Cash And Money Market ETFs Review

Apr 11, 2023 | Feature, Newsletter

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Regular AAC (Asset Allocation Composite), SAA and TAA portfolios are always rebalanced on the first trading day of a month. the next re-balance will be on Monday May 1, 2023. 

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Cash And Money Market ETFs Review

Many people are now realizing the importance of finding ways to earn higher interest rates on their cash deposits, especially in light of recent bank runs that have shaken their confidence. We have repeatedly highlighted this issues over the past five years, as seen in our article “Bank On My Own For Safer And Much Higher Returns.” One option to consider is using “Cash” or money market style ETFs, which are widely available in most investment brokerage accounts. However, investors should be aware of what these instruments are and whether they qualify as a money market fund.

We have discussed this topic extensively in previous newsletters, but this article aims to provide a more comprehensive review of the subject. We will also make effort to keep this article up to date so that it can serve as a useful reference for our readers.

What are money market funds?

A typical definition: A money market fund is a type of mutual fund that invests in low-risk, short-term debt securities, such as government bonds, certificates of deposit, and commercial paper. The goal of a money market fund is to provide investors with a relatively safe place to park their cash while earning a slightly higher return than traditional savings accounts or other types of cash investments. Money market funds are typically managed to maintain a stable net asset value (NAV, i.e. its holdings’ value) of $1 per share, making them a popular choice for investors who want to preserve their capital and earn some income without taking on too much risk. 

A money market fund’s NAV is permitted to fluctuate within a narrow range of 0.5% above or below the stable $1.00 per share value. This means that a money market fund’s NAV may be reported as $1.005 or $0.995 per share without triggering any action to restore the stable NAV. If the NAV falls below this 0.5% threshold, the fund is required to take certain steps to restore its stable NAV, such as waiving fees, suspending redemptions, or liquidating assets.

Notice in the above, a money market fund is a mutual fund. Technically, an ETF can not be classified as a money market fund. We will discuss this more shortly. 

There are regulations that govern the duration of a money market fund’s debt holdings. In the United States, for example, the Securities and Exchange Commission (SEC) requires that at least 30% of a money market fund’s assets be invested in securities that mature within 7 days, and at least 60% be invested in securities that mature within 60 days. This is known as the “7-day liquidity rule” and is designed to ensure that money market funds can meet their obligations to investors in the event of sudden redemptions. Additionally, the SEC imposes restrictions on the credit quality and diversification of a money market fund’s holdings to help mitigate the risk of default. These regulations help to make money market funds a relatively safe and stable investment option for short-term cash holdings. For example, Vanguard Federal Money Market Fund maintains an average maturity of 60 days or less.

To summarize, a money market fund needs to 

  1. maintain its NAV to be within a narrow range of 0.5% above or below the stable $1.00 per share value. 
  2. it needs to hold enough short term (30% 7-day maturity and 60% 60-day maturity) debts — interest rate risk.
  3. it needs to hold high quality debts — credit risk

In general, a money market fund is only available in an investment brokerage account. Some banks might offer money market accounts. 

Cash and money market ETFs

Why should we consider ETFs as a substitute for cash or a money market fund? The answer is that many brokerages no longer offer money market funds or, if they do, they often provide lower yields. In addition, only a few brokerages offer good money market funds, and many of these have minimum investment requirements. For instance, the Vanguard Federal Money Market Fund previously required a minimum investment of $3,000, but we are pleased to note that this requirement was recently eliminated (as of 4/1/2023).

In contrast, ETFs can be purchased at any brokerage that offers stock trading, and there is no minimum investment requirement. Some brokers even provide fractional shares, allowing investors to purchase ETFs in any dollar amount.

While no ETF can technically be classified as a money market fund, we can further explore the so-called ultra short-term bond ETFs to see what options are available.

Ultra short term Treasury bill or note ETFs

The first type are the ETFs that invest solely in ultra short term Treasury bills or notes. We have done some comprehensive studies on this and come up with the following liquid enough ETFs in this category:

Treasury Cash ETFs (returns are as of 4/6/2023):
Symbol (Name) Expense Asset Size  Maximum Drawdown SEC Yield YTD
Return**		 1Yr AR 3Yr AR 5Yr AR
BIL (SPDR Barclays 1-3 Month T-Bill ETF) 0.14% 29B -0.14% 4.52% 1.1% 2.5% 0.8% 1.2%
SGOV (iShares 0-3 Month Treasury Bond ETF) 0.03% 10B 0% 4.64% 1.2% 2.8%    
USFR (WisdomTree Floating Rate Treasury Fund) 0.15% 15B -0.05% 4.78% 1.3% 3.0% 1.1% 1.4%
TFLO (iShares Treasury Floating Rate Bond ETF) 0.15% 5.8B -0.06% 4.79% 1.2% 2.6% 0.9% 1.3%
CASH (CASH) N/A   0%   1.4% 2.8% 1.0% 1.1%
VMFXX (Vanguard federal money market) 0.15% 238B N/A 4.75% 1.18% 2.7% 0.9% 1.3%

Maximum Drawdown: maximum loss from a peak to a subsequent trough. 

