Joyce Huang and Jason Greenblath of American Century Investments have published The Rising Risk of Investing in Cash, which examines the potential benefits of shifting from cash into short-duration bonds.
After the Federal Reserve (Fed) increased interest rates more than five percentage points, investors moved approximately $6.4 trillion into cash equivalent investments. But now, as the Fed eases monetary policy, yields1 on these investments are likely to fall with each subsequent rate cut. This backdrop underscores rising reinvestment risk, or the possibility that investors cannot reinvest cash flows at the same yield they’re currently earning.
In a declining rate environment, reinvesting in cash equivalents, which generally move in sync with the federal funds rate, may lead to lower income. Huang and Greenblath believe this dynamic highlights the potential yield and total return opportunities of short-duration bonds compared to cash equivalents.
We believe yields on many short-duration, investment-grade fixed-income investments have remained relatively attractive compared to pre-pandemic average yields. In addition to their solid yields, these bonds offer price appreciation potential in a declining rate environment—a feature unavailable from cash equivalents. And, because their durations2 are short, they remain less-sensitive than their longer-duration peers to the interest rate volatility characteristic of today’s market.
The timetable and magnitude surrounding future Fed rate cuts remain unclear and dependent on prevailing economic data. Huang and Greenblath expect short-term interest to decline in 2025, but they also expect economic and market uncertainties to trigger near-term interest rate volatility. Against this backdrop, they suggest investors consider the American Century Short Duration Strategic Income ETF (SDSI).
The fund focuses on generating attractive income by opportunistically shifting exposure to various fixed-income sectors, while managing interest rate risk. The fund’s benchmark is the Bloomberg U.S. 1-3 Year Government/Credit Bond Index.3 As of September 30, 2024, more than half the fund was invested in government securities and investment-grade corporate bonds.
Resources:
The Rising Risk of Investing in Cash
Can Corporate Bonds Deliver in a Slowing Economy?
WEBCAST – Is It Time to Redeploy Cash?
With the Fed now in easing mode, yields on cash equivalents likely will fall from recent multiyear highs, reducing their income appeal. Join us as we outline strategies to help fixed-income investors manage this climate of heightened reinvestment risk.
The team will discuss:
- The rising cost of staying heavily invested in cash investments
- How prior periods of falling interest rates have affected the fixed-income market
- The important role short-duration bonds may play, given the current interest rate backdrop
Accepted for 1 CFP® / IWI / CFA CE Credit
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Exchange Traded Funds (ETFs) are bought and sold through exchange trading at market price (not NAV), and are not individually redeemed from the fund. Shares may trade at a premium or discount to their NAV in the secondary market. Brokerage commissions will reduce returns.
This fund is an actively managed Exchange Traded Fund (ETF) that does not seek to replicate the performance of a specified index. To determine whether to buy or sell a security, the portfolio managers consider, among other things, various fund requirements and standards, along with economic conditions, alternative investments, interest rates and various credit metrics. If the portfolio manager considerations are inaccurate or misapplied, the fund’s performance may suffer.
Generally, as interest rates rise, the value of the bonds held in the fund will decline. The opposite is true when interest rates decline.
The lower rated securities in which the fund invests are subject to greater credit risk, default risk and liquidity risk.
Derivatives may be more sensitive to changes in market conditions and may amplify risks.
1Yield: For bonds and other fixed-income securities, yield is a rate of return on those securities. There are several types of yields and yield calculations. “Yield to maturity” is a common calculation for fixed-income securities, which takes into account total annual interest payments, the purchase price, the redemption value, and the amount of time remaining until maturity.
2Duration: Duration is an important indicator of potential price volatility and interest rate risk in fixed income investments. It measures the price sensitivity of a fixed income investment to changes in interest rates. The longer the duration, the more a fixed income investment’s price will change when interest rates change. Duration also reflects the effect caused by receiving fixed income cash flows sooner instead of later. Fixed income investments structured to potentially pay more to investors earlier (such as high-yield, mortgage, and callable securities) typically have shorter durations than those that return most of their capital at maturity (such as zero-coupon or low-yielding noncallable Treasury securities), assuming that they have similar maturities.
3A Bloomberg U.S. 1-3 Year Government/Credit Bond Index: A component of the U.S. Government/Credit Bond Index, which includes Treasury and agency securities (U.S. Government Bond Index) and publicly issued U.S. corporate and foreign debentures and secured notes (U.S. Credit Bond Index). The bonds in the index are investment-grade with a maturity between one and three years.
The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments’ portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.
Generally, as interest rates rise, the value of the securities held in the fund will decline. The opposite is true when interest rates decline.
Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.
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