Insights

How to Manage Reinvestment Risk and Put Cash to Work Now

With Federal Reserve (Fed) rate cuts on the horizon, cash-like money market mutual fund returns may be challenged by lower yields and increased reinvestment risk — the process of reinvesting current income streams at lower rates.

Lower future returns for a category with more than $1 trillion of inflows in the past year¹ means that many investors may want to reconsider portfolio construction decisions, with the goal of putting this excess “cash” to better work.

April 25, 2024 5 min read

Matthew J Bartolini, CFA, CAIA

Head of SPDR Americas Research

Rate Cuts Can Increase Reinvestment Risk and Decrease Returns

Consensus estimates and forward looking futures pricing suggest investors should expect three rate cuts in 2024, with the policy rate falling from 5.5% to 4.6% by yearend.² With a 99.5% correlation between the federal funds rate and US 3-month Treasury Bill yields (T-bills),³any rate reduction will likely have a one-to-one impact on T-bills yields and similar ultra-short tenors. And, historically, lower rates have indicated lower future returns for cash-like instruments.

Over the past 30 years, as T-bill yields began to adjust, so did future 12-month returns. In fact, there is a 98% correlation between the two (Figure 1).⁴ This illustrates the challenges with reinvestment risk, and the reason why you may want to consider new strategies now.

5 Fixed Income ETF Strategies to Consider Now

Investors’ aggressive buying of $1 trillion of money market funds over the past year primarily was propelled by generationally elevated yields. But it was also driven by the need for return stability.

As a result, any strategy you’re considering to manage the impact of reinvestment risk and replace cash-like exposures should also seek to balance income with stability. As you aim to move further out on the curve and put cash to work, here are five potential SPDR® ETF solutions that may help you strike that balance:

1. SPDR SSGA Ultra Short Term Bond ETF (ULST)

ULST is an actively managed strategy that invests primarily in US dollar-denominated investment-grade fixed income securities but can own up to 10% in high yield, as it seeks to maximize current income consistent with the preservation of capital and daily liquidity. In pursuing this objective, the ETF also targets a duration of 1 year or less and a weighted average maturity of 2.5 years or less.

Given State Street Global Advisors’ Active Investment team’s credit selection and risk management tactics, ULST currently offers a yield greater than core bonds (SEC Yield of 5.2% versus the Bloomberg US Aggregate Bond Index’s yield-to-worst of 4.9%), but with 86% less return volatility over the past three years.⁵

2. SPDR DoubleLine Short Duration Total Return Tactical ETF (STOT)

STOT is an actively managed strategy that prudently combines traditional interest rate-sensitive sectors with non-traditional credit-sensitive sectors in a duration-controlled portfolio (between one and three years), to potentially create a high-quality, low-volatility income strategy.

With this approach, STOT has beaten its benchmark and had top quintile returns within the Morningstar Short Term Bond peer category over the last one-, two-, and three-year time periods. And its 30-day SEC yield is currently 5.2%, but with only 1.3 years of duration.⁶

3. SPDR Portfolio Short Term Corporate Bond ETF (SPSB)

SPSB seeks to track an index of US-denominated, high quality investment grade corporate bonds with maturities between one and three years. This leads to a weighted duration of 1.8 years, but with a 5.2% 30-day SEC yield for the ETF.⁷

And the yield on the types of bonds in the ETF is less correlated (72%) with the federal funds rate than ultra-short instruments.⁸ That means that if the Fed does cut three or more times, those cuts won’t be felt on a one-to-one basis in the yield.

4. SPDR Portfolio Intermediate Term Corporate Bond ETF (SPIB)

SPIB seeks to track an index of high quality investment grade corporate bonds with maturities between 1 and 10 years.

This leads to a weighted duration of 4 years, which allows investors to modestly lengthen duration even more versus ultra-short markets and also trim duration risk (and volatility) relative to broader core bonds — all with a current 30-day SEC yield of 5.2%.⁹

5. SPDR DoubleLine Total Return Tactical ETF (TOTL)

TOTL is an active core bond strategy that combines traditional and non-traditional fixed income sectors, while seeking to generate high-quality income and exploit inefficiencies within the global fixed income market. Combined with active risk constraints, the ETF’s approach has led to above-benchmark performance over the past one, two, and three years.

