From money markets to ultrashort assets: In pursuit of new opportunities
July 20, 2016
Editor’s note: Portfolio manager Cynthia Isom has managed assets on the short end of the yield curve for more than 30 years. Under Cynthia’s expert guidance, Delaware Investments has managed money market portfolios through all phases of the economic cycle and established a long track record of overseeing short-term assets. With the money markets evolving due to recent years' regulation, Cynthia and the team at Delaware Investments have focused attention on ultrashort fixed income assets. Below, Cynthia highlights this new approach, and the anticipated market conditions as we move deeper into 2016.
For many years, money market mutual funds were considered among the least risky of investments, essentially regarded as a default place to park assets and commonly accepted as a near cash equivalent. But money market funds went through challenges in the aftermath of the Global Financial Crisis. Not only did the Federal Reserve’s zero-interest-rate policy make it difficult for most money market investors to realize much yield, but some funds also had difficulty maintaining a stable net asset value (NAV). In 2008, one money market fund saw its NAV dip below $1.00. This event, known as “breaking the buck,” was extremely rare — very few funds have broken the buck in the entire history of money markets — but it was enough to rattle confidence among investors and regulators alike.
Tighter regulations stimulate change
Since an initial effort to make money market funds more resilient by attempting to reduce risks, regulatory repercussions have taken the form of a complex series of new rules from the Securities and Exchange Commission (SEC). The latest set of regulations, the product of a second round of reform that was announced in 2014 and goes into effect in October 2016, lays out certain conditions depending on the types of money market funds involved. The reforms discussed here were originally enacted as amendments to Rule 2a-7 of the Investment Company Act of 1940. The regulatory changes consist of two main provisions:
- Money market funds that cater to institutional investors (such as foundations, endowments, pension plans, and other similar investors) will be required to calculate daily NAVs based on the actual market values of portfolio holdings — that is, funds must produce a floating NAV instead of fixing their share prices at $1.00 per share. (Note that this requirement applies specifically to so-called “prime” funds, which are allowed to invest in securities other than U.S. government securities, and to institutional funds that invest in municipal debt.)
- All money market funds — institutional as well as retail — will be allowed to impose so-called “liquidity gates,” which temporarily prevent investors from making withdrawals during times of market stress. These gates are to be implemented at the discretion of each fund’s board of directors, who will also have the authority to impose liquidation fees for investors who redeem shares.
Taken together, the intricacy of the requirements and the search for higher returns in a low-rate environment have inspired some asset managers to develop alternatives to traditional money market options. As part of this wave of change, Delaware Investments has developed an ultrashort fixed income solution that allows investments in the short-term markets, using investment grade corporate bonds and highly rated asset-backed securities to step out a little further into the short-term yield curve.
About the Delaware Investments ultrashort solution
The potential for higher yield relative to traditional money markets, along with the potential for higher total return (see Table 1), provides a good starting point when considering ultrashort investments as prudent tools for investors who have cash management needs. Table 2 captures the basic features of Delaware Investments’ approach to the asset class, along with some details about daily operations.
Table 1. Comparative returns: Ultrashort fixed income versus money markets
||1-year total return
||3-year total return
||5-year total return
||10-year total return
|Morningstar ultrashort bond category
|Morningstar U.S. money market category (taxable)
Data: Morningstar. Returns as of Dec. 31, 2015. Past performance is no guarantee of future results.
Table 2. At a glance: Delaware Investments ultrashort fixed income
Table 2. At a glance: Delaware Investments Ultrashort Fund
||To provide principal preservation above all else, while aiming to generate maximum current income and maintain liquidity
To seek total return while maintaining a relatively low volatility of income
||BofA Merrill Lynch U.S. 6-Month Treasury Bill Index
|Portfolio construction (100% investment grade securities)
- investment grade corporate bonds
- high-quality asset-backed securities
- high-quality mortgage-backed securities
- government securities and money market instruments
|Duration and yield
||Under current conditions, average duration is anticipated to range between six months and one year, with a yield typically between 50 and 75 basis points.
|Distinctions from traditional money market portfolios
- the ability to seek opportunities in securities that may generate greater income and capital appreciation without sacrificing liquidity
- broader diversification, including securities with longer maturities
Drawing on deep resources
In an era of low interest rates and little certainty about global economic growth, our investment team relies on experience and expertise to produce a short-term fixed income portfolio that seeks to generate meaningful yield while aiming to keep a conservative, risk-aware posture. While security selection is ultimately performed by the portfolio manager, a given course of action is influenced by recommendations from our research analysts and bond traders. As an integral part of the investment process, their contributions deliver a rich, complete set of inputs to our portfolio decisions. This inclusive approach is designed to allow us to respond quickly to market developments and issuer-specific events.
