Today’s edition of On the Trading Desk® features a discussion about ways to invest cash that you maybe haven’t thought of, meaning investment opportunities beyond money market funds. We’re talking with Jeff Weaver, Senior Portfolio Manager and Head of Municipal and Short Duration Fixed Income, Wells Fargo Asset Management (WFAM) Global Fixed Income.
Laurie King: I’m Laurie King and you are listening to On the Trading Desk®.
We’ll be talking about investment opportunities beyond money market funds today, and that’s because investors have a lot of cash on hand right now, but the challenge is finding yield since short-term rates like the federal funds target rate is close to zero. Lots of cash that isn’t earning income is a pretty big opportunity cost.
So to discuss some ideas for how to mitigate that opportunity cost, I’m joined by Jeff Weaver, Senior Portfolio Manager and Head of the Municipal Fixed Income, Short Duration Fixed Income, and Money Market Fund teams at WFAM, to share his insights. Thanks for being here, Jeff.
Jeff Weaver: Thank you, Laurie. It’s nice to be here.
Laurie: So to begin, let me ask you, as a bond manager, what do you see as most important from a macro standpoint? Especially as it relates to interest rates?
Jeff: Our expectations are the economy continues to recover from the dramatic decline caused by the COVID pandemic.
The economic recovery has been, and will continue to be, aided by a very accommodative Federal Reserve (Fed) who is committed to keep short-term interest rates low.
The Federal Open Market Committee (FOMC) dot plot shows the Federal Funds Target Rate is expected to remain at zero through 2023.
Short-term rates will continue to trend closer and closer to zero. 3-month bills, for example, currently yield 3 basis points while 2-year notes maintain yields in the 10 to 18 basis points range.
From a macro perspective, we expect growth is likely to surge as the vaccine rollout accelerates. The labor market’s recovery has been slowed by COVID’s third wave, but we expect continued improvement over time.
Meanwhile, inflation expectations are rising. Of course, this is a desired outcome of the Fed, as they have stated their comfort of an inflation rate above or around their 2% target.
From a fiscal policy standpoint, we await the final outcome and details of President Biden’s $1.9 trillion stimulus plan, which will also result in bigger deficits. As such, we’ve recently witnessed a bear curve steepening where short-term interest rates have remained anchored at close to 0% while longer rates have gone up with increased inflation concerns, economic stimulus, and increased debt issuance.
Since late summer, we’ve seen 10-year yields up 80 basis points to around 1.3%. Long-term rates will continue to drift higher but are likely to attract additional buyers, particularly from foreign investors, which will help keep rates from dramatically rising. Meanwhile, short-term rates will remain low until the Fed considers raising the Fed Funds Rate, which is not likely to occur over the next year.
Laurie: And now turning to what you’ve seen happening with cash investors, can you set the stage for our listeners and let them know what this pile of cash is that I’ve referred to, where it came from, and maybe even where you see it being invested?
Jeff: The COVID pandemic has certainly affected all of us in many ways. Both institutional and individual investors increase their liquidity to buffer against the risk of the potentially damaging economic fallout from the pandemic. In 2020, there was record new issuance of investment-grade corporate bond supply, $1.8 trillion in total. Including high-yield new issue, this total increases to $2.3 trillion.
From an individual standpoint, the U.S. Personal Savings Rate increased from 7.2% to 13.7% over the last year, spiking to almost 34% last April. A majority of this cash has ended up in bank deposits and money market funds. Money market fund assets grew 19% last year from $4 trillion to $4.7 trillion. That is a lot of cash that is now earning at or very close to 0% interest.
As a result, we’ve been spending a lot of time working with cash investors on solutions that can enhance return while still maintaining the key objectives of preservation of principle and providing for liquidity.
Laurie: Interesting. And so what opportunities are there beyond money market funds?
Jeff: Well, Laurie, first of all, we recommend that clients segment their cash into buckets where there are more liquidity needs and those where there are less. We talk about utilizing the two levers to enhance return, those two levers being extending duration or going down in credit.
We’ve been talking about this for some time. We recently authored an Income Generator piece called Déjà vu for cash investors, for example, which examines the parallels of today’s 0% interest rate with the time period following the global financial crisis. By extending maturities beyond the 13-month money market universe and by going lower in credit quality while still retaining investment-grade ratings, investors are able to pick up valuable yield.
The solutions we suggest include ultra-short and short-term bond funds or, for our larger institutional clients, customized separate accounts that are tailored to each client. In either case, our clients can enhance the yield on their cash portfolios. Yields on our strategies currently yield between 20 and over 100 basis points in yield.
Laurie: So you frame your discussion with clients as there being two levers available for adding return. Let’s start with the first one. What can you tell us about extending duration?
