Why are investors flocking to money market funds amid falling interest rates?

In an environment of falling interest rates marked by investor caution toward fixed-income instruments, money market funds are emerging as the preferred option for short-term investments. These schemes are seeing increased investor interest, with AMFI data showing combined inflows of nearly Rs 43,000 crore in April and May 2025-the second highest among 16 debt-fund categories. Himadri Buch examines the factors driving demand for this debt category.

WHAT ARE MONEY MARKET FUNDS?

Money market funds are a category of debt mutual funds that invest in high-quality, short-term instruments such as treasury bills, commercial papers, and certificates of deposit. These instruments typically mature within one year. Given their short duration and low credit risk, these schemes aim to deliver stable returns, higher than those of savings accounts or short-term fixed deposits. These schemes also offer T+1 liquidity, which means your money is credited the next business day after withdrawal.

WHAT IS DRIVING INVESTOR INTEREST IN MONEY MARKET FUNDS?
Money market funds are currently offering yields of 7.2–7.5%, which is higher than many savings accounts (approximately 3%) and even some fixed deposits. Also, when interest rates fall, fresh FDs get reset at lower rates. Money market funds, however, continue earning better yields on existing holdings purchased before the rate cuts. Unlike fixed deposits that lock in your money, money market funds allow quick exits, usually with no or very low exit loads after a short holding period. These funds invest in high-quality instruments and are less volatile than longer-term debt funds.

HOW SHOULD INVESTORS CHOOSE A MONEY MARKET FUND?
While choosing a money market fund, investors should look for funds with high exposure to AAA-rated or sovereign instruments to minimise default risk. Check if the fund has an exit load for redemptions within the first few days, often up to seven days. Consider funds with a consistent performance track record and reasonable assets under management (AUM) for better liquidity and lower volatility

HOW ARE THESE FUNDS DIFFERENT FROM LIQUID OR OVERNIGHT FUNDS?
Overnight Funds invest only in securities with one-day maturity. These schemes carry virtually no interest rate or credit risk and are suitable for very short parking of funds (1–7 days). Yields are usually lower (around 5.5–6.0%) . Liquid Funds invest in instruments with a maturity of up to 91 days. They offer slightly higher yields than overnight funds (6.8–7.0%) and are suitable for parking money for a few days to a month. Money Market Funds invest in instruments with maturity of up to one year. They offer higher yields (7.2–7.5%) because they can lock into better rates for slightly longer periods. These funds are suitable for a 3–12 month investment horizon and carry modest mark-to-market (MTM) risk compared to liquid funds.