A Money Market Alternative for a Zero Interest-Rate World

Investors earn nothing in their money market funds. Fees eat the meager income short-maturity instruments generate. Most would be better off putting their money in CDs or high-yielding savings accounts. With search engines, it's easy to find banks offering 1%-plus rates. They can afford to do so because the FDIC backstops their losses--big institutions don't get that subsidy. But what about investors with sums too big for FDIC-insured accounts? They have a decent alternative in  PIMCO Enhanced Short Maturity Strategy (MINT), an actively managed ultrashort-maturity bond fund with a wide-ranging mandate.

Just as money market funds were designed to get around 1970s-era interest-rate caps on bank accounts, MINT is a clever bit of regulatory arbitrage designed to capture money fleeing tighter money-market regulation. Because we're in the early innings of the sea change, this space is ripe for active players: MINT's mandate rests just beyond the strict quality and duration limits set on money market funds and below the mandates of most short bond funds. While MINT can collect pennies left by others, it does so by venturing beyond the implicit government guarantee money market funds get.

Heedful of the well-worn saying that "more money has been lost reaching for yield than at the point of the gun," let's dissect the risks. First, history suggests investors should be extra cautious with their cash investments in a low-rate environment. Many big investors who target expected returns, such as pensions (and to some extent money market funds), may be stretching for more risk with cashlike instruments, driving up prices. In the past, these bets haven't been well compensated.

Second, since it's an active fund, MINT's investment merit largely rides on its manager's competence. Former manager Paul McCulley made PIMCO's short-term bond desk famous. Manager Jerome Schneider is a relatively new face at PIMCO, so his public performance record is sparse. But the fund isn't a one-man show; its performance in large part reflects the quality of PIMCO's committee-generated macroeconomic forecasts. More so than stock-picking funds, MINT's prospective performance is a bet on PIMCO's process.  PIMCO Total Return's (PTTRX) long and consistent record of success suggests it's very good. But the short-term bond market is a creature of its own.

Fortunately, we can gain more clues as to quality of PIMCO's process via the performance history of its flagship ultrashort-bond mutual fund  PIMCO Short-Term (PTSHX). The fund is a bright spot in a category littered with blowups and failures. From November 1987 to January-end 2012, the fund earned 4.97% annualized, beating one-year Treasury bills by about 50 basis points but with tad higher risk. The biggest blemish on the fund's record is its late 2008 performance. The fund swiftly lost more than 4% exactly when the market was going to hell in a handbasket, whereas Treasuries and most money market funds did fine. Investors may have earned higher returns over the long run, but they did so at the cost of risk that showed up at the worst possible moment. However, once the crisis passed, the fund bounced right back. PTSHX's performance in late 2008 is an object example of liquidity risk. To be fair, MINT likely won't court as much of it owing to PTSHX's experience and its money marketlike mandate.

PIMCO's record means MINT will likely generate enough alpha to compensate for its fees. This is more than can be said for the vast majority of money market wannabes and ultrashort bond funds. If all you ask is for fair compensation for bearing modest risk, MINT is just the tool.

 

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