Neil Hutchison, executive director, lead portfolio manager for managed reserves portfolios in Europe within J.P. Morgan Asset Management’s Global Liquidity Group, explains how these assets can bolster cash balances in the current environment.
The macro-economic backdrop may be changing but cash management is still driven by the same three key objectives - principal preservation, liquidity and yield. However, the winding down of quantitative easing and rising rate environment has necessitated a shift in fixed income allocation, which is why J.P. Morgan Asset Management (JPMAM) has launched the euro and sterling versions of its JPMorgan USD Ultra-Short Income ETF, introduced in January.
J.P. Morgan Asset Management’s GBP Ultra-Short Income UCITS ETF (JGST) and the EUR Ultra-Short Income UCITS ETF (JEST) have the same objectives – to make the cash on corporate balance sheets work harder and to provide an incremental return over AAA-rated liquidity funds, in a low-risk framework.
Like their US counterpart. JGST and JEST will be run by the Managed Reserves team of JPAM’s Global Liquidity Group, which has 132 dedicated global liquidity specialists in seven countries overseeing more than USD 597.6 billion in short-term assets under management.*
Although actively managed, the investments are conservative in nature and selected by an in-depth and disciplined process. Analysis of top-down macro-economic trends is combined with bottom-up corporate and structured credit research with a strong risk management oversight.
In terms of the securities, the funds aim to mitigate volatility and limit duration exposure by investing in a diversified basket of very short maturity bonds and debt instruments. These range from investment-grade fixed and floating-rate corporate and structured debt to government bonds. The return target is 40% to 60% [net of fees] over Money Market Funds and a total expense ratio (TER) of up to 22 basis points, waived to 18 basis points until February 28, 2021.
Traditionally in the corporate world, ultra- short securities have played a cash alternative role but they are also increasingly becoming a fixed income substitute. The focus has become sharper as companies look to navigate the challenges and leverage opportunities of an evolving rate environment.
ETFs have not usually been the first port of call for corporate treasurers but in this current climate, these liquid, low-cost and transparent products are gaining traction as liquidity management tools. They can be deployed as both a cash management solution as well as an effective hedging mechanism. While equities have been the most popular asset class, fixed income allocations have grown to approximately 18% or USD 28 billion in total fixed-income assets among the 87 institutions, canvassed by a Q2 2018 Greenwich Associates report.
One of the main attractions of ultra-short bonds – securities with durations of less than one year – over short duration bonds, which have a timespan of one to three years, is their performance. They are less sensitive to interest and inflation rate fluctuations and not only provide a cushion, but help to generate better risk-adjusted returns. In fact, three-month US Treasury bills are often referred to as the global finance industry’s closest proxy for hard cash.
This trend is confirmed in a rising rates paper from October 2018, produced by the Global Liquidity Group within J.P. Morgan Asset Management**, that examines historical data covering three periods of Federal Reserve tightening between 1994 and 2006. It shows that the BofA Merrill Lynch (BAML) three-month US Treasury Bill index, which has a duration of about 0.2 years, outperformed core bond strategies, such as the Barclays US Aggregate (US Agg) and BAML US Corporate & Government (C&G) Master indexes. Each had durations of around five years.
In addition, the BAML three-month US T-Bill index outshone benchmarks of short-duration mandates such as the BAML one-to-three-year US C&G index and the BAML one-to-three-year US Corporate-only index - each with a duration of roughly two years.
On the inflation front and more recently, yields of three-month US Treasury bills were higher than all three main measures of US inflation for the first time since the early days of the global financial crisis. They climbed to a new post-crisis level of 2.3%, increasing above the latest “core” US inflation rate reading in late September and even the main headline inflation rate. By contrast, yields on the ten-year Treasury note dropped 1-bp to 3.08%.***
Returning to normal
The US is much farther down the normalisation path than the UK and Europe, having started unwinding its quantitative easing programme and raising rates in 2015. Although it began gradually, the Federal Reserve picked up the pace, hiking interest rates three times as signalled in 2016 and to date a similar number in 2018. The final tally for this year is forecast to be four, with three expected in 2019. The UK, on the other hand, is proceeding at a much slower pace, while the Europeans are trailing far behind. However, the direction of travel is the same, although it is difficult to know when the European Central Bank will make the first move higher. It has indicated, though, that it will phase out its three-year €2.4tn stimulus programme by the end of the year.
Although the market has priced in these impending movements, investors need to be prepared for central banks to act faster than expected. A steepening curve can be painful, which is why corporates need to be prepared and have their cash management solutions in place. If they are not able to respond quickly, they will lose money and not be able to fulfil their cash requirement objectives.
*All figures are as at 30 September 2018.
***J.P. Morgan Asset Management as at November 2018
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