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%.
Not All Short-Duration ETFs Created Equal
SHV, BIL, MINT and NEAR are by no means the only ETFs in the ultra-short-term bond space. There are a number of funds that provide low-duration exposure. Some exclusively hold Treasuries; others take on riskier debt. Some limit their maturities to one year or less; others hold longer maturities.
Generally, fixed-income instruments with maturities of less than five years are considered short term, while instruments with maturities of less than one year are considered ultra-short term.
Wading away from Treasuries may boost yields but adding credit risk. Taking on longer maturities may add yield at the expense of greater interest rate risk.
“Not all short duration ETFs are created equal. They all have their own risk and return profiles,” said Kelly Ye, director of research for IndexIQ. “The majority of the short-duration ETFs are composed of short maturity bonds, which still have some interest rate risk. Floating-rate ETFs can benefit from a rising rate environment, but they’re subjected to liquidity, credit and call risk. Interest-rate-hedged products could subject investors to curve risk.”
According to Ye, there is no “one size fits all” ETF for investors.
“Short-duration Treasury ETFs are good for investors looking for cash equivalent and value safety above all,” she added, “while short-duration corporate bond/bank loan ETFs are for investors willing to take credit risk to pick up incremental yield.”
Things To Consider
Jordan Farris, managing director of ETF product development for Nuveen, recommends investors consider funds that offer an attractive yield—something that will generally outpace inflation—and minimizes interest rate risk while still achieving income objectives.
Meanwhile, CLS’ Jenkins advises that investors have a clear vision of what they want out of their allocation to short-term bonds.
“Some decision points to help narrow the available options include active versus passive, fixed versus floating, one year or less versus one- to three-year maturity, and government versus spread sector, he explained. “These decisions will impact expected risk and return. Other factors to analyze include cost, liquidity, portfolio construction, tracking error (for passive ETFs), and manager process and philosophy (for active ETFs).”
Most Popular Short-Term Bond ETFs Of 2018
Data measures the year-to-date period through May 24, 2018.