Institutional investors are reportedly turning toward ETFs, particularly ultra-short-term bond funds, as their choice du jour to equitize massive amounts of cash. Think funds like the $7.3 billion PIMCO Enhanced Short Maturity Active ETF (MINT), the$2.6 billion iShares Short Maturity Bond ETF (NEAR) and the newcomer Arrow Reserve Capital Management ETF (ARCM), with $50 million in assets. Together they have attracted more than $2 billion in combined new assets in 2017. Meanwhile, money market mutual funds have faced net redemptions this year. Joe Barrato, CEO of Arrow Funds, talks about the space and why these ETFs are winning the race.
(The chart plots the year-to-date performance of MINT and NEAR relative to the iShares Core U.S. Aggregate Bond ETF (AGG). StockCharts had not enough data on ARCM because it’s recently launched.) Chart courtesy of StockCharts.com
ETF.com: Is the challenge of generating income getting harder? Are ETFs changing the way investors solve for that?
Joe Barrato: From a big-picture perspective, we're entering a period where interest rates are going to rise, and in a rising rate environment, what tends to lag are things like long-term and intermediate-term Treasuries, compared to things like munis and aggregate bond index. Things with higher yield tend to do very well, like high-yield bonds, REITs, sovereign debt from overseas.
There's a gamut of products in the ETF realm investors can use. For example, higher-yielding ETFs like high-yield bonds and preferred stock funds are delivering in the 5-6% range. In the 4-5% range, you've got energy and limited partnership products; you've got global real estate. At the other end, you've got your standard equity instruments, the large growth, the large blend, going from 0-2% in yield, and then the short-term bonds.
As a firm, we approach it two ways. We have a very-high-volatility approach in a portfolio that’s 60% equities and 40% bonds, which is the Arrow Dow Jones Global Yield ETF (GYLD). And we have the Arrow Reserve Capital Management ETF (ARCM), which is all about what you’re doing with your cash. It’s a reserve cash management strategy that delivers consistent yield with the same amount of volatility as a money market fund, but with a much higher Sharpe ratio.
But the bottom line is that ETFs are viable solutions that, in this segment, weren’t available 10 years ago.
ETF.com: How does ARCM, which is months old, compare to other money-marketlike strategies such as MINT and NEAR?
Barrato: MINT has the ability to have greater exposure to some of the riskier instruments like euro corporate bonds, mortgage-backed securities, euro sovereigns. NEAR is similar in that respect.
I’d classify those products as having a much higher risk profile. They're going to have a higher yield and return than our strategy, but our volatility’s going to be more like a money market fund.
We're somewhere in between cash and ultrashort-term bond funds in terms of expected volatility and expected yield. We're going to generate alpha greater than what a money market would, and greater than what you’d see for a typical ultrashort-term bond fund for the amount of risk you're taking.
ETF.com: In terms of usage, these types of ETFs are all about squeezing some return from a cash position without taking on too much more risk?
ETF.com: Institutional investors have been increasingly using ETFs to put cash to work at the expense of money market mutual funds. Are ETFs really disrupting the role money market funds have played in the institutional space?
Barrato: You could argue that ETFs have been a disruptor for many years. What I’m sensing more is that people have migrated toward ETFs and moved away from mutual funds, but they’re trying to stay in instruments that are very similar to what they've been doing.
ETFs have always been a way to equitize your cash until you either put it to work or find the strategy you're looking for. Let's say you know at some point you want to get a narrower basket in large-caps; you could buy the SPDR S&P 500 ETF Trust (SPY) and then sell that when you're ready to put that strategy to work with your own equity basket.
On the cash side, ETFs are cheaper in many cases than some of the brethren products that are in the mutual fund structure. There's been a mass migration at the institutional level, and to some extent, at the broker level, with financial advisors who are starting to use those.
The other thing is that a lot of these instruments didn't exist 10 years ago; over time, as ETFs have evolved, it’s allowed these types of strategies to be added to the ETF tool box.
ETF.com: Do these money-marketlike ETFs have a permanent place in an investor portfolio, or are they short-term instruments by design?
Barrato: It all comes back to goals. There's always some element of cash in everybody's portfolio, whether it's retail or institutional, whether it’s for equitizing or for sheer liquidity. It comes down to, what's the best way to get some type of income with not a lot of volatility or risk from that position?
That’s why we have ultrashort-term bond funds. I have a chart that breaks down the U.S. fixed-income market by how much money is in all the products.
Not surprisingly, most of the money was sitting in intermediate-term Treasuries, but there was some sitting in short-term Treasuries, and the ultrashort-term bond category is one of the larger ones. There’s a sizable amount of money that sits in cash, because of some of the reasons we talked about.
For a larger view, please click on the image above.
ETF.com: Is the current macro environment, filled with geopolitical tension, positive for ETFs like ARCM and MINT? What are the main risks?
Barrato: There are a couple scenarios. In a rising rate environment, there are far riskier components of the portfolio that are going to do very well, such as aggregate, global aggregate, sovereigns, REITs, high yield. The traditional stuff is what's usually challenged in that environment.
On the lower risk side, investors can look at short-term Treasuries as a way to put their money into safety. That's where ultrashort-term bonds have the opportunity to add value.
But geopolitical events that come into play will impact those instruments. When geopolitical tension rises, it’s Treasuries—any type of Treasury instruments—that do very well.
ETF.com: What's the biggest misconception investors have about what these money-marketlike ETFs offer?
Barrato: It's funny, because when we talk to clients, there's an element of wanting to do something with their cash allocation to generate income, whether it's static or not.
When we talk to investors who are buying, say, long-term bond funds, they'll ladder their bond portfolios to prepare themselves for the rising rate environment. That's a common approach.
The challenge is that, inside the ultrashort-term bond realm, people forget you have to look at the underlying risk of what you're investing in. Some people have gone into ultrashort-term bond funds and have gotten burned because they weren't aware of what exposures were in there. You're not getting more income without taking on some element of risk.
Contact Cinthia Murphy at email@example.com
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