This month, Crane Data's Bond Fund Intelligence publication featured the story "Payden & Rygel's Kerry Rapanot on Rethinking Cash." The BFI piece explains, "Payden & Rygel recently hosted a media briefing on low duration bond strategies featuring Director Kerry Rapanot, a member of their Low Duration Strategy leadership team. Rapanot says, 'It's a good time to be talking about cash. We've reached a new peak in money fund assets at $7 trillion. We went from the lower band of zero back in 2022 all the way to 5.25% in the summer of 2023. Finally, this past September, the Fed began their easing cycle. We had a 50-basis points rate cut in September and then another 25-basis point cut just recently here in November [and another 25 bps cut last week.'" (Note: The following is reprinted from the December issue of BFI, which was published on December 13. Contact us at info@cranedata.com to request the full issue or to subscribe. BFI is $500 a year, $1,000 including our Bond Fund Intelligence XLS spreadsheet or $2,000 including our Bond Fund Portfolio Holdings dataset.)
She continues, "Now as yields are decreasing as the Fed is cutting the federal funds rate, yields on money market funds are declining. It's a bit of a surprise to us to see fund balances continuing to increase, as that $7 trillion number is eye-popping. While we've reached these new highs, prime institutional funds are the only category with net outflows this year. This is directly a result of the SEC's latest round of reforms, which went into place this year."
Rapanot explains, "As investors think about moving cash out of money market funds into longer bonds, a low duration strategy makes sense. A low duration strategy is a compelling solution for investors looking to balance safety, liquidity, and enhanced income. We're currently in a period of increased interest rate volatility and lower credit risk premiums, which means the additional yield investors earn by buying higher risk securities is lower than normal. With this backdrop, we don’t think it’s sensible to take on credit risk that doesn’t fairly compensate the investor."
She continues, "We have a similar view for interest rates, where we do not see value in taking on additional risk where youre not compensated. We came into January of this year with the market pricing in seven cuts. And now at the end of the year we've had three cuts.... Since we believe the market is pricing in fewer future cuts than what we think, we see value in extending out bond duration right now."
She asks, "So what are low duration strategies and how do they differ from money market funds? Low duration strategies have a lot of other alternative names. You may have heard ultra short, short duration, enhanced cash, enhanced income, etc. These strategies offer investors the potential to earn more than money market funds or bank deposits. They broaden the investible universe in two key ways. Number one, low duration strategies invest in bonds with maturities as long as five years, compared to the 397-day maturity limit on money market funds. This enables an investor the potential to lock in longer term yields, as well as take advantage of price appreciation as interest rates fall, something money market funds cannot do as effectively. And second, low duration strategies invest across the fixed income universe -- from Treasury bills to corporates to structured bond credit. `This investment diversification can generate greater returns while maintaining liquidity."
Rapanot says, "Now, expanding the guidelines does add some risk, as these strategies are not $1 net asset value (NAV). While they do offer the higher potential for return than money market funds, they come with greater price volatility due to owning longer maturities, and the inclusion of credit. However, the investments remain short-term enough to limit this risk, especially as bonds quickly approach maturities and their prices pull to par, which help to stabilize returns. By its nature, a low duration portfolio should be liquid. However, not every individual holding needs to be able to function as liquidity. Though money market securities have less price risk and lower trade costs than corporate bonds, both can be sold to generate liquidity. Through active management, portfolios can maintain liquidity and participate in total return opportunities."
She states, "Payden & Rygel's low duration strategy team manages two strategy solutions: Enhanced cash and low duration. Both aim to outperform passive cash strategies, but they differ in their benchmarks and duration profiles."
Rapanot comments, "Enhanced cash is your first step out beyond a money market fund. The duration is typically short, less than three quarters of a year, and the spread duration is typically under one and a quarter year. As a result, the volatility is low, and liquidity is exceptional. The next step out is what we call low duration. Typically a one- to three-year benchmark duration will range somewhere between one and a half and two and a half years and spread duration somewhere between one and three years. The price volatility here is going to be a little higher than the enhanced cash strategy but remains low when you look at it compared to longer, intermediate, or core bond strategies. And again, active management looks to minimize this price volatility over time."
She adds, "Many of our clients employ a mix of both enhanced cash and low duration strategies as they look to put their longer reserve cash to work. Within the strategy, we offer customized approaches to fulfill our clients' investment objectives."
The Payden PM also asks, "How does a low duration strategy differ from other fixed income strategies? With the Fed cutting interest rates to a more neutral level, this is going to have the greatest impact on short-term securities. That means money market yields will fall rapidly as the Fed lowers rates. However, low duration bond portfolio yields will not decrease as quickly. By investing a portion of the cash in longer duration bonds investors can lock in higher yields further out the maturity curve. Clients can customize the amount of duration or credit risk they wish to tolerate through their investment guidelines. The broader the guidelines, the more opportunity to earn higher long-term returns, along with some additional volatility than a money market fund. Low duration strategies are for investors who want a balance of liquidity and moderate returns with lower risk. While intermediate to core bond strategies are for those seeking higher returns, but over a long run, and willing to accept more volatility."
She adds, "Low duration strategies are positioned between the safer world of money funds, and the more volatile space of intermediate and core bond strategies. And while they do carry more price risk than a money market fund, they do have lower volatility and credit risk compared to other bond strategies."
Finally, Rapanot states, "So what factors should investors consider when seeking higher yields? Returns in a low duration strategy are primarily driven by sector allocations. Investment grade corporates and structured credit are integral parts of the portfolio. We invest in debt, ranging from zero to five years in maturity, both fixed rate and floating rate coupons. Diversification guidelines limit our exposure to any single issuer except within government securities, and we actively manage that credit exposure, selling and buying securities when changes in their valuations or fundamentals make it necessary or worthwhile. This multi-sector approach seeks to provide multiple sources of return and allows us to improve risk-adjusted performance across a variety of market environments."
