a return linked to prevailing short-term interest rates. MMFs can form part of a wider cash-management strategy by helping businesses preserve capital, maintain liquidity and diversify where their cash is held.

Common uses include:

• Managing short-term surplus cash: Investing cash that is temporarily surplus to operational or investment requirements.
• Maintaining a liquidity buffer: Holding cash reserves that may be needed at short notice.
• Holding cash before it is deployed: Managing cash while waiting to invest capital, complete a transaction or make a planned payment.
• Diversifying cash holdings: Reducing reliance on deposits held with a single bank by investing across a portfolio of short-term securities.

 

Access money market funds with MillTech

MillTech gives corporates, fund managers and institutional investors access to a range of multi-currency, AAA-rated money market funds through one platform.

Clients can compare funds, spread cash across multiple Tier 1 providers and set rules for how surplus cash is invested. MillTech can also automate subscriptions and redemptions, helping finance teams seek competitive returns, reduce administration and keep cash readily available.

Key benefits include:

• Access to leading providers: Invest across a panel of AAA-rated money market funds from firms including BlackRock, HSBC, J.P. Morgan, Morgan Stanley and State Street.
• Keep returns competitive: MillTech’s platform allows users to compare current allocations with the latest rates across their MMF panel. This enables users to maximise returns, while staying within client-defined fund, issuer and concentration limits.
• Less administration: MillTech manages provider onboarding and account opening through one platform.
• Automated cash management: Set rules for how cash is allocated, invested and redeemed based on your liquidity needs.
• Better visibility and diversification: View cash positions and fund holdings in one place while reducing reliance on a single provider.
• Zero platform and transaction fees: Clients do not pay MillTech to access or use the platform. Any fund management fees are charged by the underlying money market fund provider and are generally reflected in the fund’s published yield.

Learn how MillTech can help you manage surplus cash more efficiently, explore our solution.

 

*Any investment involves a high degree of risk, including the risk of loss of the entire amount invested. Past performance should not be construed as a guarantee of future performance and the value of any investment may fall as well as rise.