7/23/2012 5:49 PM ET|
Is new money-market fund an ETF?
Actively managed, ultrashort fixed-income ETFs are marketed as an alternative to money-market funds. What’s the risk?
Two years ago, faced with clients sitting on more cash and for longer periods, investment adviser Greg Sullivan began shifting some of their cash holdings into the Pimco Enhanced Short Maturity (MINT) exchange-traded fund. "At least with this we have a chance to get a small return," says Sullivan, who is a managing director at Harris SBSB in McLean, Va.
The fund's recent SEC yield (updated every 30 days, after expenses) of 0.99% doesn't sound like much, but it sure beats the alternative -- earning zilch in a money-market fund.
The fund, says Sullivan, is one of the best places to park cash for six months to a year. If clients are counting on the cash for an immediate need or the amount isn't significant, he'll stick with a money-market fund. "But if you have $100,000 or more that's otherwise sitting idle for a year, it's worth it," he says, adding that he frequently uses the strategy if a client wants to dollar-cost-average new assets into the market.
Before rates hit record lows -- the average money-market fund now pays just 0.03%, according to iMoneyNet -- few investors made the distinction between immediate cash and intermediate cash. "People were either in money-market funds or bond funds," says Tony Davidow, portfolio strategist at Guggenheim Investments, which manages the Guggenheim Enhanced Short Duration Bond (GSY) ETF. "But with rates lower and lower, there is interest for this."
There are currently a handful of ETFs investors might use in lieu of money-market funds. Most are passive index funds such as SPDR Barclays Capital 1-3 Month T-Bill (BIL) or PowerShares VRDO Tax-Free Weekly (PVI). They all stick with very short-term, highly liquid securities and generally yield slightly more than money-market funds but less than traditional short-term bond funds and ETFs.
Only 2 funds
The universe for actively managed, so-called ultrashort ETFs is composed of just two funds, Pimco's and Guggenheim's. If money-market funds are the answer for investors' immediate cash needs, these funds are the elixir for intermediate cash needs.
Like their mutual-fund brethren, these ultrashort ETFs favor high-quality issues with average durations of less than a year. They aren't subject to the stringent regulations money-market funds are, such as rules that govern how much of a portfolio must be able to be liquidated in seven or 30 days, or limits on the maximum average weighted maturity of a portfolio. But when packaged as an ETF, investors get intraday liquidity, low costs and real-time transparency.
Investors worried that managers are stretching their boundaries need only look at what's in the portfolio. Unlike mutual funds, which don't provide real-time holding information, ETFs are an open book.
"You're less likely to have managers taking on too much risk when they have to disclose their holdings daily," says Morningstar ETF analyst Timothy Strauts, who expects to see more near-cash strategies coming to market in the near future. In June, Franklin Templeton filed for permission to offer actively managed ETFs, the first of which will be the Franklin Templeton Short Duration Government ETF. And given the likelihood interest rates will stay low, as well as the runaway success of MINT, more will likely follow.
Guggenheim rolled out its fund in early 2008 and is also among the larger actively managed ETFs, though with about $165 million in assets it's considerably smaller than MINT. The fund recently had an SEC yield of 0.45%, with an average effective duration of about 2½ months. Although Treasurys represent the bulk of the portfolio, the fund boosts yield with single-A-minus and triple-B-rated corporate bonds. Just 5% of its corporate issues are triple-A-rated. The fund isn't taking on huge risk, says Davidow, "but we believe that additional credit work allows us to pick up some extra yield."
Launched in late 2009, MINT is clearly the favorite among both individuals and institutions. With $1.7 billion in assets under management, it's the second-largest of all actively traded ETFs, just a tad behind Pimco Total Return (BOND) ETF.
To achieve extra yield without a commensurate jump in risk, MINT dances just outside the boundaries of money-market funds, which generally cannot invest in securities with maturities longer than 397 days, and must maintain a weighted average maturity of no more than 60 days.
