Investors have been piling into cash, with portfolio allocations now at 15-year highs at nearly 6%, according to the Wall Street Journal. That data point could help explain why ETFs that behave like money-market proxies, offering cashlike exposure, are so hot this year.
What’s interesting is that the reason investors are running to cash—at least according to Russ Koesterich, head of asset allocation at BlackRock—has nothing to do with demand for safety. Traditionally, that’d be the driving force behind such high cash allocations. It would suggest pessimism about markets, and the economy.
Instead, Koesterich says that investors are looking for ways to diversify equity risk, and the historical diversifier of choice—bonds—is increasingly correlated to equity, and should become more so as monetary policy evolves and rate hikes take place.
‘Cash Is Once Again King’
In that environment, “cash is once again king,” as he puts it, as the “only major asset class available to hedge equity risk.”
“Many investors interpret high cash levels as a contrarian indicator, suggesting an excessive level of caution,” Koesterich said in a blog. “Today however, there is potentially a different interpretation regarding high cash levels. High cash levels are a rational response to the changing structure of cross-asset correlations.”
In the ETF space, there’s no question that demand and performance of ETFs viewed as money market proxies are strong this year. Consider these three funds (below) as a sampling of this segment, and their year-to-date performance—a clear uptrend:
- PIMCO Enhanced Short Maturity Active ETF (MINT)
- Guggenheim Enhanced Short Duration ETF (GSY)
- FlexShares Ready Access Variable Income Fund (RAVI)
Chart courtesy of StockCharts.com
The performance has gone hand in hand with net creations. MINT has now gathered more than $1.02 billion in fresh net assets in 2016, while GSY has taken in almost $300 million and RAVI $11.3 million in inflows.
“Fixed income is less attractive at higher correlations, particularly after accounting for low forward return expectations. Instead, portfolios hold more cash,” Koesterich added. These ETFs are bond ETFs.
Money Market Equivalents
But their ultra-short-term focus makes them, to many, an equivalent to a money market mutual fund in an ETF wrapper. Money market funds are essentially ultra-short-term bond funds that offer investors liquidity—as in quick access to their cash—and a small yield that’s typically more attractive than merely parking cash in a bank savings account. It’s as close to holding cash as it comes in fund form.
- MINT is an actively managed fund designed to deliver higher current income than the average money market mutual fund. It does so by investing in ultra-short-term, high-quality debt that’s global in scope. The portfolio currently has an average duration of 0.29 years. MINT has a net expense ratio of 0.35% and has $5.1 billion in assets—the largest actively managed ETF in the market today.
- GSY is an actively managed ETF with nearly $1 billion in assets that seeks to outperform the Barclays Capital 1-3 Month U.S. Treasury Bill Index. The global fund invests in a variety of fixed-income instruments, including commercial paper and bank loans, for an average duration of 0.25 years. GSY has a net expense ratio of 0.25%.
- RAVI is a $105 million actively managed ETF that owns investment-grade debt issued in the U.S. and globally. The fund currently tilts toward corporate bonds, and carries a net expense ratio of 0.25%. The fund has weighted average duration of 0.59 years.
“The ‘flight to safety’ concept—periods of volatility causing money to flow out of equity markets into fixed income and thus driving prices up and yields down—no longer looks viable," Bill Belden, head of ETF business development at Guggenheim, said.
"Based on some conversations we’ve had with advisors, it concerns them and contributes to their uncertainty in the interest rate environment. This uncertainty has increased their demand and need for ultra short duration,” he added.
Other Factors Driving Demand
Beyond demand for cash, another important driver of demand for these ETFs is regulatory change to money market mutual funds stemming from the 2008 credit crisis. In addition, the Securities and Exchange Commission is concerned that these types of cashlike investment vehicles may contribute to market instability in times of stress.
These changes impacting net asset values and fees of these mutual funds are said to be sending many investors looking for equivalent strategies in the ETF space.
Anticipation of higher interest rates is another important driver here, as investors look to shorten duration ahead of what many expect will be a rate hike in December.
Contact Cinthia Murphy at [email protected]