The ETF has a current 5.6% 30-day SEC yield and a duration of 6.2 years.¹⁰ That means this fund is for investors seeking to more deliberately increase duration as they put their cash to work, but to do so in a risk-aware manner, as TOTL has lesser return volatility than the Bloomberg US Aggregate Bond Index (Agg) on a one-, three-, and five-year basis.¹¹

Manage Your Reinvestment Risk

The yield, duration, and trailing three-year volatility of returns for all five of the aforementioned ETFs are plotted in Figure 2, alongside the same metrics for three-month T-bills (a proxy for money market funds given similar tenor focus) and the Agg (a proxy for core bonds).

Looking across each potential SPDR Fixed Income ETF investment option, the duration increases as does the volatility — and, so does the potential for investors to participate in any duration-induced price appreciation that could arise from a decline in rates. The opportunity to achieve greater sector diversification potentially increases too.

This illustrates how you can use these strategies to move further out on the risk curve while adopting a more total return mindset, as opposed to owning only cash-like instruments. The bottom line is, if you’re seeking to mitigate the erosive impacts of reinvestment risk on your accumulated money market fund positions, you have multiple options to consider for putting your excess cash to better work.

If you have questions about these strategies, we’re happy to help. Please reach out to your State Street Global Advisors representative directly or contact us.

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Glossary

Active Management
A portfolio-management approach that uses a human hand, such as a single manager, co-managers or a team of managers, to select and adjust a fund's holdings over time. Active managers rely on research, forecasts and their own judgment and experience to make decisions on what securities to buy, hold and sell. The opposite of active management is passive management, which includes indexing.

Bond
A debt investment in which an investor loans money to an entity — typically a corporate or governmental entity — that borrows the funds for a defined period of time at a variable or fixed interest rate. Bonds are used by companies, municipalities, states and sovereign governments to raise money and finance a variety of projects and activities. Owners of bonds are debtholders, or creditors, of the issuer.

Federal Funds Rate, or Federal Funds Target Rate
The overnight interest rate charged by depositary institutions on funds held at the Federal Reserve. The fed funds rate is set by the Fed’s policy-making body, the Federal Open Market Committee, or FOMC.

Fixed Income
A type of investing, usually involving bills, notes or bonds, for which real return rates or periodic income is received at regular intervals and at reasonably predictable levels. Fixed income can also refer to a budgeting style that is based on fixed pension payments.

Liquidity
The ability to quickly buy or sell an investment in the market without impacting its price. Trading volume is a primary determinant of liquidity.

Money Market Fund
A low risk, low return fixed-income investment designed to provide a minimum of interest while maintaining a net asset value (NAV) of $1 per share—that is, without any capital gains or capital losses. Such funds contain fixed-income securities with maturities of less than one year that are typically high in credit quality and reliably liquid. In a portfolio context, such funds are sometimes referred to as “cash equivalents” because the steadiness of their value resembles cash.

Sector Investing
An investor or portfolio that invests assets into one or more sector of the economy such as financials, energy, or health care.

US Treasury Bonds
Debt obligations of the U.S. government that pay an interest rate to the owner.

Volatility
The tendency of a market index or security to jump around in price. Volatility is typically expressed as the annualized standard deviation of returns. In modern portfolio theory, securities with higher volatility are generally seen as riskier due to higher potential losses.

Footnotes

Disclosure

Marketing Communication

This communication is not intended to be an investment recommendation or investment advice and should not be relied upon as such.

The views expressed in this material are the views of the SPDR Research and Strategy team through the period ended March 31, 2024, and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.

All information is from SSGA unless otherwise noted and has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information, and it should not be relied on as such.

Past performance is not a reliable indicator of future performance.

Unless otherwise noted, all data and statistical information were obtained from Bloomberg Finance LP and SSGA as of March 31, 2024. Data in tables have been rounded to whole numbers, except for percentages, which have been rounded to the nearest tenth of a percent.

The research and analysis included in this document have been produced by SSGA for its own investment management activities and are made available here incidentally. Information obtained from external sources is believed to be reliable and is as of the date of publication but is subject to change. This information must not be used in any jurisdiction where prohibited by law and must not be used in a way that would be contrary to local law or legislation. No investment advice, tax advice, or legal advice is provided herein.

The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSGA's express written consent.

Investing involves risk including the risk of loss of principal.

Diversification does not ensure a profit or guarantee against loss.

Frequent trading of ETFs could significantly increase commissions and other costs such that they may offset any savings from low fees or costs.

