Under The Hood: Short Term Bond ETFs

May 30, 2018

Over the past 10 years, it’s become conventional wisdom that holding cash doesn’t pay. Ever since the Federal Reserve famously cut its benchmark federal funds rate to zero in the wake of the financial crisis in 2008, cash has yielded close to nothing.

But that’s changing. After six Fed rate hikes since December 2015—and another one likely in June—cash is starting to look more attractive. The overnight federal funds rate is expected to near 1.9% next month, and could hit 2.4% by year-end if the “four rate hikes in 2018” camp is right.

While historically still low, those are pretty good yields compared with the zero that investors have come to expect in recent years.

Cash No Longer Trash

“Cash has once again become a legitimate asset class,” remarked Josh Jenkins, portfolio manager at CLS Investments.

Jenkins notes that the yield on the six-month Treasury bill recently hit a 10-year high of 2.12%, topping the dividend yield on the S&P 500 for the first time since the financial crisis.

Cash is also looking more attractive on a relative basis, he says: “The flattening of the yield curve implies investors are getting paid less by extending maturity. You’ll pick up less than 1% in additional income by extending out to the 10-year Treasury bond, and you’ll have to take on about eight years in additional duration. All things considered, that is not a great trade-off.”

“Picking up additional income by taking on credit risk does not look great either,” Jenkins added. “High-yield bonds, for example, are trading near the lowest spread to Treasury bonds of the current cycle.”

Yields & Inflows Picking Up

With cash yields on the rise, investors are taking notice. Ultra short-term bond ETFs—money-marketlike funds that hold bonds with less than one year until maturity—have seen hefty inflows so far this year. Yields on these funds are strongly correlated with the federal funds rate.

The most popular is the iShares Short Treasury Bond ETF (SHV), which garnered inflows of $5.9 billion this year, nearly doubling its assets.

SHV tracks an index of Treasury bonds that mature in less than one year, and currently has a 30-day SEC yield of 1.79%.

Meanwhile, the SPDR Bloomberg Barclays 1-3 Month T-Bill ETF (BIL), a fund that is even more “cashlike” in its holdings, also doubled its assets this year, thanks to inflows of $1.5 billion. BIL has a current 30-day SEC yield of 1.56%.

Actively managed competing products like the PIMCO Enhanced Short Maturity Active ETF (MINT) and the iShares Short Maturity Bond ETF (NEAR) have also seen interest, picking up $1.3 billion and $900 million, respectively, this year.

Both funds are more aggressive than SHV and BIL, with durations slightly higher and holdings stretching outside of Treasuries into corporates, mortgage-backed securities, and even dollar-denominated emerging market debt, in the case of MINT.

MINT has a current 30-day SEC yield of 2.19%, while NEAR has an equivalent yield of 2.29%.

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