There was a time when earning 1% from a short-term bond was acceptable. Five years ago, the average one-year Treasury bill yielded less than 0.2% and many money-market funds paid essentially nothing. Ultrashort-term bond funds, which took on a little more risk, but paid a bit more, were one of the few viable options for conservative investors seeking income from their cash.
No longer. Today, after interest rate increases, the one-year Treasury bill yields 2.4%, and there’s a question whether ultrashort funds, which buy high-quality bonds with durations of less than one year, can keep up. The average ultrashort fund has only a 1.2% five-year annualized return, according to Morningstar. But even if funds can outpace Treasury bills, are they worth the additional risk, given that, after a long recovery, recession and credit risks have increased?
The answer depends on your goals and risk tolerance, which fund you buy, and where you buy it. If you need an ultrasafe emergency stash and want to earn some income from it, you’re better off owning a bank CD or Treasury bills directly. TreasuryDirect.gov allows you to buy bills without broker price markups. Meanwhile, you can get a one-year bank CD currently yielding 2.7% from Capital One or 2.75% from Marcus, Goldman Sachs’s retail unit. Bank CDs are protected by Uncle Sam’s Federal Deposit Insurance Corp.
One step up in risk are money-market funds, which aren’t federally protected, but are so conservative that they have lost money only twice in Wall Street history. Vanguard Prime Money Market (VMMXX), one of the lowest-fee funds, has a current yield of 2.46%. It’s more liquid and convenient than owning one-year CDs, which charge early withdrawal penalties.
Places to stash your cash
The largest ultasound mutual funds and ETFs
|Name: Largest ultrasound mutual funds and ETFs / Ticker||30 Day Unsubsidized SEC Yield||30 Day Unsubsidized SEC Yield Date||Fund Size (bil)||Prospectus Net Expense Ratio|
|iShares Short Treasury Bond ETF / SHV||2.34%||3/28/19||$19.4||0.15|
|PIMCO Short-Term A / PSHAX||2.46||2/28/19||19.3||0.82|
|Lord Abbett Ultra Short Bond A / LUBAX||2.53||2/28/19||16.4||0.40|
|Putnam Short Duration Income A / PSDTX||2.51||2/28/19||15.2||0.40|
|Morgan Stanley Instl Ultr-Shrt Inc A / MUAIX||2.47||2/28/19||15.1||0.50|
|PIMCO Enhanced Short Maturity Active ETF / MINT||2.84||3/31/19||11.7||0.42|
|Fidelity Conservative Income Bond / FCONX||2.58||3/28/19||11.4||0.35|
Sources: Morningstar; company reports
But ultrashort bond funds are neither as convenient as money markets nor as safe as Treasury bills or CDs, so they should deliver higher returns. As of Feb. 28, the largest ultrashort mutual fund, Pimco Short-Term (PSHAX) at $19 billion, also had a 2.46% 30-day SEC yield—an annualized figure based on the most recent 30-day period. (Mutual funds update their SEC yields more slowly than ETFs, money-market funds and CDs, although there isn’t usually any significant yield changes in the short term for this sector.) Manager Jerome Schneider says that buying cheap bonds and selling expensive ones increase the fund’s total return: “Our history has shown that not only is the yield from the bond fund its return, but also the capital appreciation component.”
Andrew Hofer, manager of BBH Limited Duration (BBBMX), tells a similar story. Since 2010, BBH Limited Duration has produced an average return of 0.29 of a percentage point above its SEC yield on a rolling 12-month basis, according to BBH. Since the fund had, as of March 31, an SEC yield of 2.58%, it would produce a 2.87% return in the subsequent year, if history is any guide.
But is history a reliable guide? Much of the return of ultrashort bonds depends on the difference in yield between Treasury bills and other bonds. As of the end of March, investment-grade corporate paper rated BBB or higher with one- to three-year maturities had an average yield spread of 0.64 of a percentage point. The spread reached a five-year low of 0.48 in February 2018 and a peak of 1.47 points in February 2016. If you go back 20 years, the peak spread was 7.88 percentage points in November 2008.
Having a 0.64 spread leaves little room for error, especially if you consider that funds have a fee hurdle to overcome.
In the case of the retail A-share class of Pimco Short-Term, it’s a high 0.82% expense ratio, plus a 2.25% load. The convenience of trading such a fund doesn’t compensate for that. Cash is often meant as a placeholder before buying something else, not a long-term investment. But to pay 2.25% and then plan to get out of this fund soon makes no sense. In contrast, BBH Limited Term charges no load and has a 0.35% expense ratio.
Thankfully, there are other alternatives, too, such as Pimco Enhanced Short Maturity Active (MINT), an exchange-traded fund that Schneider runs in a similar, albeit more conservative, style than the mutual fund. The ETF has a relatively modest 0.42% expense ratio and no load. You will, however, pay stock transaction fees to buy it at some brokers, typically $5 to $7 a trade.
Aside from the cost of ultrashort funds, there’s also their increased credit risk. Investment-grade bonds rated BBB seem particularly troublesome after a surge of issuance. “BBB companies are more levered than they’ve ever been,” says Venk Reddy, manager of the Zeo Short Duration Income fund (ZEOIX).
Morningstar doesn’t categorize Reddy’s fund as ultrashort. It’s listed as high-yield because he invests primarily in short-term debt rated below BBB. Spreads in the high-yield sector average 4.05 percentage points over Treasuries, yet with much more credit risk. But by intensely researching his typically 50-bond portfolio Reddy has never had a default in the fund since its 2011 inception, nor a loss in any rolling six-month period. The fund’s SEC yield was 3.39% in March, making it a more viable long-term investment.
However, the simplest, safest solution would be to buy a Treasury bill ETF like the SPDR Bloomberg Barclays 1-3 Month Treasury Bill (BIL). It has a low 0.14% expense ratio, a 2.25% SEC yield, and is available commission-free at brokers such as TD Ameritrade and Vanguard. You can trade it easily when you find better opportunities. And you’ll sleep well at night.
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