SEC Yield: Based on a 30-day period ending on the last day of the previous month. Note, for a money market mutual fund like VMFXX, its SEC yield is usually a 7-day period’s holdings average yield. 

Notice in the above table, SGOV is relatively new (started on 5/28/2020). 

Technically, a risk free Cash is defined as the 3-month Treasury bill interest rate (daily reset). CASH is MyPlanIQ’s internal cash tracking symbol whose daily interest is reset daily based on the publicly quoted 3-month Treasury bill interest rate.

There are two large liquid Treasury floating rate ETFs, USFR (WisdomTree Floating Rate Treasury Fund) and TFLO (iShares Treasury Floating Rate Bond ETF). These two ETFs invest in Treasury Floating Rate Notes that essentially reset their interest rates weekly based on 13-week (3-month) Treasury bill auction results. See TreasuryDirect.gov for a more detailed explanation. So even though they hold 2-year mature notes, their interest rate risk is almost zero as they are practically matched to 13-week T-Bill. 

BIL (SPDR Barclays 1-3 Month T-Bill ETF) holds 1-3 month Treasury bills and it will replace mature ones to maintain certain ladders. Its average maturity, based on Morningstar, is about 29 days or about one month. 

All of the aforementioned ETFs exhibit minimal maximum drawdowns, ranging from -0.05% to -0.14% (BIL), which is significantly smaller than the -0.5% range required for a money market fund. Additionally, they invest in US Treasury bills or notes, which are considered the safest and equivalent to cash. They are also sufficiently liquid, at least for non-large investments. Even if a large sum of money is invested in one of these ETFs (such as multi-millions), as long as daily withdrawals are not substantial, these funds can manage up to a million dollars easily.

It is worth mentioning that these ETFs mostly pay dividends/interest monthly. Using yields to compare these ETFs’ returns is not recommended, as the dividends can sometimes be affected by the price gain/loss (capital gain/loss) of their holdings. In general, the best approach is still to compare their total returns over a period of time, including dividend reinvestment.

In comparison to Vanguard’s money market funds, these ETFs offer comparable returns. Overall, we believe that USFR and TFLO, the two floating rate Treasury ETFs, will likely have the most competitive or even a slight advantage over Vanguard’s money market fund.

Therefore, these ETFs can be viewed as “Cash” ETFs.

‘Prime money market’ ETFs? 

Regrettably, extending beyond Treasury bills to include investing in ultra short term corporate bonds or loans is challenging, as we have been unable to locate any ETF whose price remains within the (-)0.5% range. This is due to the fact that, during periods of financial market distress, investors frequently categorize these ETFs as riskier corporate bond/loan options and dispose of them indiscriminately.

Here are the best and most liquid ultra short term ETFs that may be considered as ‘prime money market’ funds. The definition of a prime money market fund is one that may hold not just Treasury and government agency bonds/bills, but also corporate bonds and loans, which are regarded as considerably riskier than Treasury bills.

‘Prime money market’ ETF candidate (returns as of 4/6/2023):
 Symbol (Name) Expense Asset Size Effective Duration Max Drawdown YTD
Return**		 1Yr AR 3Yr AR 5Yr AR
JPST (JPMorgan Ultra-Short Income ETF) 0.18% 25B 0.29 -1.56% 1.3% 2.8% 1.9% 2.0%
ICSH (iShares Ultra Short-Term Bond ETF) 0.08% 6.3B 0.43 -0.85% 2.9% 6.4% 2.7% 2.6%
NEAR (iShares Short Maturity Bond ETF) 0.25% 4.0% 0.43 -3.59% 2.6% 5.9% 3.4% 2.4%
MINT (PIMCO Enhanced Short Maturity Active ETF) 0.36% 8.3% 0.44 -2.49% 1.5% 1.9% 1.3% 1.3%
FLOT (iShares Floating Rate Bond) 0.15% 7.6B 0.05 -3.43% 2.7% 7.6% 4.1% 2.7%
VUSB (Vanguard Ultra-Short Bond ETF) 0.1% 3.4B 0.96 -0.7% 2.7% 5.0%    
CASH (CASH) 0.1%       1.4% 2.8% 1.0% 1.1%

Note: VUSB (Vanguard Ultra-Short Bond ETF) has a short history (started on 4/27/2021). It also has a longest duration (0.96, almost a year). 

From the above, we can see that none of these are qualified as a money market fund as all of them have maximum drawdown bigger than -0.5%. They can’t be simply used as cash or money market fund substitutes. 

