By Will Goldthwait, Portfolio Strategist, Global Cash and Fixed Income, State Street Global Advisors.
Optimizing intermediate cash investments in a low-yield environment.
In early March, investors began grappling with the effects of the global Covid-19 pandemic and the ensuing economic shutdown, setting off a steep decline that pushed equities into free-fall and essentially froze the fixed income market altogether – historic moves not witnessed even during the most difficult days of the 2008 global financial crisis.
Throughout the month of March, market participants identified short-term, high-quality fixed income securities as a safe place to ride out the storm.
The SPDR Bloomberg Barclays 1-3 Month T-Bill ETF (BIL US) experienced nearly $10 billion of inflows, representing greater than 100% growth in AUM in just one month.
Money market mutual funds also saw remarkable inflows, gathering $762 billion during March and growing by $1.1 trillion versus the start of 2020.
Despite mounting job losses, plummeting corporate profits, and disastrous economic data, miraculously, markets have rallied sharply since hitting their lows on 23 March. Massive fiscal and monetary policy responses have aided the unexpected rebound in risk assets and short-term market sentiment has been bolstered by the reopening of the global economy, optimism regarding potential health solutions to Covid-19, and a firm commitment from policymakers to do whatever it takes.
Although markets have rebounded, many investors are still feeling cautious, as evidenced by the large wall of cash effectively earning a 0% interest rate.
What is cash?
It’s important to clarify the definition of “cash.” Cash includes strategies such as BIL, which are typically not negatively impacted by volatility in risk assets. Ultra-short term bond strategies, such as the SPDR SSGA Ultra Short Term Bond Fund ETF (ULST US), can help to supplement cash positions and can be used to increase the yield of a cash allocation. Such strategies should be considered an intermediate holding that can be invested for up to 6 to 12 months.
Earning above-zero yield
For cash investors, the current challenge is the Federal Reserve’s interest rate policy and its impact on yields. After the Fed dropped its target rate to between 0.00% and 0.25%, the futures market indicated that no move is expected from this rate for two years, as shown below. As a result, certain short-term Treasury ETFs and money market funds are yielding close to zero.
Source: SSGA.
Investors must now determine the best path to earning above-zero yields on cash. Our research shows that, compared to BIL, ULST may currently offer almost 2.00% of additional yield, as shown below. Since 2016, this yield advantage has averaged approximately 0.50%. Over time, investors should expect that the yield differential is likely to revert to its historical average as credit spreads benefit from the Fed’s various liquidity programs and credit conditions continue to improve.
Source: SSGA.
Careful consideration should be given when choosing an ultra-short strategy. ULST uses a multi-asset, highly diversified approach to purchase credits to provide an optimal risk-return profile. Over time, this strategy can prove effective in mitigating interest rate risk and may provide greater income compared to a cash holding.
(The views expressed here are those of the author and do not necessarily reflect those of ETF Strategy.)