Matt Tucker: A New Way to Step Out of Cash

Investors have another resource at their disposal when it comes to stepping out of cash and potentially lowering interest rate risk in a rising rate environment. Matt Tucker explains.

by Matt Tucker, Blackrock

With everything that happened in the fixed income markets this past year, one theme dominated the headlines, the ETF flows, and the stories on this very blog: Short duration bonds. Through the end of 2013 $34 billion flowed into short duration bond ETFs (source: Bloomberg).

As I discussed in a recent post, investors flooded into the short duration category for two distinct reasons. First, many were rotating out of longer duration bonds, thereby lowering interest rate risk in a rising rate environment. Second, others used these bonds to toe-dip back into the market and out of cash, which is currently earning negative real returns after inflation.

ETFs have been a popular choice for investors executing both of these strategies. Because there’s a large variety of bond ETFs out there, it’s easy to customize your short duration exposure using only one or two funds. And with the recent launch of the iShares Liquidity Income ETF (ICSH), investors have another intriguing tool at their disposal.

ICSH has a very low duration (0.36 as of 1/2/13), making it one of the least interest rate sensitive funds in the iShares bond line-up. You can see how ICSH compares to the rest of the iShares short duration bond suite below:

ICSH seeks to provide income while preserving capital by investing in short term bonds and money market instruments. This makes it a natural solution for investors looking to execute the “step out of cash” strategy I mentioned above. Compared to SHV (iShares Short Treasury Bond ETF), which has the closest duration, ICSH yields 0.58% while SHV yields 0.13%.1

With so many options in the short duration space many investors may be left wondering where to invest. As always, it comes down to what risks you are willing to take on in an attempt to pick up yield. For short duration funds that means how much interest rate risk and how much credit risk you are comfortable with. Here is one way to group the above funds and make a little more sense out of them:

Treasury Funds: SHV and SHY. These funds invest in U.S. Treasuries which do not have credit risk. An investor can choose the specific fund that fits with their interest rate risk sensitivity.

Credit Funds: FLOT, CSJ, and SLQD. These funds invest in bonds from corporations and other issuers. These issuers carry some risk of default, and so an investor can expect additional yield relative to U.S. Treasuries. Again an investor can pick the level of interest rate sensitivity they want, with FLOT being the least interest rate sensitive.

Term Maturity Funds: IBDA and IBCB. These funds also invest in credit bonds. The difference is that these funds actually mature on a pre-determined date. This makes them popular with investors who are concerned about rising interest rates or who historically ladder individual bonds.

Multi-Sector Funds: NEAR, ISTB, and the new ICSH. These funds invest in multiple sectors across the short duration market. ICSH broadens the options available here by offering a fund that has less interest rate risk than either NEAR or ISTB.

Hopefully this helps you in navigating the short duration market. If 2014 is the year you want to step out of cash, ICSH – or one of the many other short duration bond ETFs out there – could be just what you need to finally toe dip back into the market.

Matt Tucker, CFA, is the iShares Head of Fixed Income Strategy and a regular contributor to The Blog. You can find more of his posts here.

Copyright © Blackrock

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