Investors need liquid assets for many reasons, such as providing an emergency cash reserve or offering a place to temporarily hold funds earmarked for short-term investment needs. Prior to the financial crisis of 2008, money market funds offered a stable source of liquidity that still generated acceptable returns. Since then, however, new restrictions have greatly reduced the yields on money market funds. As a result, investors interested in liquid assets that provide higher relative returns have had to look for alternatives in ultra-short-term fixed-income investment vehicles.
In this paper, we examine why alternatives to traditional money market funds may offer the potential for higher income generation, while still providing a measure of principal protection. We then explain how the FlexShares Ready Access Variable Income Fund (RAVI) is designed to provide investors a source of liquidity for short-term investment funds with higher potential returns than available from money market funds.
Understanding the world of ultra-short-term fixed-income investing
Investors typically seek liquid assets to meet two main goals:
Historically, money market funds helped meet both goals by offering price stability, overnight access to cash and a decent return. Before the U.S. Securities and Exchange Commission (SEC) moved to restrict money market fund investments in the wake of the 2008 financial crisis, they could be invest in a wide variety of securities, including those with durations 13 months or longer. To improve investors’ faith in money market funds following the 2008 crash, the SEC restricted the underlying investments in those funds to very-high-quality securities with a maximum duration of three months. As a result, yields on money market funds fell drastically.
Money market funds remain the best vehicle for preservation liquidity, because the safety of principal outweighs the need for competitive returns. Investors seeking investing liquidity, however, may be willing to trade some of that principal stability for higher returns. Ultra-short-term investment products that do not need to maintain a constant net asset value (NAV)1 are not constrained by the rules that govern money market funds. This allows them to invest in a wider range of security types that offer a potential yield premium, such as short-term credit, asset-backed securities, floating-rate notes and mortgage-backed securities.
For investors seeking liquidity to meet short-term investing needs, products that are allowed to have a variable NAV may fill the gap between money market funds and short-term bond funds.
THE FLEXSHARES SOLUTION: AN ACTIVELY MANAGED ULTRA-SHORT-TERM FIXED-INCOME STRATEGY
The FlexShares Ready Access Variable Income Fund (RAVI) is an ETF that’s designed to provide investment liquidity, minimum principle volatility, and the potential for higher returns.
Northern Trust Investments, Inc. (NTI), the investment adviser for FlexShares Funds, actively manages the fund, capitalizing on its deep expertise in corporate bonds and other fixed-income sectors. Because the fund is not constrained by the rules governing conventional money market funds, it invests in a wide range of securities with durations between three months and 1.5 years. These securities include:
NTI manages the overall portfolio to maintain an average duration of between 0.25 years and one year, based on its outlook for interest rates. All the Fund’s investments must be investment-grade at time of purchase, and the portfolio also includes constraints to avoid concentrations in asset-backed securities, single issuers, or debt based in emerging markets.
ATTEMPTING TO BALANCE THE NEED FOR HIGHER RETURNS AND MINIMAL PRINCIPAL VOLATILITY
In our view, the variety of fixed-income assets available to the NTI investment team provides flexibility to manage the FlexShares Ready Access Variable Income Fund’s (RAVI) duration and liquidity according to their outlook for interest rates and market conditions. Targeting durations above the three-month cap on money market funds, but below the 1.5-year minimum duration typically offered by short-term bond funds, may provide higher returns than money market funds while limiting the potential for principal volatility.
As a result, we believe the Fund provides investors a liquid vehicle for short-term funds without incurring the additional “cost” of holding cash in their portfolios in the form of low yields.
Reforms following the 2008 financial crisis constrained the type and duration of investments available to money market funds. As a result, investors seeking investment liquidity in their portfolios have had to look to other parts of the ultra-short-term fixed-income asset class.
We believe the FlexShares Ready Access Variable Income Fund (RAVI) offers investors a vehicle with stronger return potential than money market funds, while retaining the liquidity necessary to hold funds for use in near-term investment decisions. Taking advantage of Northern Trust’s expertise in the fixed-income markets, the Fund may fill a gap between money market funds and short-term bond funds.
1. Net asset value (NAV) represents the net value of an entity and is calculated as the total value of the entity’s assets minus the total value of its liabilities. Most commonly used in the context of a mutual fund or an exchange-traded fund (ETF), the NAV represents the per share/unit price of the fund on a specific date or time.