Will Goldthwait is a Senior Portfolio Strategist on State Street Global Advisors’ Fixed Income Currency and Cash Team. In this capacity, Will works closely with clients across the globe to identify their fixed income and cash opportunity set and to develop strategies to meet their unique needs. Prior to joining State Street, Will spent eight years managing cash portfolios and nine years selling fixed income instruments to cash and short-duration portfolio managers.
What themes are resonating with clients relating to their investments in cash and short-duration products?
In the US, we saw more than $600B of inflows into money market funds in 2019.1 These flows started in 2018 as short-term interest rates hit their cycle high, peaking at 2.25% to 2.50%. All of a sudden, cash as an asset class was a nice place to be, given the geopolitical backdrop. And that trend continues, particularly in the US, even though we're 0.75% lower than we were at the cycle high. Earning between 1.50% and 2% on your cash strategies has been a pretty reasonable investment as we wait for US-China trade negotiations, Brexit, and other challenges to sort themselves out.
What clients are doing with their cash portfolios is multi-pronged, depending on their objectives and desired outcomes. In addition to the flows into money market mutual funds, flows into ultra-short ETF strategies in the US have also been very strong, hitting $8.9B for 2019.2 Some clients are very focused on credit and have been moving up and down the ratings spectrum. Others focused on duration are moving up and down the yield curve. It comes down to what your risk parameters are and what you're willing to accept as far as drawdowns or price volatility. When we stress a cash, enhanced-cash or ultra-short strategy, what do those returns look like and how much does the net asset value move on those various scenarios?
Some of our clients are not willing to take a single basis point (bp) of drawdown, whereas others are willing to take 50 to 100 bps of drawdown, depending on their investment horizon. These are the types of conversations we're having with clients to help them walk through how to define their risk parameters and understand what levers they can pull to enhance returns or constrain risk given those parameters.
When you think about the cash needs of different clients, what are some of their specific needs and how should they be thinking about their investments in cash or short-duration products based on those needs?
Some clients are very familiar with the concept of bucketing their cash for immediate liquidity needs versus longer-term liquidity needs. This can be a boring conversation for many folks because we have been talking about bucketing for years, but with returns as low as they are, it has become even more important.
When you go from an interest rate environment of 4%, 5% or 6%, bucketing your cash is not as impactful as it is when you’re in an environment of negative 50 bps in Europe or negative 75 bps in Switzerland, positive 75 bps in the UK, and even 150 to 175 bps in the US. That 20, 30 or 40 bps becomes a lot more meaningful in this low interest rate environment and investors are paying more attention to it; they are mindful of how they are determining how much cash they need and when they need it.
When we talk to a client that is looking to buy a short-term ETF, such as the SPDR® Bloomberg Barclays 1-3 Month T-Bill ETF (BIL), that's cash that they need today or in a week. And when clients are thinking about owning the SPDR® SSGA Ultra Short Term Bond ETF (ULST) or the SPDR® Bloomberg Barclays Investment Grade Floating Rate ETF (FLRN), that might be cash that they need in three to nine months. Cash that's going to work a little bit harder for them but carries slightly more risk than a US Treasury bill strategy. They also need to be in that allocation for a longer time horizon to harvest that return. If there is market volatility and a resulting drawdown, they will have time to ride it out and won't be as negatively impacted by the price volatility in that strategy.
How has the nearly $14 trillion worth of global negative yields impacted clients investing in short duration?
After recently visiting with clients in Europe, this is a real challenge for folks. Our clients holding euros and yen are really struggling with negative returns on cash strategies.
So we are working closely with clients to help them mitigate the impact of negative interest rates and show them how to manage the risks that may occur as they try to prevent the deterioration of principal in markets with negative interest rates. Specifically, we talk about how to stretch for yield – whether it's duration or credit – and the need to be aware of what returns might look like if there is a shock to the portfolio. It's a little bit easier to reach for yield in euros now that the European Central Bank (ECB) has resumed quantitative easing (QE) and it looks like the theme in euro cash yields is lower for longer.
There are a lot of clients that feel comfortable with this reach for yield and extension in risk, but others feel that $14T in negative interest rates can only go one way – up! Those clients are willing to stay in their lane and let negative interest rates deteriorate principal. They understand that it is the cost of holding euros or yen.
In 2019 we saw a record inflow into fixed income ETFs, with higher flows into the shorter-duration fixed income and cash alternative type of product. What specifically do you think has been driving these flows?
Broadly speaking, flows into fixed income have been pretty consistent across both retail and institutional clients. Overall, there is a more cautious bias in the market, and as we achieve new highs in risk assets, specifically equity markets, I think investors are saying, “It's OK to take a few chips off the table and move into cash and fixed income.”
Pension funds are de-risking. They are selling equity positions and allocating more to fixed income so they can lock up the liability of their benefit payments. This demand is primarily at the longer end of the yield curve.
Also, recognizing that equity markets around the globe had a phenomenal year in 2019, a lot of folks are thinking that it might be worthwhile to take a little money off the table and have a little dry powder, as they say, in preparation for some sort of a correction. These allocations tend to move into short-term fixed income and cash.
How are investors leveraging ETFs specifically when managing their cash exposure?
I think ETFs continue to gain momentum as an optimal commingled vehicle in the marketplace. In addition to using ETFs to gain exposure in high yield – or in various equity strategies, large cap, small cap, etc. – investors also understand that there are real asset allocation advantages, even at the front end of the yield curve. In addition, we’ve recently seen certain RIA custodians remove commissions from ETF trades, which enhances their attractiveness as an option for higher yield versus traditional sweep vehicles.
When considering allocations to cash strategies, there are several options that ETFs provide. For safety, security and liquidity, you have BIL, an $8–9B ETF that will provide you that risk-free rate, secondary market liquidity, and returns that closely match US Treasury bills. It's a place to park your cash while you're looking to tactically allocate assets, or if you are just waiting for some of the geopolitical tensions to subside.
If you are looking to pick up a little more yield with credit and duration exposures, ULST or FLRN, provide two short-term strategies. ULST is a multi-asset active strategy that has some good diversification in its underlying exposures. FLRN is an index strategy benchmarked to the Barclays Floating Rate Note <5 Years Index. Both really take interest rate risk off the table as their durations tend to be less than half a year and they include a substantial amount of floating rate debt. With either ULST or FLRN you can own some longer maturing credits, and combined with BIL, you can provide investors with a nice barbelled cash strategy. This allocation within the short-term space with ETFs gives investors a lot of good options in the ultra-short fixed income and cash markets.
1 Investment Company Institute, as of 12/31/2019.
2 Source: Morningstar Direct, as of 12/31/2019.
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