Conundrum – “An Intricate and Difficult Problem”
With household cash levels at an all-time high, many investors are facing what we call a cash conundrum—what to do with their excess cash without taking significant interest rate risk, credit risk, or liquidity risk. We believe there are several potential solutions that investors should consider.
How Did We Arrive at this Conundrum?
While the COVID pandemic resulted in a recession, it was also the catalyst for what is likely the culmination of a decade of unprecedented levels of government stimulus that put cash in the hands of individuals and corporations. At the same time, increased involvement by the Federal Reserve (Fed) put downward pressure on already low fixed income rates which helped fuel record high stock prices and valuations all the way through 2021 but now has enabled inflation in goods and services to take hold in the global economy. Add in recent geopolitical uncertainty, double digit inflation, and duration risk concerns as interest rates rise and it is not surprising that investors are holding record amounts of cash, as illustrated in Exhibit 1.
Exhibit 1: Household Cash at Record Levels
Source: Board of Governors of the Federal Reserve System (US).
The Solution Is in Sight—Short Duration Strategies
As we progress in 2022, higher short-term interest rates are beginning to offer investors a possible solution to their cash conundrum. Over the last year, short-term fixed income rates have increased more than 100 basis points, as shown in Exhibit 2. Whereas previously investors were faced with essentially 0% interest on their cash holdings, today investors may be able to earn significantly higher yields on their short duration investments while mitigating duration risk.
Exhibit 2: Short-Term Rates Are Up Over 100+ Basis Points
Treasury Yield Curves
April 2021 vs April 2022
Source: Bloomberg as of 4/30/22. Past performance does not guarantee future results. All investments involve risk, including the possible loss of capital.
When a fixed income investment has a yield that is more than the duration of the investment, it provides an investor “cushion” to help protect against the loss of value created by rising interest rates. For example, if interest rates/credit yields increase by 100 basis points, an investor that has a short duration investment with a yield of 2.50% and a duration of 1.5 years can still have a positive total return, due to the yield cushion on the investment.
The table below shows the duration and yield for the Bloomberg U.S. Government/Credit (Gov’t/Credit) 1-3 Year Index over the last five years, and the total return during each period if interest rates increased by 100 basis points. With today’s higher yields, investors are once again provided with a cushion to help offset the price declines created by rising interest rates.
Exhibit 3: Impact of Duration on Total Return
Bloomberg U.S. Gov’t/Credit 1-3 Year Index
2018 – 2022
Source: Bloomberg as of 4/30/22. Past performance does not guarantee future results. All investments involve risk, including the possible loss of capital.
How Can Investors Access These Higher Yields?
Historically, investors have used prime money market funds; however, they currently yield less than other shorter duration options. In addition, some may recall that the rules for prime money market funds have changed following their bailout by the U.S. government in 2008 and again in March 2020. Currently, prime money market funds can gate withdrawals and, at times, may be subject to swing value pricing (i.e., when a fund provider adjusts the net asset value (NAV) of a fund to pass on the costs of trading to those buying and selling within the fund). Simply put, prime money market funds are no longer the guaranteed stable fixed income investment they once were.
Another option for investors to consider is short-term bond mutual funds and ETFs. These funds have experienced record asset growth such that some are now among the largest bond funds in the world. However, bigger isn’t always better and some funds may not be well-suited to certain types of investors. For example, various short-term funds have exhibited widely negative returns in times of crisis, such as in March of 2020 when some of these large funds were down over 9%. These negative returns are often due to a liquidity event (e.g., fast money investors rushing to exit a fund) or to the fund having a longer duration as a result of not owning traditional short duration investments. That is why it is of utmost importance that investors fully understand what is held in these short-term investment vehicles.
The Benefits of SBH Separately Managed Accounts
We believe that investors looking to solve today’s cash conundrum should consider short duration Separately Managed Accounts (SMAs). There are many benefits to investing in SMAs including:
– Customization of investment portfolio
– Tax advantages
– Typically a lower cost option than funds and ETFs
Segall Bryant & Hamill (SBH) offers several high quality short-term SMA options that are highly customizable and designed to enhance the cash portion of a diversified portfolio. These strategies seek to provide higher yields than traditional money market alternatives while helping to protect against interest rate risk and maintaining a high degree of liquidity.
– SBH Ultra Short Term
– SBH Short Term Gov’t/Corp
– SBH Short Term Plus
As can be seen in the chart below, the SBH short-term strategies yielded more than money market funds without taking significantly more duration risk.
Exhibit 4: SBH Short Term Strategies Offer Attractive Yields with Low Duration
Sources: BondEdge, Bank of America Merrill Lynch (BofAML), Bloomberg as of 4/30/22. Yield to worst is the lowest return that can be received on a bond without the issuer defaulting. Past performance does not guarantee future results. All investments involve risk, including the possible loss of capital.
1 Money Market represented by the Vanguard Prime Money Market Fund
2 0-1 Year U.S. Treasury represented by the BofA ML 0-1 Year Treasury Bill Index
3 1-3 Year U.S. Gov’t/Credit represented by the Bloomberg 1-3 Year U.S Government/Credit Index
In addition, these strategies are designed to generate income across market cycles while emphasizing downside protection. We pursue these objectives by identifying short maturity securities that meet our high-quality standards and may be overlooked by fixed income mutual funds and ETFs.
Our approach is further differentiated by the following:
To learn more about customized short-term SMA solutions at SBH, please reach us at (800) 836-4265 or contactus@sbhic.com.
Last updated May 2022. All opinions expressed in this material are solely the opinions of Segall Bryant & Hamill. You should not treat any opinion expressed as a specific inducement to make a particular investment or follow a particular strategy, but only as an expression of the manager’s opinions. The opinions expressed are based upon information the manager considers reliable, but completeness or accuracy is not warranted, and it should not be relied upon as such. Market conditions are subject to change at any time, and no forecast can be guaranteed. Any and all information perceived from this material does not constitute financial, legal, tax or other professional advice and is not intended as a substitute for consultation with a qualified professional. The manager’s statements and opinions are subject to change without notice, and Segall Bryant & Hamill is not under any obligation to update or correct any information provided in this material.