Why Cash is No Longer King

The Advantages of Short Duration Strategies

The Federal Reserve’s (Fed) effort to fight inflationary pressures by raising interest rates has elevated risks in fixed income markets including liquidity, counterparty, reinvestment, recession, and most recently, risks associated with the banking sector. This has left many investors facing what we call a cash conundrum—how to earn an attractive yield on their excess cash without taking on significant risk.

 

The Solution Is in Sight—Short Duration Strategies

Rate hikes have created pockets of opportunity for fixed income investors. Yields on short-term marketable bonds are at their highest level in more than a decade, while bank deposit yields remain close to zero. Since December 2020, nine boosts in the Fed Funds rate to 5.00% have outstripped banks’ action in response: bank savings deposit rates have increased to only 0.37%. We believe that investors can pick up significantly more yield by using short-term high-quality fixed income investments, as illustrated in Exhibit 1. For example, the yield differential between short-term investment grade corporate bonds and bank savings deposits is 4.85%.

 

Exhibit 1: Short-term Fixed Income Yields Are Significantly Higher than 0.37% Yield on Bank Deposits

Data as of 3/31/23. Source: Bloomberg, FDIC. One cannot invest directly in an index.

 

Current Yields Provide Investors with “Cushion”

The significant rise in short-term interest rates has provided investors with “cushion” to help protect against the loss of value should interest rates rise or credit spreads widen.

“Cushion” is the result of a fixed income investment that has a yield higher than the duration of the investment. As illustrated in Exhibit 2, an investor that has a short duration investment with a current yield of 5.22% and a duration of 1.82 years can still have a positive total return due to the yield cushion on the investment.

 

Exhibit 2: Yields > Duration Helps Protect Investors from Loss of Value
Bloomberg 1-3 Year Corporate Index

Data as of 3/31/23. Source: Bloomberg.

 

Decoding Traditional Short Duration Strategies

Although short duration strategies may be a solution to the cash conundrum, not all strategies are created equal. With the rise of risks in fixed income markets, it is important for investors to be aware of the risks associated with different types of short duration securities. Exhibit 3 compares four short duration strategies and key risks and opportunities we believe are associated with each.

 

Exhibit 3: Key Risks and Opportunities of Traditional Short Duration Strategies

 

We believe that a consistent maturity profile can protect investors both when rates go up or spreads widen (due to the investment cushion) and when rates fall (from reinvestment risk). We also believe that investing in a diversified portfolio of high-quality fixed income securities allows investors to take advantage of any dislocations caused by liquidity issues or volatility in the marketplace.

 

Accessing Higher Yields; The Advantage of Separately Managed Accounts

There are various investment vehicles through which investors can access today’s higher yields. As most are aware, investors have historically used prime money market funds; however, these funds can charge higher fees compared to other shorter duration options. In addition, the rules for prime money market funds 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 subjected 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 way for investors to access higher yields is through 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 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 a 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 understand what is held in these short-term investment vehicles.

We believe that investors looking to solve today’s cash conundrum should consider short duration SMAs. There are many benefits to investing in SMAs including:

– Customization of investment portfolio
– Tax advantages
– Full transparency of securities owned
– Typically, a lower cost option than funds and ETFs

 

The Benefits of Segall Bryant & Hamill SMAs

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 alternatives, including traditional money market funds, 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
– SBH Short Term Municipal

 

Yield to Worst on Cash Alternatives
(As of 03/31/23)

 

Duration on Cash Alternatives
(As of 03/31/23)

Sources: BondEdge, Bank of America Merrill Lynch (BofAML), Bloomberg as of 3/31/23. Past performance does not guarantee future results.
1 0-1 Year U.S. Treasury represented by the BofAML 0-1 Year Treasury Bill Index
2 1-3 Year U.S. Gov’t/Credit represented by the Bloomberg 1-3 Year U.S. Government/Credit Index
3 Tax equivalent yield at a tax rate of 35%
4 Money Market represented by the Vanguard Prime Money Market Fund

 

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 [email protected].

 

Last updated April 2023. 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.

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