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How to Manage Reinvestment Risk and Put Cash to Work Now

With Federal Reserve (Fed) rate cuts on the horizon, cash-like money market mutual fund returns may be challenged by lower yields and increased reinvestment risk — the process of reinvesting current income streams at lower rates.

Lower future returns for a category with more than $1 trillion of inflows in the past year1 means that many investors may want to reconsider portfolio construction decisions, with the goal of putting this excess “cash” to better work.

5 min read
Head of SPDR Americas Research

Rate Cuts Can Increase Reinvestment Risk and Decrease Returns

Consensus estimates and forward looking futures pricing suggest investors should expect three rate cuts in 2024, with the policy rate falling from 5.5% to 4.5% by yearend.2 With a 99% correlation between the federal funds rate and US 3-month Treasury Bill yields (T-bills),3 any rate reduction will likely have a one-to-one impact on T-bills yields and similar ultra-short tenors. And, historically, lower rates have indicated lower future returns for cash-like instruments.

Over the past 30 years, as T-bill yields began to adjust, so did future 12-month returns. In fact, there is a 97% correlation between the two (Figure 1).4 This illustrates the challenges with reinvestment risk, and the reason why you may want to consider new strategies now.

5 Fixed Income ETF Strategies to Consider Now

Investors’ aggressive buying of $1 trillion of money market funds over the past year primarily was propelled by generationally elevated yields. But it was also driven by the need for return stability.

As a result, any strategy you’re considering to manage the impact of reinvestment risk and replace cash-like exposures should also seek to balance income with stability. As you aim to move further out on the curve and put cash to work, here are five potential SPDR® ETF solutions that may help you strike that balance:

1. SPDR SSGA Ultra Short Term Bond ETF (ULST)

ULST is an actively managed strategy that invests primarily in US dollar-denominated investment-grade fixed income securities but can own up to 10% in high yield, as it seeks to maximize current income consistent with the preservation of capital and daily liquidity. In pursuing this objective, the ETF also targets a duration of 1 year or less and a weighted average maturity of 2.5 years or less.

Given State Street Global Advisors’ Active Investment team’s credit selection and risk management tactics, ULST currently offers a yield greater than core bonds (SEC Yield of 5.2% versus the Bloomberg US Aggregate Bond Index’s yield-to-worst of 4.9%), but with 86% less return volatility over the past three years.5

2. SPDR DoubleLine Short Duration Total Return Tactical ETF (STOT)

STOT is an actively managed strategy that prudently combines traditional interest rate-sensitive sectors with non-traditional credit-sensitive sectors in a duration-controlled portfolio (between one and three years), to potentially create a high-quality, low-volatility income strategy.

With this approach, STOT has beaten its benchmark and had top quintile returns within the Morningstar Short Term Bond peer category over the last one-, two-, and three-year time periods. And its 30-day SEC yield is currently 5.2%, but with only 1.4 years of duration.6

3. SPDR Portfolio Short Term Corporate Bond ETF (SPSB)

SPSB seeks to track an index of US-denominated, high quality investment grade corporate bonds with maturities between one and three years. This leads to a weighted duration of 1.7 years, but with a 5.1% 30-day SEC yield for the ETF.7

And the yield on the types of bonds in the ETF is less correlated (71%) with the federal funds rate than ultra-short instruments.8 That means that if the Fed does cut three or more times, those cuts won’t be felt on a one-to-one basis in the yield.

4. SPDR Portfolio Intermediate Term Corporate Bond ETF (SPIB)

SPIB seeks to track an index of high quality investment grade corporate bonds with maturities between 1 and 10 years.

This leads to a weighted duration of 4 years, which allows investors to modestly lengthen duration even more versus ultra-short markets and also trim duration risk (and volatility) relative to broader core bonds — all with a current 30-day SEC yield of 5.2%.9

5. SPDR DoubleLine Total Return Tactical ETF (TOTL)

TOTL is an active core bond strategy that combines traditional and non-traditional fixed income sectors, while seeking to generate high-quality income and exploit inefficiencies within the global fixed income market. Combined with active risk constraints, the ETF’s approach has led to above-benchmark performance over the past one, two, and three years.

The ETF has a current 5.6% 30-day SEC yield and a duration of 6.2 years.10 That means this fund is for investors seeking to more deliberately increase duration as they put their cash to work, but to do so in a risk-aware manner, as TOTL has lesser return volatility than the Bloomberg US Aggregate Bond Index (Agg) on a one-, three-, and five-year basis.11

Manage Your Reinvestment Risk

The yield, duration, and trailing three-year volatility of returns for all five of the aforementioned ETFs are plotted in Figure 2, alongside the same metrics for three-month T-bills (a proxy for money market funds given similar tenor focus) and the Agg (a proxy for core bonds).

Looking across each potential SPDR Fixed Income ETF investment option, the duration increases as does the volatility — and, so does the potential for investors to participate in any duration-induced price appreciation that could arise from a decline in rates. The opportunity to achieve greater sector diversification potentially increases too.

This illustrates how you can use these strategies to move further out on the risk curve while adopting a more total return mindset, as opposed to owning only cash-like instruments. The bottom line is, if you’re seeking to mitigate the erosive impacts of reinvestment risk on your accumulated money market fund positions, you have multiple options to consider for putting your excess cash to better work.

If you have questions about these strategies, we’re happy to help. Please reach out to your State Street Global Advisors representative directly or contact us.

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