With central banks globally raising interest rates, getting exposure to overnight interest rates through investing in overnight funds has become increasingly attractive. Overnight funds refer to pooled investment vehicles that aim to generate returns similar to overnight interbank lending rates. There are several ways for investors to gain exposure to overnight rates. This article will explore four common methods to invest in overnight funds and their characteristics.
Invest in money market funds tracking overnight rates
Money market funds that track overnight interbank lending rates like the federal funds rate and LIBOR are an accessible way for individual investors to invest in overnight funds. These funds have very low risk and high liquidity. Returns fluctuate daily based on small changes in overnight rates but generally closely track benchmark overnight rates.
Trade overnight index swaps
For institutional investors, trading overnight index swaps (OIS) directly provides exposure to overnight rates. OIS are derivative contracts where investors swap fixed interest rate payments for daily compounded overnight rates over the life of the contract. Trading OIS requires substantial capital and derivatives expertise.
Invest in fixed-income securities maturing overnight
Buying short-term fixed-income instruments like commercial paper and short-dated bonds maturing overnight provides direct exposure to prevailing overnight rates. However, the administrative burden of rolling over many securities makes this challenging for most individual investors.
Use repurchase agreements collateralized with cash
Repurchase agreements (repos) using cash as collateral generate returns equal to overnight interbank rates. Repos provide similar exposure as investing directly in money markets but allow greater customization of terms. However, efficient use requires extensive operational infrastructure.
The easiest way for most individual investors to gain exposure to overnight interest rates is through money market funds that track benchmark overnight rates. More sophisticated investors can get tailored overnight rate exposure through derivatives like OIS or repo transactions using cash collateral.