Enhanced cash or ‘prime money market’ portfolio

Is it possible to increase the returns of the ultra short term Treasury bill ETFs mentioned earlier? Yes, by taking on additional risk and adopting a more active strategy, one can create a portfolio that dynamically invests in these ultra-safe Treasury ETFs, as well as the riskier ultra short term bond ETFs mentioned above. The concept is to invest in the riskier ETFs when the markets are calm, as these have a low fluctuation rate and incur losses of no more than -0.5%. However, during times of market duress, the portfolio would switch to the “safer” Treasury ETFs to avoid significant drawdown or interim loss.

The following portfolio MPIQ Ultra ST Bond ETFs does just like that: 

Portfolio Performance Comparison (as of 4/6/2023):

Ticker/Portfolio Name Maximum Drawdown YTD
Return**		 1Yr AR 3Yr AR 5Yr AR
MPIQ Ultra ST Bond ETFs -0.5% 1.3% 2.8% 1.3% 1.9%
JPST (JPMorgan Ultra-Short Income ETF) -1.56% 1.3% 2.8% 1.9% 2.0%
MINT (PIMCO Enhanced Short Maturity Active ETF) -2.49% 1.5% 1.9% 1.3% 1.3%
ICSH (iShares Ultra Short-Term Bond ETF) -0.85% 2.9% 6.4% 2.7% 2.6%
NEAR (iShares Short Maturity Bond ETF) -3.59% 2.6% 5.9% 3.4% 2.4%
CASH (CASH) N/A 1.4% 2.8% 1.0% 1.1%

So this portfolio had a small dip in 2021 to 2022 but in general, its maximum drawdown is below -0.5%:

The portfolio basically invests in one ETF at any time. It looks at its holding at the beginning of every month and decides whether to switch to another fund. Its candidate funds include the above riskier ETFs and some of the ‘safe’ Cash Treasury ETFs in the above. 

This portfolio requires a basic subscription to MyPlanIQ’s service that also allows to follow MyPlanIQ’s other fixed income portfolios. Subscribers will receive a monthly rebalance email to notify any transaction needed and they can follow the rebalance instruction in their own brokerage accounts to mimic these portfolios. The MPIQ Ultra ST Bond ETFs can be used to enhance cash returns or achieve a prime money market fund’s return. 

Conclusions

Instead of a money market fund, one can consider using Ultra short Treasury bills or floating rate ETFs which are highly competitive with even the best government or Treasury money market funds. However, it’s important to note that other ultra short term bond ETFs cannot replace a traditional prime money market fund due to the fact that their prices are determined by markets and are subject to greater fluctuations than a money market fund would allow.

Market overview

The latest employment situation report from last Friday has surprised many by indicating a decline in the unemployment rate from 3.6% in February to 3.5% in March, which is both interesting and frustrating for the Federal Reserve Bank as it implies that the job market is still too hot and inflation might be high. However, the recent banking crisis or scare in March may have tightened financial conditions as banks have become more cautious and increased loan interest rates. This may take some time to fully manifest in economic reports, which makes the Federal Reserve’s situation tricky. Stopping interest rate hikes too early could result in another round of price inflation, while continuing to raise rates in an already slowing economy could push it into a recession.

The uncertainty is reflected in financial markets, with stocks hoping for a ‘soft landing’ and bond markets predicting a more softened economy, as evidenced by the decline in the long-term 10-year Treasury interest rate from 4% to 3.4%. The S&P 500 price has remained virtually unchanged since a year ago, and the markets are choppy.

As always, we call for staying the course which is guided by some well defined and sound strategies:

  • For strategic allocation (buy and hold) investors, ignore the current market behavior. Remember, as what we have emphasized numerous times, when you choose and commit to a strategic portfolio, you essentially know and commit that your investment horizon (or the time you need to utilize this capital) is 20 years or preferably much longer given the current high valuation. As we pointed out, if your investments are those diversified (index) funds such as an S&P 500 index fund (VFINX, for example), you know your money is in some solid ‘business’ that eventually (20 years later and preferably many more years later) will deliver some reasonable returns. As long as you are comfortable with this thesis, you should sit tight and forget about the current gyration.
  • For tactical investors, again, you have to ignore the current market noise. Furthermore, you should follow your strategy rigorously, especially in a time like this. Human emotion, both optimistic and pessimistic, and human desire, both greedy and fearful, are your worst enemies. This has been shown to be true time and time again.

Stock valuation has dropped and now valuation is becoming less hostile. However, it is still not cheap by historical standard. For the moment, we believe it’s prudent to be extra cautious. However how serious a correction might be, we have confidence in the US economy in the long term and thus in the stocks in aggregate. We just need to manage through interim losses carefully.

We again would like to emphasize that for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot.

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