Since the global financial crisis erupted in 2008, nervous investors have taken refuge in money market funds despite yields that hover a hair’s breadth above zero.
Call it the cash sanctuary.
Now may be the time to step outside, says Scott Warner, head of fixed-income product management at Northern Trust.
Warner believes that a more refined, calibrated approach to liquidity management could potentially improve returns, without significantly sacrificing liquidity or safety of principal.
The Northern Ultra-Short Fixed Income Fund is designed to meet that goal.
Ideally, Warner believes that short-term liquidity should be allocated among three segments, or "buckets."
The first two buckets, which he calls "operational" and "reserve," should hold liquidity needed to cover day-to-day needs, plus expenses that might come up within a month or two. Money market funds, which invest in securities with a maximum average weighted maturity of 60 days,1 are ideal for that purpose.
A third or "strategic" bucket, however, could be used for longer-term allocations or to help stabilize the more volatile parts of a portfolio. This segment seeks a higher yield than a money fund by taking on a modest increase in interest rate, credit and liquidity risk.
Though some investors are afraid that interest rates could rise — thus reducing the value of existing bonds — the Federal Reserve has pledged to keep benchmark rates near zero until at least mid-2015.
Besides, more than a quarter of the Northern Ultra-Short Fixed Income Fund’s assets are in floating rate securities, whose yields usually are designed to increase as rates rise.
"Floaters are less sensitive to rate hikes than fixed-rate bonds," notes Warner.
A larger allocation to floating-rate bonds is just one characteristic that aims to distinguish the Northern Ultra-Short Fixed Income Fund from its competition.
The Fund invests only in investment-grade securities, generally allocates less to mortgage-backed bonds and lower-yielding Treasuries, and limits the maturity of most of its nearly 300 holdings to only three years for fixed rate securities (longer for floating-rate bonds). See the Fund fact sheet for more details.
Warner says, "By stepping out of the pure cash sanctuary just a little, we look to pick up incremental yield, while still managing interest rate and credit risk."
All good reasons, Warner says, to consider keeping Bucket #3 filled to the brim.
The Northern Ultra-Short Fixed Income Fund is not a money market fund, which maintains a $1.00 NAV, and the Fund’s share price will fluctuate with its returns. An investment in the Fund can result in the loss of principal.
Past performance is no guarantee of future results.
Bond Risk: Bond funds will tend to experience smaller fluctuations in value than stock funds. However, investors in any bond fund should anticipate fluctuations in price, especially for longer-term issues and in environments of rising interest rates.
1 Securities and Exchange Commission