Optimizing Your Clients' Cash Allocations
Text on screen: PIMCO
Text on screen: John Nersesian, HEAD OF ADVISOR EDUCATION
Nersesian: Hi everybody. I'm John Nersesian, head of Advisor education at Pimco, and I'm so pleased to be joined by my colleague Jerome Schneider. Jerome is the head of portfolio management on short-term strategies here at Pimco. Jerome, thanks for spending some time with us.
Schneider: Great to be here again with you, John.
Nersesian: Yeah. Thank you so much. What a timely opportunity to discuss this idea of cash balances and client portfolios. Recent Fed action raising interest rates to significantly higher levels has suggested that many investors are attracted to cash, significant balances in money market accounts may be suggest that investors are missing an opportunity. Can you give us an update since the last time we spoke as to what's going on in the marketplace today and how recent Fed actions might suggest investors need to rethink their allocation to cash?
Schneider: Absolutely. You know, we still have a tremendous amount of cash on the sidelines,
Text on screen: TITLE – Rise in cash balances; SUBTITLE – Substantial growth in money market funds (2003-2024)
The chart shows substantial growth in money market funds’ assets under management, which climbed to an all-time high of approximately $6 trillion as of April 30, 2024, significantly surpassing the historical average of approximately $3.4 trillion since 2007. Inflows into money market funds steadily increased from approximately $3.4 trillion starting from around late 2018 to a little over $6 trillion as of April 30, 2024. From 2007 to April 2024, money market fund inflows totaled $3.451 trillion, reflecting 136% growth for that period.
about six trillion dollars sitting in money market funds. The reality is that these investors have probably been given a green light of sorts from the Federal Reserve over recent times.
Part of that green light has clearly come from the Federal Reserve's pivot, and more importantly, the adoption of a more data dependent view.
Text on screen: Jerome M. Schneider, Portfolio Manager
That rates are gonna be higher for longer so that they can help fight inflation and that inflation metric to get back down to that target that they so earnestly want to achieve over the next two quarters. Reality is gonna be a little bit of a long road. And for investors, what that fundamentally means is the higher rates hit the front of the yield curve are going to be here for a longer, but really what that is a green light, not just to sit in T-bills.
In fact, we would suggest that, you know, investors begin to break their bond to bills and move into more ultra short strategies. And there's a few reasons why to think about that, but really what we're saying is investors are really putting an emphasis on liquidity, but in that context, it's a little bit more prolonged than it should be for a proper portfolio construction.
Nersesian: It is interesting how investors often are seduced by or attracted to the allure of liquidity. And, in many personal accounts, clients are kind of paying for that liquidity. They don't necessarily need their dollars to be readily available, and maybe they're missing out on other opportunities using the expression that you've often suggested that not all cash is the same.
Schneider: Yeah! Not all cash is the same. And what we really have to rationalize is the fact that by being in a traditional money market fund, investors are paying a premium for the right for same day liquidity, traditionally through lower yields than you would find in benchmark rates. And so with this, we need to create a balance between being conservative and understanding the liquidity metrics, which are prudent for an investor. Right. And at the same time rationalize the opportunity that's here in a structural sense.
Yes. Higher rates at the front of the yield curve make a lot of sense, but how you obtain those rates and find that opportunity at the front of the yield curve is another story.
Nersesian: We were all anticipating significant cuts by the Fed during this year, at the beginning of the year, a couple of months ago, and now it seems less likely that the Fed is going to move as quickly as was once projected. How do investors think about those probabilities? In fact, maybe some have suggested that the next move by the Fed is a small probability might be an increase.
Schneider: Listen, I think one of the things that we have to think about is understanding or having an insight to what the Fed is going to do is part of the evaluation. But in reality, we're actually given great fortune right now, because there's high rates both in nominal terms and real or inflation adjusted terms at the front end in the yield curve.
The need for precision for exactly predicting what the Fed's going to do in the next meeting, in the next two or three meetings is actually not that relevant to overall portfolio construction. Well why is that? Well, in the unlikely event that the Fed actually moves to a higher rate regime over the near term, the reality is that short term portfolios still have a lot of carry, have a lot of income within them.
Ultimately said, what we're saying is that when the Fed ultimately succeeds in fighting inflation over the longer term, you will eventually see rate cuts. In that paradigm, money market funds will potentially recalibrate to lower yields almost instantaneously.
Text on screen: TITLE – Fixed income performance across hiking cycles. The summary bullets on the left shows: 1) Market participants expect the Fed to begin cutting rates in 2024; 2) Looking at the prior +40 years of hiking cycles we find that performance turns at similar points across cycles; and 3) The 2003 cycle, while more severe than average, has followed a similar pattern as prior cycles. The chart on the right shows Fixed income performance across hiking cycles for the 12-month trailing return of Diversified Fixed Income Portfolio versus Treasury bills. It shows average hiking cycles of 19 months. The red bars show trailing 12-month returns were negative before the Fed’s hiking cycle ended. The green bar shows 12-month trailing returns in the current cycle were positive after peak rates, with the assumption that rates potentially peaked in July 2023.