The areas of analysis, and the teams that work in them, include:
- technicals, which are studied by traders monitoring supply-and-demand relationships that are often in flux
- fundamentals, with research analysts measuring each issuer’s vital signs, including assets, liabilities, cash flows, and the overall likelihood of making interest payments on time
- environmental factors, which are analyzed by traders, research analysts, and portfolio managers who take stock of economic growth, interest rates, monetary policy, and other exogenous indicators.
Working together, the investment staff puts forth an ultrashort product that aims for competitive rates of return while seeking to minimize overall risk.
On the ground today: Trading conditions and outlook
With U.S. Treasury yields still low, many investors who seek higher levels of income are being forced to go out further on the yield curve. (Meaning that they are investing in bonds with longer maturities, which normally generate more yield than those with relatively shorter maturities.) This applies to the very short-term market as well, where money markets and ultrashort products reside. From our investment team's vantage point, trading conditions on our end of the curve are generally good; there is reasonable liquidity and attractive yield opportunities are generally available.
But we caution that the path forward probably won’t be perfectly smooth, especially with uncertainty about Fed policy actions. Looking ahead to the balance of 2016 final months of 2016, we believe certain headwinds could be possible, not the least of which is volatility, particularly as markets contend with mixed global growth signals and divergent central bank policies around the world. To attempt to accommodate the inevitable market swings, our team will rely on a long-standing commitment to preserving capital, putting risk management at the front of everything we do for our clients.
The views expressed represent the Manager’s assessment of the market environment as of July 2016 October 2016 and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Views are subject to change without notice and may not reflect the Manager's views.
IMPORTANT RISK CONSIDERATIONS
Investing involves risk, including the possible loss of principal.
Past performance does not guarantee future results.
Index performance returns do not reflect any management fees, transaction costs, or expenses. Indices are unmanaged and one cannot invest directly in an index.
Fixed income securities and bond funds can lose value, and investors can lose principal, as interest rates rise. They also may be affected by economic conditions that hinder an issuer’s ability to make interest and principal payments on its debt.
Fixed income portfolios may also be subject to prepayment risk, the risk that the principal of a fixed income security that is held by the portfolio may be prepaid prior to maturity, potentially forcing the portfolio to reinvest that money at a lower interest rate.
Diversification may not protect against market risk.
The performance quoted represents past performance and does not guarantee future results. Current performance may be lower or higher than the performance quoted. An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although money market funds seek to preserve the value of an investment at $1.00 per share, it is possible to lose money by investing in them.
International investments entail risks not ordinarily associated with US investments including fluctuation in currency values, differences in accounting principles, or economic or political instability in other nations. Investing in emerging markets can be riskier than investing in established foreign markets due to increased volatility and lower trading volume.
The Fund may invest in derivatives, which may involve additional expenses and are subject to risk, including the risk that an underlying security or securities index moves in the opposite direction from what the portfolio manager anticipated. A derivatives transaction depends upon the counterparties’ ability to fulfill their contractual obligations.
Interest payments on inflation-indexed debt securities will vary as the principal and/or interest is adjusted for inflation.
This information should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice.
Duration measures a bond’s sensitivity to interest rates, by indicating the approximate percentage of change in a bond or bond fund’s price given a 1% change in interest rates.
Mortgage-backed securities are fixed income securities that represent pools of mortgages, with investors receiving principal and interest payments as the underlying mortgage loans are paid back. Many are issued and guaranteed against default by the US government or its agencies or instrumentalities, such as Freddie Mac, Fannie Mae, and Ginnie Mae. Others are issued by private financial institutions, with some fully collateralized by certificates issued or guaranteed by the US government or its agencies or instrumentalities.
Asset-backed securities are bonds that are backed by pools of loans or accounts receivable that have been generated by credit providers such as banks and credit card companies.
The Morningstar ultrashort bond category measures the performance of funds that have an average duration or an average effective maturity of less than one year. The category excludes international, convertible, multisector, and high-yield bond funds.
The Morningstar US money market category tracks the performance of fund that invests primarily in low-risk, short-term investments such as treasury bills, government securities, certificates of deposit, and other highly liquid, safe securities.
The BofA Merrill Lynch US 6-Month Treasury Bill Index tracks the performance of US Treasury bills with a maturity of six months. The index comprises a single Treasury issue purchased at the beginning of the month, which is then sold at the end of the month and rolled into a newly selected issue that matures closest to, but not beyond, six months from the transaction date (known as the rebalancing date).
This material is not intended and should not be construed to be a presentation of information for any mutual fund.
Delaware Investments claims compliance with the Global Investment Performance Standards (GIPS®) and has prepared and presented this report in compliance with the GIPS standards. Delaware Investments has been independently verified for the periods from January 1, 1992 through December 31, 2013. The verification reports are available upon request. Verification assesses whether (1) the firm has complied with all the composite construction requirements of the GIPS standards on a firm-wide basis and (2) the firm’s policies and procedures are designed to calculate and present performance in compliance with the GIPS standards. Verification does not ensure the accuracy of any specific composite presentation.