In recent days we executed several tactical adjustments in the fixed-income sleeve of client portfolios. We sold or reduced exposure to short-maturity bond funds and reinvested proceeds into position-traded money funds. These adjustments take advantage of attractive yields available on short-term money funds relative to the variable return potential on short-maturity bonds in a rising interest rate environment.
From where we sit, there is an increasingly strong case to be made for utilizing some of the position-traded money-funds in place of short-term bonds. The yield on these position traded money funds is actually better (presently 1.86% – 2.06%) than the total return (yield plus price change) being generated and anticipated from short-term bond investments so long as we are in a rising rate environment. The Fed continuing to raise interest rates is a headwind for traditional bond prices. By contrast, in the money funds we have stable net asset value so they are a perfect zero correlation to equity markets (no credit risk). Add also that the money fund yields are actually increasing now with each Fed interest rate hike, so the total return of the money funds improves (again, opposite of the impact of rising rates on bond investments). The Fed is still communicating desire to hike 1 more time in 2018 and as many as 3 more times in 2019 (although we believe there is good possibility that they will need to back away from forecast/pace at some point if it is becoming clear the economy’s pace is shifting to a slower gear). It is worth noting that there is no minimum holding period on these money funds, so if/as it would become apparent that the Fed is likely done raising rates this cycle (meaning that the headwind of rising rates on traditional bonds is in the rearview mirror) it would from our perspective then make sense to re-deploy these short-term money instruments back into more traditional bonds which would see their return more closely reflect the coupons being paid by individual bond holdings AND also possibly receive a boost from price appreciation related to any rate cuts.