Being in an ultra-short strategy potentially allows you the flexibility to navigate both the upside to risk to rates as well as the downside likely probability to rates over the intermediate term.
Nersesian: Yeah. I like your suggestion there. Investors often wait for that signal that the coast is clear, that they're definitely assured as to what the next move by the Fed will be. And when we wait for that opportunity, behaviorally, we've often missed an opportunity. It's something that you've obviously spoken to.
Schneider: The way we think that you should approach it is instead of being and trying to identify what the next move per se is by rates or by the federal reserve, terroir liquidity has a structural approach to how you think about this. And in doing so, that allows for not only diversification of your liquidity over a longer period of time, but also allows you different avenues to invest that liquidity.
Text on screen: TITLE – Liquidity Tiering. The graphic shows an inverted pyramid with three parts that illustrate how investors can balance the need for liquidity with the opportunity cost of cash equivalent investments. The topmost and widest part represents Tier three, Return driver “traditional fixed income” (in burgundy) with its purpose: Used for excess liquidity and long-term spending needs for investors with a multi-year time horizon. The middle part represents Tier two, Capital preservation “Short-Term” (in green) with its purpose: Enhance returns to cash, liquidity buffer, for investors with a time horizon of daily and intra-month. The bottom and smallest part represents Tier one, Traditional cash – “money market” with its purpose: Used for daily expenses and liquidity needs for investors with daily and intra-month time horizon.
Whether it's high quality corporate bonds, high quality asset-backed securities and also having a good amount of liquidity.
So making the move outta that tier one money market funds, rationalizing that move to that second tier or even a third tier of liquidity potentially actually has constructive benefits to portfolios.
Nersesian: How do I implement, what is the approach that you might suggest? And let's discuss the potential benefits of active management within that context.
Schneider: So, active management comes in various contexts. First of all, as an investor, you wanna think about how to actively manage your Liquidity in that tiered discussion we were just having. Secondly, in terms of thinking about the implementation of it, active management means not only managing your interest rate exposure, but managing the asset classes which you can invest in.
I highlighted corporate bonds as one example. I like high quality asset backed securities backed by prime credit card receivables or prime auto loan receivables.
These are very good places to create differentiation and diversification within portfolios and still remaining at AA average credit quality for many strategies. How you choose to implement it and access it at this active management is actually through ETF complexes and mutual fund complexes.
And in that ETF complex, we really suggest looking at portfolios which are very diversified, have a high degree of liquidity, but yet have the resources to really discern between the asset classes, not just today, but on a go forward basis. And as we move through the later stages of this economic cycle we're gonna find ourselves in situations whereby the portfolio evolution is not just about what you hold today, but it's what you don't hold tomorrow. And so, we're gonna see this as a constant evaluation to do so.
Nersesian: That sounds like a great opportunity for investors to rethink their allocation to cash and take advantage of some of the resources and capabilities that you have at your disposal that the individual investor may not have access to individually.
Schneider: Well, we would encourage investors to have a discerning look across different strategies. Not all strategies are the same even in that ultra short space. And in doing so, look at how the portfolios are constructed. Look at the average credit quality, look at the liquidity in those portfolios, and then make a determination about how they performed in various economic cycles.
You know, at Pimco we think that there is a limited room for rate cuts in the immediate future at this point in time. But not, our portfolio positioning isn't necessarily predicated on benefiting from that at this point in time.
Okay. So, we're thinking about an array of opportunities,
Text on screen: TITLE – PIMCO Enhanced Short Maturity Active ETF (MINT). There are three rows describing MINT. The first one is: “Duration band of 0-1 year allows for limited actively managed interest rate exposure.” The second is: “Invests primarily in actively selected U.S. dollar-denominated investment grade debt securities.” The third is: “Targets opportunities that are just outside the scope of regulated money markets.”
From a philosophical perspective, MINT has been designed since 2009, really to be the incremental step out of money market funds. The incremental step out of T-bills and what it's done basically is market makers or investors to utilize market makers in the ETF complex to access Pimco's expertise, not only in macroeconomic views, but also liquidity management. What that fundamentally means is having a portfolio that's highly high in quality.
MINT specifically has a very short duration right now, but has the ability to add duration once we get the all clear from the Federal Reserve that are going to increase or that they're going to decrease rates. Well, why is that? We want to be able to be in the position that we can benefit from price appreciation and bonds as yields begin to decline. That's one part of active management that will begin to evaluate over the coming months here at Pimco.
Nersesian: So, it's locking in the higher yields that are available by extending a little bit out on the duration curve and maybe the opportunity for price appreciation.
Thank you so much for sharing your comments with us today, Jerome. We really appreciate it. Thanks to our audience for joining us today. We want to encourage you to contact your Pimco account manager or to visit us at pimco.com for additional information.
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Text on screen: PIMCO
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