Eric Dutram: The second quarter of fiscal 2012 marked great uncertainty for equity markets worldwide. After posting double digit gains for the first quarter of fiscal 2012, the markets were unable to extend their streak further into the year.
Sluggish economic data from the domestic U.S. front and lack of proactive measures to resolve the euro zone debt crisis were the major contributors behind the slump, and these issues look to plague the market going forward this year as well (read Spanish Bailout: Did It Help European ETFs?).
After two consecutive quarters of above average earnings seasons, corporate America is most likely going to post a disappointing picture this time around, given the sluggish global demand and slowdown in global economic conditions. An appreciating U.S. Dollar is also likely to impact revenues; especially for the export oriented sectors of Technology, Materials, and Industrials (read Is It Time To Buy The Hedged Currency ETFs?).
This is of concern given the fact that companies from these sectors generate a bulk of the revenues from outside the U.S. Any sluggish global demand for the products globally will also hurt their revenues.
These factors increase the possibility of another round of QE3 significantly, although the domestic U.S. economic condition is not as bad as other developed economies. However, the ultra low interest rate policy of the Federal Reserve (Fed) seems to be running out of steam as anything significant is yet to occur.
Thankfully, the Consumer Price Index (CPI) number for the U.S. economy stands at depressed levels of around 1.70% for the month of May 2012. This is well in alignment with the Fed’s inflation targets of 2%. It rules out any necessity for a tighter monetary policy leading to rate hikes which would increase long term borrowing costs.
From an investment point of view, bond investors are having a tough time choosing between stability, income and capital protection because the interest rates presently stand at depressed levels (read Floating Rate Bond ETF Investing 101). The indication is that further investment in them would result in capital loss once interest rates start rising. This is especially true for longer dated securities with greater duration levels are more sensitive to interest rate movement.
Therefore, at a time like this, is important to lay emphasis on asset allocation for bond investors. Exchange Traded Funds are the ultimate tools for portfolio management as they provide a holistic exposure in a particular index, asset class or economy.
Money market ETFs provide an opportunity as a cash alternative investment. These ETFs target the immediate end of the yield curve which results in the ETFs having lower durations (i.e. lower sensitivity to interest rate movements) and lower residual maturity. These attributes of the ETFs make them a safe haven investment (read Real Estate ETFs: Unexpected Safe Haven).
However, the flip side also holds true. The upside potential for these funds are also significantly reduced compared to long term bond ETFs. Also, the money market securities currently sport a paltry yield which makes them poor destinations for investors seeking current income (read Real Return ETF Investing 101).
Still, thanks to the extreme safety in funds targeting this corner of the market as well as the relatively low fees associated with many products in the space, any of the money market ETFs could make for interesting safe haven choices as a way to park cash in this troubling time.
For investors seeking exposure to money market ETFs as a spot to stash cash during the tumultuous market, we have highlighted some of the options in the short-duration space which could make for interesting, and very liquid, alternatives to traditional money market fund investments:
iShares Barclays Short Treasury Bond ETF (NYSEARCA:SHV)
Launched in January of 2007, SHV is the biggest and cheapest product in the ‘money market’ ETF space. It tracks the Barclays Capital U.S. Short Treasury Bond Index which measures the performance of short term Treasuries. The ETF targets the shorter end of the treasury yield curve and is pretty much immune to interest rate risk as it has an effective duration of just 0.40 years (see Looking for Safety? Try These Money Market ETFs).
This means that if the interest rates increase by 1%, the value of the investments in SHV would only go down by 0.40%. However, the weighted average coupon is just a mere 0.94% which is lower than most bond funds out there.
At an expense ratio of just 15 basis points, the ETF is one of the most cost effective products in the space. SHV has witnessed a huge inflow in its asset base of late which presently stands at a $2.45 billion.
The ETF has an average daily volume of 265,736 shares. Presently it holds 17 Treasury bonds having a residual maturity from a month to a year.
The product sports a paltry 30-day SEC yield of just 3 basis points. However, it is an appropriate choice for investors seeking cash alternative investments coupled with stability in terms of protection.
The ETF is a safe haven investment and in volatile markets it surely would go a long way in protection of invested capital (readThree Muni Bond ETFs to Weather the Coming Storm). The ETF has pretty much been flat over the past year for returns, despite the market turmoil.
PIMCO Enhanced Short Maturity Strategy ETF (NYSEARCA:MINT)
MINT is one of the more aggressive and actively managed products in the money market ETF space that seeks to outperform the performance of the broader money market. It is not linked to any particular benchmark index but includes securities with shorter maturities in order to gain short term exposure.
