As interest rates rose steadily over the past year and a half, investors rushed into ultrashort-term fixed-income exchange-traded funds.
Primarily low- to no-duration products, these ETFs benefited both from the safety and the yield at the short end of the curve.
Assets under management for "cash equivalent" ETFs rose to $190 billion at the end of April from $123 billion at the end of 2021, according to FactSet Research Systems Inc. Now, as the repercussions of swift rate hikes ripple through the banking system, could ETFs penetrate further into cash management?
So far this year, traditional money market mutual funds have shown themselves to be the alternative of choice. According to the Investment Company Institute, money market funds held $5.26 trillion as of April 26, compared with roughly $4.7 trillion at the end of 2022. Such a large gain in assets smothers the $13.6 billion of net inflows experienced by ultrashort ETFs over the same time period, according to FactSet.
Yet the liquidity, cost and transparency of ETFs have attracted investors across the spectrum. Treasurers and chief financial officers may be on the cusp of understanding that value as well. For years, institutional investors have utilized ETFs through manager transitions, tactical shifts and cash-flow solutions. But the growth of fixed-income ETFs, in particular, have brought ETFs deeper into insurance general accounts, margin and trading collateral, areas where ETFs had been less accepted.
"The speed with which corporate and consumer deposits are shuffling around the banking system highlights the need for thinking about cash differently," said Tony Kelly, co-founder of asset manager BondBloxx Investment Management LLC in San Francisco.
Detractors of ETFs as a cash solution are quick to point out that, unlike bank deposits and money market products, ETF prices fluctuate by the second. Moreover, ETFs require a brokerage account or investment advisory relationship to access. And even the cheapest short-term term Treasury ETFs, the $482 million BondBloxx Bloomberg Six Month Target Duration US Treasury ETF and BlackRock Inc.'s $10.1 billion iShares 0-3 Month Treasury Bond ETF, or SGOV, at expense ratios of 0.03% and 0.05%, respectively, still cost more than TreasuryDirect, a free U.S. Treasury service that allows investors to buy and redeem securities.
Following the shock to the commercial paper market in 2008 and money market funds "breaking the buck", a handful of ETFs emerged to capture money market refugees. The most successful at gathering assets then was Pacific Investment Management Co.'s $8.2 billion Enhanced Short Maturity Active Exchange Traded Fund, known by its ticker MINT. More recently, J.P. Morgan Asset Management's $24.7 billion Ultra-Short Income ETF, or JPST, has surged in usage.
But products that introduce credit risk are less likely to entice cash managers looking for maturity of less than a week and some semblance of stable value — even if that stable value is manufactured through the accounting treatment of money market fund NAVs.
That price stability has a cost. Depending on the share class, the $137 billion BlackRock BLF FedFund, for example, can cost anywhere from 0.17% to 0.67% for a portfolio with weighted average maturity of 21 days and a yield of about 4.25% that can fluctuate higher or lower depending on the share class. In contrast, the SGOV ETF at a 0.05% expense ratio has a weighted average maturity of 0.1 years (or 36.5 days) and a 4.25% yield to maturity.
"Are ETFs contemplated within the existing investment guidelines?" asks Shawn McNinch, managing director and global head of ETFs at Brown Brothers Harriman in Boston. "If not, (investment) policies would have to be updated to accommodate ETFs."
Mr. McNinch points out that companies may not have (or may not want) the trading relationship needed to access the ETF in the most cost-efficient way. "When trading in size, it's best to utilize an ETF specialist who can help manage the trade execution, often through an introduction from an issuers' capital markets team," he said.
Such consideration would be needed for direct ownership of ETFs by companies, as well as through outsourced treasury management. In Canada, ETF issuers Purpose Investments Inc. and Evolve Funds Group Inc. offer cash management and high-interest savings ETFs that have attracted nearly C$10 billion ($7.5 billion). Similar products are not available in the U.S.
To cater to institutional and corporate clients using ETFs within cash management, some ETF issuers have begun striking NAV twice per day on ultrashort products. "From an authorized participant perspective, this allows for creation and redemption orders at multiple points during the day," said Brendan McCarthy, managing director and head of ETF specialists and ETF capital markets at Goldman Sachs Asset Management in New York. The benefit of the intraday NAV strike is that it allows for same-day settlement in some cases, he said.
Elisabeth Kashner, vice president and director of global fund analytics at FactSet, observes that some appeal of ultrashort fixed-income ETFs isn't really needed in the corporate environment. "NAV instability and execution risk are significant deterrents," she said.
"The treasury function is to manage the cash flow," said Allan Roth, founder of Wealth Logic LLC, in Colorado Springs, Colo. Before turning to financial planning, Mr. Roth was a finance officer for two large health-care firms. "CFOs are punished for surprises. Why pay the basis points when bank products or Treasury securities can give you more certainty," he said.
Young, cash-rich companies, on the other hand, may need a more sophisticated treasury function than they currently have. They are both managing a runway that could be as long as two years, but also to a burn rate that grows daily through hiring and investment.
"ETFs have the ability to extend duration and credit exposure, often leading to greater diversification across maturities and bond types and/or greater yield potential," Goldman's Mr. McCarthy said.