While the shares of ETFs are tradable on secondary markets, they may not readily trade in all market conditions and may trade at significant discounts in periods of market stress.

Passively managed funds invest by sampling the index, holding a range of securities that, in the aggregate, approximates the full Index in terms of key risk factors and other characteristics. This may cause the fund to experience tracking errors relative to performance of the index.

Actively managed funds do not seek to replicate the performance of a specified index. An actively managed fund may underperform its benchmarks. An investment in the fund is not appropriate for all investors and is not intended to be a complete investment program. Investing in the fund involves risks, including the risk that investors may receive little or no return on the investment or that investors may lose part or even all of the investment.

TOTL, STOT, and ULST are actively managed. The sub-adviser’s judgments about the attractiveness, relative value, or potential appreciation of a particular sector, security, commodity or investment strategy may prove to be incorrect, and may cause the fund to incur losses. There can be no assurance that the sub-adviser’s investment techniques and decisions will produce the desired results.

Bonds generally present less short-term risk and volatility than stocks but contain interest rate risk (as interest rates rise, bond prices usually fall); issuer default risk; issuer credit risk; liquidity risk; and inflation risk. These effects are usually pronounced for longer term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss.

Floating rate securities are often lower-quality debt securities and may involve greater risk of price changes and greater risk of default on interest and principal payments. The market for floating rate bank loans is largely unregulated and these assets usually do not trade on an organized exchange. As a result, floating rate bank loans can be relatively illiquid and hard to value.

Bank Loans are subject to credit, interest rate, income and prepayment risks. The fund may invest in secured and unsecured participations in bank loans. Participation loans are loans made by multiple lenders to a single borrower, e.g., several banks participate in one large loan with one of the banks taking the role of the lead bank. The lead bank recruits other banks to participate and share in the risks and profits. There is also the risk that the collateral may be difficult to liquidate or that a majority of the collateral may be illiquid. In participation the fund assumes the credit risk of the lender selling the participation in addition to the credit risk of the borrower.

Investments in asset backed and mortgage-backed securities are subject to prepayment risk which can limit the potential for gain during a declining interest rate environment and increases the potential for loss in a rising interest rate environment.

Government bonds and corporate bonds generally have more moderate short-term price fluctuations than stocks, but provide lower potential long-term returns.

Investing in high yield fixed income securities, otherwise known as “junk bonds”, is considered speculative and involves greater risk of loss of principal and interest than investing in investment grade fixed income securities. These Lower-quality debt securities involve greater risk of default or price changes due to potential changes in the credit quality of the issuer.

Increase in real interest rates can cause the price of inflation-protected debt securities to decrease. Interest payments on inflation-protected debt securities can be unpredictable.

The values of debt securities may decrease as a result of many factors, including, by way of example, general market fluctuations; increases in interest rates; actual or perceived inability or unwillingness of issuers, guarantors or liquidity providers to make scheduled principal or interest payments; illiquidity in debt securities markets; and prepayments of principal, which often must be reinvested in obligations paying interest at lower rates.

Foreign (non-US) Securities may be subject to greater political, economic, environmental, credit and information risks. Foreign securities may be subject to higher volatility than U.S. securities, due to varying degrees of regulation and limited liquidity. These risks are magnified in emerging markets.

DoubleLine® is a registered trademark of DoubleLine Capital LP.

Derivatives are based on one or more underlying securities, financial benchmarks, indices, or other obligations or measures of value; additional risks with derivatives trading (e.g., market, credit, counterparty and illiquidity) are possibly greater than the risks associated with investing directly in the underlying instruments. Derivatives can have a leveraging effect and increase fund volatility that can have a large impact on Fund performance.

An annualized yield that is calculated by dividing the investment income earned by the fund less expenses over the most recent 30-day period by the current maximum offering price.

Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other income as applicable.

The trademarks and service marks referenced herein are the property of their respective owners. Third party data providers make no warranties or representations of any kind relating to the accuracy, completeness or timeliness of the data and have no liability for damages of any kind relating to the use of such data.

Distributor: State Street Global Advisors Funds Distributors, LLC is the distributor for certain registered products on behalf of the advisor. SSGA Funds Management has retained DoubleLine Capital LP as the sub-advisor. State Street Global Advisors Funds Distributors, LLC is not affiliated with DoubleLine Capital LP.

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