Money market funds have been inflowing since the Federal Reserve began its interest rate hike cycle. But now that the central bank appears close to cutting interest rates, financial advisors are trying to steer clients away from these funds, whose yields could soon fall substantially. Short-term bonds have been a popular investment for several years, and money market funds are a prime example. According to the Investment Company Institute (ICI), there are currently more than $6 trillion in money market funds outstanding, with about $2.5 trillion of that held by retail investors. For reference, the total value of money market funds as of the fourth quarter of 2019 was about $4 trillion, according to the St. Louis Fed. Money market funds hold very short-term bonds, and many currently offer yields above 5%. However, their yields are closely tied to the Fed’s benchmark interest rate, and they do not benefit from price increases due to lower interest rates like longer-term bonds. “In my opinion, the state of the financial markets makes it difficult for investors to make the right decisions right now,” said Sam Fuscho, founder of SGH Wealth Management in metro Detroit, Michigan. Fuscho said he has used senior loan products with floating-rate exposure to capture short-term yields for the past few years. But now that the possibility of a Federal Reserve rate cut is increasing, Fuscho is shifting to target-date maturity bond funds, specifically Invesco’s BulletShares ETF. With a rate cut looming, Fuscho said it’s better to move sooner than later. “Instead of getting stuck on whether to lock in at 5.4 or 5.29, both of which are really good and one unpredictable economic event and they’re suddenly gone,” Fuscho said. The potential benefit of target-date bond funds is that investors can effectively “lock in” the interest rate when they buy. The fund buys the bonds and holds them until maturity, which makes them different from many other exchange-traded funds. This keeps the fund’s time exposure fairly constant. “Bond funds can go bust, but at least for these stated maturities, they’re really more of a standard fixed income product, and you’re still getting principal and interest at the end of the day,” said Todd Son, Strategas ETF strategist. As the yield curve starts to flatten, moving to intermediate-term bonds doesn’t mean you’re losing out on a lot of income in the meantime. For example, the Invesco BulletShares 2029 Corporate Bond ETF (BSCT) has a 30-day SEC yield of 4.94%. BSCT YTD Mountain This bond ETF has a yield of almost 5%. Actively Managed For investors who don’t want to manage their own bond strategy, actively managed bond funds can make sense. Ken Brodkowitz, chief investment officer at Grease Financial Partners, said the firm is shifting to strategic income funds to get a little more duration. These are actively managed multi-sector bond funds that have the flexibility to chase additional yield when interest rates fall. “We looked at a number of funds and found one that had the right duration profile for us (very short-term, under two years) and wasn’t off the risk curve,” Brodkowitz said. Many firms offer strategic income mutual funds. One example is the Fidelity Strategic Income Fund (FADMX), which has a four-star rating from Morningstar. Active bond ETFs have seen strong growth. The BlackRock Flexible Income ETF (BINC), which has over $3.5 billion in assets in just over a year since it listed, focuses primarily on short- and intermediate-term debt. Brodkowitz said Grease Financial doesn’t expect any dramatic rate cuts from the Fed and is maintaining exposure to short-term interest rates in the form of the 3-Month Treasury ETF (TBIL), which has a much lower expense ratio compared to actively managed products. Cash on the sidelines? The trillions of dollars parked in money market funds, dubbed “sideline cash” by some on Wall Street, could help propel the stock market higher if it were to rev up. But investors seem content to get a yield, even if returns underperform the stock market. Strategas’ Song noted that money market fund assets were growing consistently in the 1990s, when the excitement of the dot-com era began. “Historically, we don’t tend to see money market inflows stop or start to turn to outflows until interest rates get below, say, 3 percent. People are happy at 4 percent or 5 percent,” Song said. For younger investors, missing out by not participating in the stock market could be a long-term mistake, said Carrie Cox of Ritholtz Wealth Management. “I think that’s one of the biggest mistakes investors are making right now. At Ritholtz, we’re actively educating our clients about the changing interest rate environment and the opportunities they could miss by putting too much money in cash,” Cox said. Fuscho said there appears to be a psychological barrier for some investors: The promise of short-term yield with little risk masks the opportunity for better long-term returns. “For most people, the opportunity cost is a much harder pain to bear than the actual loss,” Fuscho said.
If the Fed cuts interest rates, these income investments could fare better than money market funds.
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