[This article appears in the January issue of ETF Report
In recent years, fixed-income investors have grown more anxious. Indeed, they’re caught in a dilemma between seeking higher yields and avoiding losses due to looming interest-rate hikes. They yearn for high rates to provide current income, yet safety to avoid significant losses.
Fortunately, ETF issuers have not been strangers to this development, and have created several products with effective duration of less than one year, and the possibility of better yields to satisfy this niche. Ranging from active, short-term maturity funds to complex hybrid hedge structures, these funds have been warmly embraced by investors.
Moving Away From Money Market Funds
Not long ago, money market funds (MMFs) were an attractive cash management choice for retail and institutional investors, providing stable income generation with little worry about volatility.
Yet in today’s low-rate environment, MMFs do not satisfy investors’ appetite for better yields. On top of that, new regulations adopted by the Securities and Exchange Commission will make MMFs less attractive to yield-seeking, short-term investors and may favor structures such as ETFs.
One of the major regulatory changes is the introduction of floating net asset values (NAVs) for institutional prime MMFs. No longer will MMFs have the implicit safety of $1.00 NAV, and funds may be free to “break the buck.”
Although these cases may be extreme, some managers could see MMFs being not that different from an ETF. However, retail MMFs will continue to have a “stable” NAV.
Other major regulation changes include the decrease in the average maturity of securities in MMFs, down to 60 days or less. While the required lower average maturity makes MMFs safer, it also means lower yields, further decreasing their appeal as short-term income-generating vehicles.
Active Short-Duration ETFs
Investors are aware that higher yields translate to higher risks. Some of them have turned to professional managers to help them navigate through this environment. Enter the actively managed short-duration ETFs.
One quick look at a newcomer fund, the First Trust Enhanced Short Maturity ETF (FTSM), helps us realize the robust demand for these ETPs. Launched in August 2014, it already boasts $1.6 billion in assets. Actively managed short-maturity funds leave their trading decisions in the hands of the fund administrator. Their main premise is to beat MMFs on a total return basis. They hold securities such as investment-grade bonds, commercial paper, bank notes, repurchase agreements and, in some cases, foreign-denominated bonds.
From being almost nonexistent before 2008 in the ETF space, these funds have steadily accumulated assets (Figure 1). As of October 2014, they hold almost $7 billion in assets under management (AUM).