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ETF Alternatives to Money Funds

Potential money market reforms could make short-duration fixed-income ETFs more attractive as a long-term cash reserve.

Tim Strauts, 04/19/2013

Money market funds will likely see substantial reforms in the coming year. During BlackRock’s BLK latest earnings conference call, BlackRock CEO Larry Fink was asked about his view on potential money market reforms. Fink indicated he expected an announcement from the SEC shortly, now that the new commissioner, Mary Jo White, has been sworn in. Fink also commented that BlackRock expected prime money market funds would move to floating net asset values. He also expressed that he thought the more conservative government money market funds would be allowed to keep their fixed $1 per share NAV.

If Fink’s suspicions pan out, this would be a monumental change for the money market industry. There is currently $2.2 trillion invested in taxable money market assets, of which 60% is in prime funds that may wind up with a floating NAV. If this change is implemented, there could be large redemptions of prime funds and flows into more conservative government offerings. With a floating NAV, prime funds would become--in many regards--just like any other mutual fund.

Many investors maintain large cash balances in money market funds. Implementing a cash-tiering strategy can be a way for investors to maintain enough liquidity to meet short-term needs, while also getting slightly higher yields by better matching fund duration to their future cash needs. Should prime funds move to a floating NAV, funds needing overnight liquidity will likely increasingly be kept in a government money market fund or an FDIC insured bank account. For funds that are part of a longer-term cash reserve, short-term bond ETFs may become an increasingly appealing solution.

It is important to note that none of the ETFs listed below are money market funds. These funds assume greater levels of risk to get relatively higher yields versus traditional money market funds. Traditional bank savings accounts may also grow in appeal in the wake of potential reforms. Many online banks offer FDIC-insured accounts with interest rates close to 1%. The ETF options listed below are best suited for investors with large cash balances or those who need to keep their funds inside their brokerage account. Investors using ETFs as part of their cash reserve strategy need to be cognizant of trading costs. In the current ultralow yield environment, trading commissions can take a big bite out of returns.

PIMCO Enhanced Short Maturity ETF MINT 
MINT was launched in response to money market regulation changes that went into effect in 2010. The new rules limited money markets from owning any security with a maturity greater than 397 days. PIMCO’s active strategy seeks to take advantage of this limit by buying securities just slightly beyond the maturity limit. With no competition from money markets, MINT is able to get higher relative yields. MINT has a duration limit of one year and it can buy only investment-grade securities. As an actively managed fund, MINT has the flexibility to purchase a wide range of securities based on their view of opportunities in the market. The ETF has a current SEC yield of 0.65%.

iShares Floating Rate Note FLOT
FLOT tracks an index of investment-grade floating-rate bonds with a maturity of less than five years. Coupons are typically linked to LIBOR plus a spread and are reset every three to six months. Floating-rate notes should not be confused with bank loans, which are below-investment-grade securities with much higher risks. FLOT has an average maturity of 1.7 years, but because the interest rate resets frequently it has a duration of only 0.14 years. FLOT has a current SEC yield of 0.37% and an average credit quality of A. During the financial crisis the Barclays U.S. Corporate Floating Rate Note Index declined 7% and didn't fully recover for 11 months, but corporations are in a much better financial position today than in 2008.

iShares Barclays 1-3 Year Treasury Bond SHY 
SHY owns bonds up to three years to maturity, but because it invests only in government securities the fund has had very stable returns. The fund’s strong 1.76% trailing five-year annualized return is the result of capital gains from falling interest rates. Going forward, rates don’t have much room left to fall, so you should expect future returns closer to the fund’s SEC yield of 0.11%.

SPDR Barclays 1-3 Month T-Bill BIL 
BIL is not a good choice as a money market alternative, because it invests only in U.S. Treasury bills with a maximum maturity of three months. The fund has a current SEC yield of negative 0.07%, because the expenses of the fund are more than the yield of the portfolio. There is no reason for an investor to purchase this fund. Unless interest rates rise, BIL will have negative returns for the foreseeable future.


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