Investors take liking to ultrashort fixed-income ETFs

When ultrashort fixed-income exchange-traded funds first launched 15 years ago, asset managers were quick to point out that these products were very much not money market mutual funds. Not only were they exchange-traded, but they also featured floating net asset values and trading costs that were externalized by in-kind creation and redemption of fund shares. They were tools that could be used for cash management and risk reduction in a fixed-income portfolio, but they were not cash equivalents — at least not like money market funds.

Several economic crises later, it appears these products were on to something. Market conditions in September 2008 during the global financial meltdown and in March 2020 with the spread of COVID-19 highlighted challenges to constant NAV products and the customer needs and money markets they support.

Now, as the U.S. Securities and Exchange Commission takes another shot at revising rules regarding money market fund pricing and liquidity, ultrashort fixed-income ETFs have been steadily gaining assets.

Classifying ultrashort fixed-income ETFs is a challenge, but the category generally includes ETFs holding fixed-income securities with duration of less than one year. According to Morningstar Direct, ultrashort ETFs held $136 billion as of June 30, gathering $33.6 billion in net new assets this year.

Two products in particular benefited from the short rush. The $21 billion SPDR Bloomberg 1-3 Month T-Bill ETF from State Street Global Advisors saw $7.5 billion in net flows this year through June 30, while the $21.7 billion iShares Treasury Bond ETF from BlackRock Inc. saw $8.7 billion in net flows over the same time period. Both funds have recently returned to making monthly distributions as higher interest rates have given the funds enough income to eclipse their expense ratios.

"There was an uptick in interest in these products as COVID-19 was hitting, and again more recently as the rate environment shifts," said Jay McLaughlin, institutional sales executive at iMoneyNet, a unit of Informa PLC, which tracks money market funds.

According to iMoneyNet, assets in U.S. short-duration ETFs, which includes ultrashort funds, have grown steadily over the past several years. As of June 30, such funds held $175 billion, a 36% increase from the end of 2019. Assets in comparable mutual funds, which typically have a duration of less than one year but can go as high as three years, have experienced more volatility, up 5% to $412 billion since the end of 2019, but down 17% from a September 2021 peak of $499 billion.

Assets in retail and institutional government money market funds are up 55% and 57%, respectively, over the same time frame to $1.1 trillion and $2.9 trillion.

By Morningstar's account, two dozen ETF issuers offer 41 ultrashort products with expense ratios as low as 5 basis points for the iShares 0-3 Month Treasury Bond ETF to as high as 50 basis points for the Arrow Reserve Capital Management ETF. A majority of the offerings are actively managed.

"For fixed-income asset managers, ultrashort ETFs have served an entry point into the active ETF marketplace," said Todd Rosenbluth, New York-based head of ETF research for VettaFi LLC, a data and analytics provider.

"They can leverage existing infrastructure and expertise running mutual funds and separately managed accounts."

For ETF strategists or large registered investment advisers building ETF model portfolios, said Mr. Rosenbluth, "these products can approach cash in terms of liquidity and limited downside risk without leaving the model."

For example, according to the 13-F holdings report for wealth manager SVB Private through March 31, three of its largest reported client holdings were ultrashort ETFs.

Shannon Saccocia, Boston-based chief investment officer at SVB Private, a unit of Silicon Valley Bank, says that such ETFs are "slightly easier to transact in" and have fewer limitations or minimums compared with money market funds.

"We use ultrashort ETFs as a placeholder and for liquidity when building bond portfolios or raising cash," Ms. Saccocia said. "Because the bond market remains rather inefficient, the use of ultrashort ETFs allows us to maintain flexibility in buying and selling bonds," she said.

IMoneyNet's Mr. McLaughlin added that he's "seeing hedge funds and equity managers take a look at these products in trying to pick up some additional yield." Corporate treasury managers, significant users of money market funds, however, tend to be limited in their ability to buy such "equity" securities, he said.

With just a few days to weeks of duration difference between most of these products, VettaFi's Mr. Rosenbluth added that security selection is a critical factor for the manager. Many ultrashort ETF prices were down by more than 1% through July 8, he said, while others were flat to slightly positive for the year.

With short-term rates back up, however, yields are increasing. The $19.5 billion J.P. Morgan Ultra-Short Income ETF sports a yield of 2.15%, while the $137 million IQ Ultra Short Duration ETF has a yield of 3.16%, according to the funds.