Ultrashort ETFs Appeal In Murky Market

While the asset class feels relatively safe right now, investors need to keep the big picture in mind.

Reviewed by: Jessica Ferringer
Edited by: Jessica Ferringer

Two worries have been at the forefront of investors’ minds in recent weeks: inflation and the Omicron variant.

These two factors could have significant impact on the markets going forward, though the impact of each is still up in the air, leaving the outlook uncertain.

Both concerns have rattled markets as investors work to assess the potential outcomes around each factor and what that could mean for the months ahead.

Combined with the exponential rise of the market since March 2020, lofty market valuations and historically low rates, some investors might feel inclined to call a timeout, opting for the safety of ultrashort fixed income ETFs.

Ultrashort Attracts Interest

Ultrashort fixed income ETFs like the Vanguard Ultra-Short Bond ETF (VUSB) and the JPMorgan Ultra-Short Income ETF (JPST) have no equity risk and limited interest-rate or credit risk. In an environment where worries of both an equity drawdown and rising rates abound, it is easy to understand their appeal.

JPST is an actively managed fund that aims to maximize income and preserve capital by investing in USD-denominated debt securities with an effective duration of one year or less. The fund has been around since 2017 and has amassed an impressive $18.5 billion.

JPST recently saw its highest net inflow of the year on Nov. 16, with nearly $281 million coming into the fund in a single day. Overall, JPST has seen nearly $3 billion in inflows since the year started.


JPST Daily Fund Flows

Courtesy of FactSet

(For a larger view, click on the image above)


VUSB is a newer entrant to the space, having launched in April. The fund has already amassed nearly $2 billion this year, and also saw its largest daily net flow of $68 million on Oct. 28.


VUSB Daily Fund Flows

Courtesy of FactSet

(For a larger view, click on the image above)


Unique Environment Supports Appeal

Though investors—particularly those who are in it for the long haul—are advised to stay invested and ignore short-term volatility, it is easy to understand why allocating to cash or shorter-duration fixed income has more appeal than usual in this particular environment for those who want to take equity risk off the table.

Fixed income does not offer the protective power it once did due to accommodative monetary policy that has been in place since the financial crisis. But given this particular set of dueling worries, the path forward for interest rates is especially murky.

The narrative at the beginning of November was around rising rates, given the threat of inflation looming over the market. But on Tuesday, Fed Chair Jerome Powell told lawmakers that the Omicron variant posed downside risks to economic growth and employment.

If the latest variant turns out to evade vaccine immunity or have more serious symptoms than currently expected, equities and the economy could be affected negatively, which would likely extend the timeline for raising rates.

But delaying rate hikes could have the effect of worsening inflation, setting the stage for aggressive rate hikes going forward. At least for now, Powell is signaling that inflation is a greater risk, with the central bank considering speeding up tapering at the next FOMC meeting in December.

The expectation for rising rates and inflation means that the iShares Core U.S. Aggregate Bond ETF (AGG) has underperformed funds like VUSB and JPST over the past few months.



Following this rationale, ultrashort fixed income can feel like an ideal place to be for the time being.

Market-Timing Drawbacks

But market timers who stay on the sidelines until they feel certain equities are back on solid ground are playing a dangerous game. Looking at the SPDR S&P 500 ETF Trust (SPY) over various time periods in 2020 illustrates that point.

In the rebound from the market sell-off in late February and early March, SPY gained 69.8% from March 24 through the end of 2020.



But an investor who sat out on March 24 and was only invested from March 25 through the end of the year would have seen gains chopped by over 14%.



And an investor who needed a little more reassurance that markets were on solid ground and waited until March 31 missed out on over 25%.



This example illustrates the potentially high price of sitting on the sidelines and missing the beginning of the stock market’s recovery for tactical investors who desire equity exposure over the long run.

Consider Your Circumstances

With every investor having unique parameters for their investment goals, time horizon and risk tolerance, there are many factors to consider when evaluating how to play the current market environment.

Some investors will be able to weather a potential simultaneous downdraft in equities and fixed income, while others will be better served by preserving capital. Those who work with a financial advisor to assess their risk tolerance and asset allocation will likely have done this work already, while benefiting from an objective eye.

However, it is easy to misjudge risk tolerance in markets that only seem to go up. A prolonged downturn could highlight that some investors have been lulled by the relative calm of the market.

And other investors should be certain they are not letting fear get the best of them, sitting on the sidelines when staying invested might be more appropriate for their long-term investment goals.

DIY investors in particular, especially those who are younger and with limited experience with market drawdowns, may need to take extra care to keep their big picture investment goals in mind.

Contact Jessica Ferringer at [email protected] or follow her on Twitter

Jessica Ferringer, CFA, is a writer and analyst for etf.com. She has 10 years of experience in investment research and due diligence, including helping to manage ETF portfolios. Jessica has a bachelor’s degree in economics from Lafayette College and an MBA from the University of Pittsburgh.