Jeff: Duration is certainly a consideration. With interest rates so low and the economy continuing to rebound from the major pandemic-induced slowdown, interest rates will likely go up sometime down the road.
However, the Fed is expected to remain extremely accommodative with low short-term rates remaining for some time. Incremental extensions beyond money market funds can make a difference in yield without extending significantly out the curve. With ultra-short and short-term strategies maintaining shorter durations of .5 or less and out to 2 years, investors can still guard against higher rates.
Laurie: Turning now to the credit lever, can you tell us what that means and what’s included—credit ranges and sectors? Does it mean both?
Jeff: Since the global financial crisis of ’08, we suggested clients take advantage of the entire investment-grade universe by allowing for BBB-rated bonds.
Historically, guidelines were written with an A or better minimum credit rating. A or better tends to be dominated by global banks and very large global companies. By allowing for BBB, one can achieve greater diversification while adding to yield and increasing risk-adjusted returns. The BBB category adds opportunities in sectors such as communications, transportation, autos, energy, and technology.
In addition to BBB-rated corporate bonds, we like asset-backed securities. These securities are secured by auto loans and leases, credit cards, and other receivables. The sector’s high quality and quite liquid and we currently recommend AA or single A-rated tranches for additional yield.
In today’s compressed yield environment, we also like agency mortgage-backed securities. This sector’s known for its high quality and liquidity. Mortgages currently represent compelling value versus highly-rated corporate bonds.
And finally, while tax-exempt municipals are rich, we do find opportunities in the taxable municipal sector.
Laurie: Those sound like a lot of potential opportunities to take advantage of. So as cash investors think about moving out beyond money market funds, are there other conversations that you typically have with clients?
Jeff: With regard to investment policy statements, we see a large variety. In order to take advantage of opportunities out the curve, we suggest to our clients that they consider extending their maximum maturity and maximum average maturity or target duration to take advantage of a steeper yield curve beyond the 13-month money market universe.
As mentioned previously, we believe that clients should consider allowing for BBB-rated securities in order to take advantage of the entire investment-grade sector. We recommend that investment policy statements take advantage of the wide array of investment-grade sectors available. These include corporate bonds, government-related debt, asset-backed securities, mortgage-backed securities, and municipal bonds.
Lastly, we suggest that investment policy statements allow for ultrashort and short-term bond mutual funds. It’s possible that these funds may not exactly fit existing guidelines, but allowing for funds with similar objectives and within the same spirit is highly advised.
Laurie: Thank you, Jeff, for those sentiments and for sharing your insights about investing beyond money market funds today.
Jeff: Thank you very much, Laurie. Much appreciated.
Laurie: That wraps up this episode of On the Trading Desk. If you’d like to read more market insights and investment perspectives from the investment teams at WFAM, you can find them at our AdvantageVoice® blog, as well as by visiting wellsfargoassetmanagement.com.
There’s also a section of wellsfargoassetmanagement.com that is dedicated to Institutional Cash Investors, and that’s where you can find all our recent Liquidity Client Group publications, the money fund portfolio manager commentaries, and also primers about the money fund space.
And finally, I’d like to say to stay connected to On the Trading Desk and listen to past and future episodes of this program, you may subscribe to the podcast on iTunes, Stitcher, Overcast, or Google Podcasts. Until next time, I’m Laurie King; take care.
100 basis points equals 1.00%. Diversification does not ensure or guarantee better performance and cannot eliminate the risk of investment losses. For retail money market funds: you could lose money by investing in the fund. Although the fund seeks to preserve the value of your investment by $1 per share, it cannot guarantee it will do so. The fund may impose a fee upon sale of your shares or may temporarily suspend your ability to sell shares if the fund’s liquidity falls below required minimums because of market conditions or other factors. An investment in the fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. The fund sponsor has no legal obligation to provide financial support to the fund and you should not expect that the sponsor will provide financial support to the fund at any time. For government money market funds: you could lose money by investing in the fund. Although the fund seeks to preserve the value of your investment at $1 per share, it cannot guarantee it will do so. An investment in the fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. The fund sponsor has no legal obligation to provide financial support to the fund and you should not expect that the sponsor will provide financial support to the fund at any time. For municipal income funds: a portion of the fund’s income may be subject to federal, state, and/or local income taxes or the alternative minimum tax. Any capital gains distributions may be taxable. For government funds: the U.S. government guarantee applies to certain underlying securities and not to shares of the fund. Stock values fluctuate in response to the activities of individual companies and general market and economic conditions. Bond values fluctuate in response to the financial condition of individual issuers, general market and economic conditions, and changes in interest rates. Changes in market conditions and government policies may lead to periods of heightened volatility in the bond market and reduce liquidity for certain bonds held by the fund. In general, when interest rates rise, bond values fall and investors may lose principal value. Interest rate changes and their impact on the fund and its share price can be sudden and unpredictable.