Issuers have "flooded the market" with those types of securities and still can't meet the demand, says MINT's manager, Jerome Schneider, who also manages the $11 billion Pimco Short-Term (PSHAX) mutual fund. "To the extent you can step outside those confines, you can capitalize on that." After all, he says, it doesn't make sense to own commercial paper from an issuer paying 0.1% when you can own the same credit -- but with a maturity that's six months longer -- and get a 1% yield. Although MINT's average effective duration is less than one year, its holdings range from maturities of six months to three years.
Likewise, MINT has the leeway to take advantage of mispriced liquidity premiums. Take triple-A-rated Canadian covered bonds issued by Canadian banks and collateralized by high-quality assets. While the bonds themselves aren't guaranteed by the Canadian government, many of the underlying assets are. Yet, the yields on these securities can be far better than comparable U.S. securities. "Our (U.S.) government obligations trade at Libor minus 20 to 30 basis points, and these are Libor flat or plus 10," Schneider says. "It's not that you're taking on more risk, but that you're getting a better risk-reward trade-off.
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Worth the risk?
Matthew Garrott, manager of investment research at Fairway Wealth Management in Independence, Ohio, isn't so dazzled. He points out that for an investment of $1 million, that difference amounts to about $5,000 over six months. He's not sure it's worth the risk. "If you have to think to the right of the decimal, is it really worth it?" he says.
To be sure, money-market funds, which have $2.5 trillion in assets, are still the preferred parking spot for cash. For now, most investors will choose the implicit guarantee of a steady net asset value -- a dollar in generally equals a dollar out -- over a better, but still-paltry, return. Even so, some experts believe that ETFs like MINT are a viable alternative to money-market funds, which have been under scrutiny recently. Policymakers, led by Chairman Mary Schapiro of the Securities and Exchange Commission, say money funds are prone to investor runs and, because of their size, are a liability to the financial markets.
"Investors treat shares in a money-market fund like a checking account, but that doesn't mean shares are actually worth a dollar, and when they go below it's a problem," explains Darrell Duffie, Dean Witter distinguished professor of finance at Stanford Graduate School of Business. When the Reserve Primary Fund infamously broke the buck in September 2008 (which meant investors lost their principal), the government issued a $3 trillion guarantee of money-fund assets. That guarantee has since expired, but Duffie says that the notion that the federal government will step in if a money fund breaks the buck is a fallacy that provides investors with a false sense of security and could also cause the funds themselves to take on undue risk.
In 2010, the SEC tightened restrictions on money-market funds, and Schapiro is now lobbying for more reform, which could include scrapping the stable net asset value or requiring issuers to keep capital reserves and impose redemption restrictions. Those changes could further drive demand for near-cash ETFs, says Duffie, who is a former member of the iShares board and member of the Squam Lake Group, which is composed of more than a dozen prominent economists calling for money-fund reform.
Reform or no reform, rising interest rates could further bolster these ETFs' popularity. "If rates rise, the mean return will increase," adds Duffie. "Something like a MINT will always offer a higher return than a money fund, even if rates go up."
Then again, says Sullivan, once money- market funds offer some kind of return, investors may not be so desperate to pick up yield. If given the choice between earning a 1% risk-free return and a 2% return with some risk, he thinks most investors will go for the former. Of course, given the current economic outlook, "I don't see that happening anytime soon," he says. "I think these exchange-traded funds will be in business for a while."
Guggenheim Short Duration Bond (GSY)
|0.42%||0.27%||Actively managed, invests primarily in short-term investment-grade securities|
|iShares Barclays Short Treasury Bond (SHV)||0.03%||0.15%||Passive ETF tracks an index of U.S. Treasuries with remaining maturities of one to 12 months|
|Pimco Enhanced Short Maturity (MINT)||1.02%||0.35%||Actively managed, invests in a variety|
|PowerShares VRDO Tax-Free Weekly (PVI)||0.45%||0.25%||Passive ETF tracks index of tax-exempt, variable-rate municipal bonds|
|SPDR Nuveen S&P VRDO Municipal Bond (VRD)||0.61%||0.20%||Passive ETF tracks index of tax-exempt, variable-rate municipal bonds|
|These ETFs aim to mimic the short-term, highly liquid nature of money-market funds. Many offer more attractive yields. But they aren't subject to the same stringent rules that money-market funds are, and you could lose some of your principal.|
Source: Morningstar -- Data as of July 10
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