Rethinking Cash

It's a good time to be talking about cash. We've reached a new peak in money fund assets at $7 trillion. We went from the lower band of zero back in 2022 all the way to five and a quarter in the summer of 2023. Finally this past September, the Fed began their easing cycle. We had a 50 basis points rate cut in September and then another 25 basis points cut just recently here in November. The market is split 50/50 as to whether we will get another move at the final meeting of the year in December. The official Payden call is for another 25 basis points, so that would bring the lower band down to four and a quarter.

Now as yields are decreasing as the Fed is cutting the federal funds rate, yields on money market funds are declining. It’s a bit of a surprise to us to see fund balances continuing to increase, as that $7 trillion number is eye popping. While we've reached these new highs, prime institutional funds are the only category with net outflows this year, down by over half of the assets under management and expected to continue to shrink. This is directly a result of the SEC's latest round of reforms, which went into place this year.

As investors think about moving cash out of money market funds into longer bonds, a low duration strategy makes sense. A low duration strategy is a compelling solution for investors looking to balance safety, liquidity, and enhanced income. We're currently in a period of increased interest rate volatility and lower credit risk premiums, which means the additional yield investors earn by buying higher risk securities are lower than normal. With this backdrop, we don't think it's sensible to take on credit risk that doesn't fairly compensate the investor. We have a similar view for interest rates, where we do not see value in taking on additional risk where you're not compensated. We came into January of this year with the market pricing in seven cuts. And now at the end of the year we've had three cuts, and we may or may not get a fourth. Since we believe the market is pricing in fewer future cuts than what we think will occur, we see value in extending out bond duration right now.

So what are low duration strategies and how do they differ from money market funds? Low duration strategies have a lot of other alternative names. You may have heard ultra short, short duration, enhanced cash, enhanced income, et cetera. These strategies offer investors the potential to earn more than money market funds or bank deposits. They broaden the investible universe in two keyways. Number one, low duration strategies invest in bonds with maturities as long as five years, compared to the 397-day maturity limit on money market funds. This enables an investor the potential to lock in longer term yields, as well as take advantage of price appreciation as interest rates fall, something money market funds cannot do as effectively. And second, low duration strategies invest across the fixed income universe – from Treasury bills to corporates to structured bond credit. This investment diversification can generate greater returns while maintaining liquidity.

Now, expanding the guidelines does add some risk, as these strategies are not $1 net asset value (NAV). While they do offer the higher potential for return than money market funds, they come with greater price volatility due to owning longer maturities, and the inclusion of credit. However, the investments remain short-term enough to limit this risk, especially as bonds quickly approach maturities and their prices pull to par, which help to stabilize returns. By its nature, a low duration portfolio should be liquid. However, not every individual holding needs to be able to function as liquidity. Though money market securities have less price risk and lower trade costs than corporate bonds, both can be sold to generate liquidity. Through active management, portfolios can maintain liquidity and participate in total return opportunities. Payden & Rygel's low duration strategy team manages two strategy solutions. Enhanced cash and low duration. Both aim to outperform passive cash strategies, but they differ in their benchmarks and duration profiles.

Enhanced cash is your first step out beyond a money market fund. The duration is typically short, less than three quarters of a year, and the spread duration is typically under one and a quarter year. As a result, the volatility is low, and liquidity is exceptional. The next step out is what we call low duration. Typically a one- to three-year benchmark duration will range somewhere between one and a half and two and a half years and spread duration somewhere between one and three years. The price volatility here is going to be a little higher than the enhanced cash strategy but remains low when you look at it compared to longer, intermediate, or core bond strategies. And again, active management looks to minimize this price volatility over time. Many of our clients employ a mix of both enhanced cash and low duration strategies as they look to put their longer reserve cash to work. Within the strategy, we offer customized approaches to fulfill our clients' investment objectives.

Now, how does a low duration strategy differ from other fixed income strategies? With the Fed cutting interest rates to a more neutral level, this is going to have the greatest impact on short-term securities. That means money market yields will fall rapidly as the Fed lowers rates. However, low duration bond portfolio yields will not decrease as quickly. By investing a portion of the cash in longer duration bonds investors can lock in higher yields further out the maturity curve. Clients can customize the amount of duration or credit risk they wish to tolerate through their investment guidelines. The broader the guidelines, the more opportunity to earn higher long-term returns, along with some additional volatility than a money market fund. Low duration strategies are for investors who want a balance of liquidity and moderate returns with lower risk. While intermediate to core bond strategies are for those seeking higher returns, but over a long run, and willing to accept more volatility.

Low duration strategies are positioned between the safer world of money market funds, and the more volatile space of intermediate and core bond strategies. And while they do carry more price risk than a money market fund, they do have lower volatility and credit risk compared to other bond strategies.

So what factors should investors consider when seeking higher yields? Returns in a low duration strategy are primarily driven by sector allocations. Investment grade corporates and structured credit are integral parts of the portfolio. We invest in debt, ranging from zero to five years in maturity, both fixed rate and floating rate coupons. Diversification guidelines limit our exposure to any single issuer except within government securities, and we actively manage that credit exposure, selling and buying securities when changes in their valuations or fundamentals make it necessary or worthwhile. This multi-sector approach seeks to provide multiple sources of return and allows us to improve risk-adjusted performance across a variety of market environments.

Payden & Rygel has specialized in custom cash management solutions for four decades. Our deep experience in this area allows us to create more customized cash solutions tailored to our client's liquidity and investment objectives. Moreover, our long-term relationships and experienced team of experts have enabled US market insights and better access to liquidity in challenging markets. Low-duration strategies remain a core part of Payden's business. While we've expanded to many other fixed income strategies as well as equities, low-duration strategy team and assets continue to grow.

Kerry G. Rapanot, CFA

Kerry Gawne Rapanot is a director and a member of the Low Duration Strategy leadership team at Payden & Rygel. She is responsible for the development and implementation of investment strategies within the firm’s liquidity-oriented and ultra short portfolios. In this capacity she is responsible for oversight of idea generation, strategy implementation and risk management. Prior to her role in strategy, she was the Manager of the Cash Trading desk active in trading government, money market and corporate bonds.

Before joining Payden & Rygel, Kerry was part of the Institutional Fixed-Income Group at Salomon Smith Barney where she sold bonds to institutional clients such as local governments and bank trust departments. Previously, she was with TD Waterhouse assisting retail clients with financial planning.

Kerry holds the FINRA series 7 and 63 licenses. Kerry is chair of the investment committee at the California Council on Economic Education, a 501c3 organization. She is past President of the CFA Society of Los Angeles and a member of the CFA Institute.

She earned a BBA degree from Wilfrid Laurier University, Ontario, Canada, with an emphasis in finance and a minor in economics.

ABOUT PAYDEN & RYGEL

With $164 billion under management, Payden & Rygel is one of the largest privately-owned global investment advisers focused on the active management of fixed income and equity portfolios. Payden & Rygel provides a full range of investment strategies and solutions to investors around the globe, including Central Banks, Pension Funds, Insurance Companies, Private Banks, and Foundations. Independent and privately-owned, Payden is headquartered in Los Angeles and has offices in Boston, London, and Milan.

This material is intended solely for institutional investors and is not intended for retail investors or general distribution. This material may not be reproduced or distributed without Payden & Rygel’s written permission. This presentation is for illustrative purposes only and does not constitute investment advice or an offer to sell or buy any security. The statements and opinions herein are current as of the date of this document and are subject to change without notice. Past performance is no guarantee of future results.

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