Where are the safest investments now? Just a few years ago, you probably would have said “money market funds, of course.”
Yet financial historians soon will reflect back on the hair-raising moment of truth that was the credit crisis of late 2008. In a flash, huge institutions — Lehman, Bear Stearns, AIG — went belly up. Along with them went our cherished notions of safety: The run on Lehman in turn caused a run on cash itself. The Reserve Primary Fund, a pillar of the money market fund universe, broke the buck.
The problem, it was later learned, wasn’t the bad Lehman securities held by the money market market fund. Rather, it was a run on the fund itself as nervous depositors requested their dollars back, pronto. Flooded with redemptions, The Primary Fund’s net asset value fell below $1 per share, and the fund was done. Investors eventually sued to get their money back.
Every so often, you get a glimpse of the cracks in the machinery. Normally liquid, deep, and generally trusted by the world over, our markets nevertheless offer up periodic moments of panic: The nerve-wracking Flash Crash in stocks in May 2010. A significant recent rise and fall for both gold and emerging markets stocks. The Libor mess.
Is there any safe haven? One might presume that holding dollars in an insured U.S. bank account is the paragon of safety. Banks certainly depend on that public image. Brokerages, eager to assure individual investors, now offer versions of FDIC coverage using “sweep” accounts to hold cash deposits between trades.
And, of course, the $2.5 trillion money market industry didn’t fold after the Primary Fund debacle. SEC Chairman Mary Schapiro has been gunning for increased regulation of money market funds. She makes the case that money funds are a source of great risk in the financial system, offering the illusion of safety where there is none.
Driving investors, too, has been the Fed’s campaign of rock-bottom interest rates. It puts savers in a pickle for sure. They get nearly zero return on money markets while taking on unspecified risk. CDs are not much better. The risk is less, but the long lock-up means CDs are a better place for your rainy day cash, not investment capital.
Even so, rates are bottom of the barrel. A 5-year CD today is barely ahead of CPI. It’s among the safest investments now, but only if you ignore inflation.
Near-zero rates force investors to hunt for yield, even to redefine their idea of what “cash” means. As Barron’s recently pointed out, bond ETFs are beginning to seem like reasonable alternatives to money market funds. You get liquidity, a generally better return on your cash, and since they hold short-maturity U.S. debt, protection against a sudden rise in the interest rate.
Like their mutual-fund brethren, these ultra-short ETFs favor high-quality issues with average durations of less than a year. They aren’t subject to the stringent regulations money-market funds are, such as rules that govern how much of a portfolio must be able to be liquidated in seven or 30 days, or limits on the maximum average weighted maturity of a portfolio. But when packaged as an ETF, investors get intraday liquidity, low costs, and real-time transparency. Investors worried that managers are stretching their boundaries need only look at what’s in the portfolio. Unlike mutual funds, which don’t provide real-time holding information, ETFs are an open book.
Are short bond funds safer than cash? Safer than a CD? No. They offer risks like any other investment. Nevertheless, the risks they contain are, as Barron’s points out, mostly knowable and often measurable.
If your portfolio strategy results in incoming cash with no immediate home, you could do a lot worse than putting it into an ETF such as the SPDR Barclays Capital 1-3 Month T-Bill ETF (BIL). It holds U.S. Treasury Bills of less than three months’ but more than one month duration. It is among the very small group of the safest investments now, once you take into consideration all of the risks, not just a select few.