What This Strategy Aims To Do
This strategy aims to provide clients with an enhanced liquidity vehicle. Similar to the role played by money market funds, this is a place to park cash. It differs, though, in terms of its potential to deliver a bit more in terms of return.
Why It’s Worth Considering
Cash is something that can and should be managed.
Corporate treasurers take this for granted, and notwithstanding their intense concerns regarding safety and liquidity, they still try to generate at least some sort of return. They don’t look to hit home runs, but they understand that some cash and cash-equivalent vehicles offer risk-reward-liquidity tradeoffs that, while easy for the casual observer to ignore, can over the long term make a difference compared with what would be achieved through ownership of the most basic checking accounts or money market funds. Others who are or have been members of organizations such as Homeowner Associations, PTAs, etc. have likely addressed similar matters or listened at meetings to the obligatory and almost ritualistic “Treasurer’s reports” that describe such activity.
Investors would do well to think and do likewise, especially given that as of this writing the most basic of cash holdings returns close to zero.
How We Do It
This is our simplest strategy. It involves ownership of just one ETF, the PIMCO Enhanced Maturity Active ETF (MINT).
As with fixed income in general, there are three kinds of relevant risk: cash-receipt (credit) risk, liquidity risk, and interest-rate risk.
This ETF is easily tradable so liquidity risk is not substantial. When you want or need to sell, you can expect to be able to sell easily and have your transaction executed at the fair market price.
Cash-receipt risk exists because this is not a Treasury fund. However, based on policy (“investment grade” issues only) and active decision making on the part of PIMCO (a well-regarded fixed-income manager), we believe credit risk is as modest here as you’re likely to find outside the much lower-yielding Treasury market. Note, too, that even money market funds, seen by many as the penultimate parking space for cash, have comparable credit risk (unless they specifically identify themselves as such, you should assume these funds likewise do not hold Treasuries).
The issue here, the difference between MINT and money market funds, is interest-rate (market) risk. Money market funds usually invest in commercial paper and other securities scheduled to mature in a few weeks or, at most, months, thus bringing risk of loss due to rising rates as close to zero as one can get from fixed income. MINT, on the other hand, states that the portfolio’s weighted average maturity is not expected to exceed three years.
That potential for a three-year average maturity could raise eyebrows at first glance. But in fact, interest-rate risk is mitigated by two considerations:
- The portfolio’s weighted average “duration” is expected to be not longer than one year. In the world of fixed-income duration, as a measure of market (interest-rate) risk, is superior to maturity. That’s because it counts not only the cash that will be received when the bond pays off at the end, but also the cash received in the interim (through coupon-interest payments) and the money that can be earned by reinvesting the interest. To the uninitiated, this may sound like hair splitting. It’s not. In the flexed income arena, the advantages of managing duration as opposed to maturity are real and substantial.
- This is an actively-managed fund. The Prospectus states that maturity and duration are not expected to exceed three years and one year respectively. But that does not mean they will always stay on that schedule. If, for example, the fund managers expect interest rates to rise, they can adjust the portfolio so that average maturity and duration are shorter. This puts it at a big advantage viz. standard passive ETFs that are required to stay in their prescribed maturity-duration ranges even if its obvious that market conditions would require a prudent investor to make adjustments. Those funds count on the willingness and ability of shareholders to trade into and out of appropriate funds on their own. The traditional way would likely be much better in a falling interest rate environment (in which naive inertia on the part of many investors would prevent them from swapping into shorter term funds prematurely). Going forward as of this writing, with benchmark rates still near zero making meaningful declines virtually impossible, inertia would not likely serve investors nearly as well as active management on the part of a firm like PIMCO.
Is It Suitable For You?
This strategy is suitable for cash (i) that is already in a Portfolio123 ADVISOR account (and hence already subject to the asset-based advisory fee) that would otherwise sit idle (i.e. in the brokerage cash-equivalent account); and (ii) that is not likely subject to such a pressing immediate need that even the short maturity-duration profile would become too burdensome. In other words, this is suitable for cash that is already in the advisory account that is idle because of a choice on your part to be less than fully invested in stocks or other fixed-income vehicles.
- Market risk is present but due to the ETF's targeted one-year portfolio duration, it’s extremely low.
- Cash-receipts risk is present since fund invests in non-treasury securities, but is as low as one can get outside the treasury market.
- Trading is minimal; the strategy consists of a single ETF.
- There is no need to adjust the model; trades will occur only as investors commit money to or withdraw money from this near-cash vehicle.