Beyond money markets: The case for short maturity bonds

An ever-changing fixed income landscape can be challenging for investors seeking the right opportunities to achieve their financial goals. While money market funds have long been a staple for conservative investors, we believe that now is a good time to consider short maturity funds as a potentially superior alternative.

Short maturity funds have typically offered higher yields compared with their money market counterparts. The latter are constrained by numerous regulatory requirements, while the former have a greater degree of flexibility to choose securities across maturities, issuers (including both sovereign and corporate issuers) and the credit spectrum. Exhibit 1 illustrates that the average yield-to-worst on euro-denominated short maturity bonds has historically been higher than the yield on euro-denominated money market funds.

Not only are short-maturity fund managers able to look for more compelling yield opportunities, they can also search for securities that might help diversify portfolio holdings. Adding allocations to securities that have a low correlation with existing holdings can help reduce the return volatility of a portfolio.

An additional benefit of investing in short maturity bonds is that this asset class can exhibit some defensive characteristics. Exhibit 2 shows that during periods of high volatility (as measured by the Merrill Lynch Option Volatility Estimate [MOVE]¹ index), the flight of capital from the sector was often not very severe. In fact, investors tend to view short maturity bonds as a sort of “safe haven” in times of uncertainty, which is reflected by the many instances when the total assets invested in this market increased even as fixed income volatility was rising.

The experienced, active asset managers who run short maturity funds have deep resources at their disposal, which can support improved performance potential and more efficient risk management, especially when compared with the more passive approach often seen in money market funds.

Our portfolio managers closely follow bonds that are no longer part of most indexes due to maturity constraints (since most require eligible securities to have at least 12 months to maturity). Bonds that fall out of these indexes as their maturity date approaches may be appropriate for money market funds. However, if they are not appropriate for money market funds, these securities are less in demand since they have fewer buyers, which can create attractive opportunities for active fund managers.