The ETF employs an active management strategy and includes securities from different sectors like Government, mortgage, emerging markets, municipal bonds and also other investment grade securities. This strategy enables the ETF to differentiate itself from its peers and provide superior upside potential.
However, in order to do this it has to somewhat compromise on the credit quality of the securities given the fact that MINT includes securities issued by other institutions besides the Government (seeTop Three Mortgage Finance ETFs).
Despite employing an active methodology for portfolio construction, the ETF charges a paltry 35 basis points in fees and expenses. The ETF was launched in November of 2009 and since then has managed to amass an asset base of $1.73 billion.
The fund also has a robust volume, coming in close to 200,000 shares in a normal day. The fund also has a well diversified portfolio, holding over 580 securities in its basket (Guide to the 25 Most Liquid ETFs).
From an interest rate risk analysis perspective, an average duration of around 1 year can be considered too high for comfort for a ‘money market’ ETF, given the generic nature of these funds. On the other hand, this provides greater scope for maximizing returns than traditional cash alternative short term investments.
Also, the non-government issued securities in the portfolio will be subject to higher magnitude of credit risk. Nevertheless, the ETF has a relatively high 12-month yield of 1.02% compared to other money market ETFs and is a good option for investors with a slightly higher risk appetite.
SPDR Barclays Capital 1-3 Month T-Bill ETF (NYSEARCA:BIL)
The ETF is designed to replicate the performance of U.S dollar denominated short term Treasury securities which have a residual maturity of 1-3 months as represented by the Barclays Capital U.S. 1-3 Month Treasury Bill Index.
From a credit risk point of view, the ETF is risk-free as it includes only Government issued Treasury bonds. All securities in its portfolio are basically zero-coupon, which makes the ETF extremely low yielding.
BIL was launched in May 2007 and has $1.41 billion in total assets. The ETF holds 9 securities in total and has a weighted average maturity of 0.13 years. The interest rate risk is more or less non-existent due to its short end focus of the yield curve as indicated by this modified duration of just over one-tenth of a year.
However, the investments in BIL should only be considered for safety purposes as it offers very limited upside potential, mainly thanks to its ultra short term focus (see Four Easy Ways to Play Beta and Volatility with ETFs). Moreover, the premium that the investors are charged is an ultra low 13 basis points making it a cost effective investment avenue. The ETF has lost 10 basis points in the last one year.
Guggenheim Enhanced Short Duration Bond ETF (NYSEARCA:GSY)
GSY was launched in February of 2008 and has total assets of $164.84 million with an average daily volume of 34,029 shares. Although the ETF abstains from calling itself a money market ETF, its investment theme, objective and strategy are very similar to that of an actively managed money market ETF.
GSY employs a short duration strategy by targeting securities with low residual maturities. The ETF does not benchmark itself to any particular index; however it attempts to outperform the Barclays Capital 1-3 Month U.S. Treasury Bill Index, the same index which BIL tracks.
Similar to MINT, this particular fund also invests across a variety of short term securities issued by various institutions including Government, Commercial Paper, Corporate Bonds, Asset backed securities, High yield securities and municipal bonds.
This causes the ETF to allocate towards securities having low credit ratings thereby making the ETF prone to credit risk of the issuer (read iShares Debuts Two High Yield Bond ETFs). However, a majority of its assets are invested in high rated securities (45.81% of its assets are rated A+ and above).
At present, the ETF holds around 83 securities with 32.93% of its total assets allocated towards the top 10 holdings. Thanks to the active management of the ETF, it charges investors 0.27% in the form of annual fees and expenses (read Guide to the 25 Cheapest ETFs).The ETF pays out a yield of 0.42% annually and has a slightly higher average maturity of 1.40 years compared to other money market ETFs.
Despite this fact, the ETF does really well in maintaining an average duration of just 0.24. Therefore, the ETF can be thought of an investment avenue, which could be more volatile than other cash alternative investments; however it also has a superior upside potential.
The following table summarizes the relative position of the discussed ETFs from the money market ETF space.
|ETF||Total Assets||Expense Ratio||Avg. Maturity||Avg. Duration||Avg. Daily Volume||YTD Returns||Yield|
|SHV||$2.45 billion||0.15%||0.40 years||0.40 years||265,736 shares||-0.03%||0.03%|
|MINT||$1.73 billion||0.35%||1.04 years||0.99 year||198,605 shares||1.13%||1.02%|
|BIL||$1.41 billion||0.13%||0.13 years||0.13 years||12,570 shares||-0.04%||0.00%|
|GSY||$164.84 million||0.27%||1.40 years||0.24 years||34,029 shares||0.56%||0.42%|
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