Bryan Dooley
This year global central bank monetary-policy tightening has caused the most damage to conservatively managed investment portfolios in over 100 years. Federal Reserve chairman Jerome Powell and his colleagues wiped about $30 trillion off of world equity prices through the end of Q3, worse than the total damage caused in 2008 during the great financial crisis.
And yet, one asset class is benefiting. Short-term money market funds have been enjoying a resurgence in yields not seen in well over a decade and this may be a boon for conservative investors.
For the first time in 15 years, short-term AAA rated US Treasury bills are yielding close to 4% while 90-day investment grade corporate obligations are paying up to 1% more. Many money market funds are yielding north of 2% with returns likely to go higher as near-term maturities are rolled over into progressively higher-paying obligations.
Interest rate hikes
Thrifty savers unwilling to take any market risk have generally fallen behind inflation since the 2008 credit crisis. Immediately after the crisis, most developed world central banks pursued programmes of zero interest rate policy, or ZIRP for short. These programmes were designed to help commercial banks recapitalise and to resurrect an anaemic world economy.
However, when inflation dramatically spiked at the beginning of this year, the old programme was no longer considered viable by government economists. With this year’s landmark policy shift, the old paradigm has ended. RIP, ZIRP!
The Fed was clearly behind the curve in not raising interest rates after it flooded the economy with inflationary dollars during the pandemic years of 2020 and 2021. But now, America’s central bank is laser-focused on recovering from its massive monetary policy error. Already this year, the Fed has hiked rates six times for a total increase of 3.75% in the base rate. Another rate hike is expected in December and more could follow in 2023.
Meanwhile, investors may have learnt a bit more about their personal risk tolerance during the past three years. Within this relatively short time span, equity markets have experienced two sharp declines of 25% or more.
While we remain comfortable with the longer-term prospects for a traditional balanced portfolio comprised of stocks and bonds, investors who are risk averse should consider money market funds for at least a portion of their net worth. This is also true for any part of one’s portfolio where funds are earmarked for near-term expenditures anticipated within the next year.
Money market funds return
Money market funds have been around for over 50 years since they were first introduced as an alternative to lower paying bank deposits. In practice, money market funds work like typical mutual funds, issuing redeemable shares whose price is based on their net asset value calculated at the close of business each day.
Unlike other mutual funds, however, money market funds are mandated to maintain a NAV which does not decline from any one day to the next. In other words, money market funds are designed to protect investors’ principal while providing an ongoing income stream.
Money market funds will either pay out income distributions on a regular basis, or the value of the fund units will increase over time consistent with the yield of the underlying securities on an accumulated basis. Money market funds have similar liquidity to bank savings accounts, where in most cases money is available for withdrawal the next day.
Assets underlying money market funds include US Treasury and government agency notes, certificates of deposit, banker’s acceptances, commercial paper, repurchase agreements and short-term corporate bonds.
One subset of these funds is those invested solely in government debt, providing investors with the highest safety level of them all. Of course, safety has a price and the government-backed funds yield less than those funds which are permitted greater flexibility.
Presently, $5 trillion is invested in USD-backed funds with about 78.8% in government funds, 19.1% in so-called prime funds with more flexible mandates and 1.8% in tax-exempt funds.
Tax-exempt funds would generally not be of interest to investors in offshore jurisdictions such as Bermuda and Cayman.
While money market funds look attractive these days, those investors with a time horizon of up to a year or two can do even better. We regularly see investment grade bonds maturing in one to two years paying between 5% and 6%. Short is sweet in the bond market as near-term maturities have less default risk than longer-term obligations which have more time for negative credit events to occur.
Overall, investment strategies should be tailored to each investor’s ability and willingness to undertake risk. One important checkpoint in building a portfolio is whether the investor will lose sleep over its potential volatility. Most equity and bond funds have been on a roller coaster this year, which has driven risk-averse investors into holding larger cash positions.
Just remember cash does not have to be sitting in your bank’s checking or saving account earning close to nothing. In the investment world, we view money market funds and Treasuries as cash equivalents due to their risk-free and liquid nature. With interest rates at the highest in over a decade, there are now good options for conservative savers.
While 2% or 3% from a money-market fund or 4% from a short-term Treasury is not as high as the historic return of a balanced portfolio, the compounding effect of current yields on short-term bonds and money market funds should not be ignored.
Bryan Dooley, CFA, is the chief investment officer at LOM Asset Management Ltd in Bermuda.
Please contact LOM at +1 345 233-0100 or visit www.lom.com for further information.
This communication is for information purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, investment product or service. Readers should consult with their Brokers if such information and or opinions would be in their best interest when making investment decisions. LOM is licensed to conduct investment business by the Bermuda Monetary Authority.
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