With interest rates at levels not seen for 10+ years, the question ‘what's a good yield on my cash?’ is top of mind for many investors. Understanding how to benchmark and compare your cash investments is crucial for optimizing returns, assessing risk, and making informed decisions in a changing market.
“You can’t improve what you don’t measure.” – Peter Drucker
Since 2015 the Fed has moved interest rates by almost 1,000 basis points: up, down, back up and most likely back down this year. With the emergence of new liquidity products (deposits, DEI share classes, earnings & tech credits) and the evolving rate environment, institutional cash investors are faced with a difficult question, “Is my approach to managing our organization’s liquidity competitive?”. We at SSGA receive this question continuously and work closely with our clients and prospects to help them benchmark their cash based on liquidity type, whether that be operating, core, or strategic.
The overarching goal of a traditional cash product is to preserve principal and provide liquidity. As such, they do not tend to have benchmarks in the more traditional sense, where a portfolio’s aim may be to match or exceed the performance of its benchmark index. The benchmark rate or index chosen for a cash product is more indicative in nature, and can help to measure a portfolio’s performance over a risk-free rate of return or against a pool of similar products. Commonly used benchmarks in the cash space include:
Pros and Cons of Different Benchmarks
Benchmark | Pros | Cons |
---|---|---|
SOFR | Risk-free, reflects actual transactions | Backward-looking with no credit component or term market |
T-Bill Rates | Risk-free, easily accessible | May not fully reflect credit risk taken by other cash instruments |
Fed Funds Rate | Widely followed, influences other rates | Doesn't directly reflect yields on most cash investments |
BSBY | Credit-sensitive, potential LIBOR alternative | Regulators not supporting the index |
Money Market Fund Indices | Easy to compare against your fund | May not be perfectly aligned with your fund's specific portfolio |
LIBOR's phase-out resulted in a number of market-wide changes. In advance of the switch, millions of contracts referencing LIBOR needed to be transitioned to new benchmarks, with SOFR being the dominant benchmark for many financial products. In addition, the dissolution of LIBOR also forced investors to use alternative methods to gauge risk in the absence of the legacy LIBOR/OIS spreads. The absence of a term structure and the lack of a credit component to the SOFR replacement have created a void, and the difference in its calculation methodology has made risk assessment more complex. Today, investors must take a multi-faceted approach to measuring portfolio risk, with metrics including:
Benchmarking Beyond “Cash”
Ultra-Short Bond Funds invest in short-term bonds and can offer higher returns than money market funds, albeit with greater credit and interest rate risks. If benchmarked to a traditional money market fund or money market fund index, one could easily compare the incremental risk to the associated returns over a full economic and credit cycle.
Things to Consider when Choosing a Cash Strategy
Benchmarking your cash investments is an ongoing process that requires staying informed about market developments and adjusting your strategy accordingly. By understanding the available benchmarks and their nuances, you can make informed decisions to optimize your cash returns while managing risk effectively.
In part 2 of this series we will explore the various types of returns that are available to cash investors in the cash and short term fixed income universe and how those returns have performed over time and through various economic and credit cycles.