Early this month, BofA Global Capital Management, the new name for Bank of America's former Columbia Management money fund unit, posted market commentary on their website entitled, "Translating QE2 into Higher Returns on Cash Portfolios." The update, which is subtitled, "Second Round of Fed Easing Presents an Opportunity for More Aggressive Cash Investors," says, "The U.S. Federal Reserve's decision to purchase $600 billion of U.S. Treasuries over the next year might or might not succeed in quickening the pulse of the U.S. economy, but it has the potential to benefit cash investors willing to accept a modest increase in risk to achieve higher returns."

The piece explains, "The opportunity presented by the second round of quantitative easing, known formally as Large Scale Asset Purchases (LSAP) and informally as QE2, stems from the drop in Treasury yields LSAP is likely to trigger. By increasing demand for Treasuries, LSAP should push down already anemic Treasury yields. That, in turn, should drive up demand for spread product, such as corporate bonds and asset-backed securities (ABS), which historically have outperformed Treasuries. The increased demand for these asset classes likely would drive up their prices, creating an opportunity for investors who buy at the right time."

The manager of the BofA Funds continues, "Of course, rising prices of spread product would lower the instruments' yields, which is not optimal for income-oriented investors who buy too late in the easing cycle. However, for those who get the timing right, price increases for ABS, corporates, mortgage-backed securities (MBS), etc. potentially could generate attractive total returns if those investors pursue a buy-and-hold strategy."

It says, "Holding the assets is necessary to capture the opportunity presented by LSAP because: Holding the structured product could enable the investor to fully exploit the potential increase in the value of the bonds as the Fed implements QE2.... Short-duration bonds historically have drawn the lion's share of their total return from 'carry,' i.e., the clipping of coupon during the holding period.... Investors who hold their short-term debt also may benefit from the 'roll down the curve.' In a normal, upward-sloping yield curve environment, bonds increase in value as time passes because as their maturities shorten, the bonds' yields fall and their prices rise."

The paper also says, "To benefit from the potential increase in demand for spread product, cash investors need to be comfortable with the risk/reward profile of these assets. Spread product historically has outperformed government debt, but it also carries more credit risk. In addition, investors must be willing to go farther out the yield curve because the Fed is targeting two- to 10-year Treasuries, which means cash investors would need to purchase spread product that falls within that part of the yield curve. Naturally, extending the duration of their portfolios would expose them to higher interest rate risk."

BofA Global comments in a section entitled, "Another Reason to Consider Separate Accounts," "Investors in money market funds cannot benefit from the potential flight to spread product because the maturities of money market fund credits cannot exceed 397 days. In addition, funds cannot invest in some spread product because federal regulations prohibit the inclusion of these higher-risk assets in fund portfolios. As such, investors interested in capturing the benefits that might accrue from LSAP need to consider an alternative to money market funds: the separately managed account."

Finally, they add, "Customized to the risk tolerance and objectives of each investor, a separate account can hold debt with maturities that extend beyond those of money market fund investments. Moreover, separate account strategies can invest in the full array of debt instruments available to cash investors. This flexibility enables cash investors to fully exploit not only the opportunities that may arise from the latest round of Fed easing, but also from any other change in the market environment. When selecting a separate account manager, it behooves the investor to assess firms' experience managing separately managed accounts as well as their ability to manage risk, the latter being particularly important for investors who intend to pursue a more aggressive investment strategy."

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