Cash ETFs eye chance to no longer be a losing proposition

Money market ETFs have been a tough sell over the last decade but duration risk in other safe haven fixed income products and concerns the bull market is running out of steam could work in the products’ favour.

Within the Morningstar money market category there are just 13 ETFs available to UK investors. Six of those were launched in 2015, while the remainder were launched between 2007 and 2008.

The largest is the Lyxor Smart Cash ETF with £907m assets under management, according to Morningstar data from October.

Portfolio Adviser spoke to a handful of discretionary fund managers and found none using ETFs for their cash allocations. Architas uses short-term money market funds, from large institutions like JP Morgan and Blackrock, while Thomas Miller Investments uses a cash account on the SEI platform for its model portfolios and Cornelian Asset Management uses a depository bank for its strategic allocations within its multi-asset range.

Cornelian uses the iShares Ultra Short Duration ETF, which has an effective duration of 0.26%, but considers it a credit rather than cash allocation, says senior investment manager Richard Stark.

Robo adviser uses cash held in a bank on behalf of clients for its allocations, which currently sit around 1%.

Active vs passive cash ETFs

Money markets are one of the few asset classes where active ETFs have been more popular than passives with investors, says Morningstar associate director for passives Jose Garcia Zarate. “The ones that have been tracking money market rates, particularly in the eurozone, have been a losing proposition. There’s not much point in tracking Eonia when it’s been negative for quite a few years.”

The Lyxor Smart Cash ETF is an active fund that uses repurchase agreements to achieve short-term returns higher than the benchmark Eonia index.

In June, JP Morgan launched the Ultra Short Income Ucits ETF with sterling, euro and US dollar versions of the fund with a TER of 0.18%. Although the ETF doesn’t sit in the money market category, it is marketed as a cash-like product and the sterling strategy has attracted £51.1m.

Money market ETFs for UK investors

Source: Morningstar

Lyxor head of ETF strategy for North Europe Adam Laird says money market ETFs are starting to attract more interest.

Laird says: “To be blunt it has been a tough sell. The reason the interest has been growing is because investors need somewhere to shelter their cash. When we see traditional low-risk assets, like government bonds, are suffering.”

He says within fixed income there has been a general rotation out of riskier assets into safe havens and products like floating rate notes that can navigate duration risk. That includes money market ETFs, which have attracted €468m across Europe in the year to date.

Fixed income ETF inflows in Europe YTD

Source: Lyxor/Data for the year to 22 October 2018

Transparency, currencies and trading

Transparency and easy access to a range of currencies makes accessing money markets via ETFs more appealing than mutual funds, says Laird.

“For example, maybe there’s someone living in the UK but investing with the intention to retire in Spain. They will want to have some of their investment in sterling and some in euros. Having that option to use low-cost cash ETFs gives them a simpler way of holding a number of currencies rather than opening up multiple bank accounts,” he says.

Garcia says: “The one thing with ETFs is you can go in or out at real time and therefore it allows for speed of action if that’s something the investor needs. More traditional active mutual funds are more expensive.”

The JP Morgan Sterling Liquidity fund charges 0.21% while its Ultra Short Income Ucits ETF is 0.18%.

Short-duration bond funds

ETF providers need to take an active approach to cash products in order to extract some yield, says Garcia.

“But then you want to keep duration below one year. That has basically only been possible by taking on credit risk and going into the corporate bond space.”

European medium term notes (MTNs) and commercial paper dominate the JP Morgan Ultra Short Income ETF top holdings.

JP Morgan head of international ETFs Bryon Lake says the suite of ETFs is either a step up from cash exposure and or a step down from credit. Funds of funds, discretionary fund managers, private banks and family offices are among clients using the products, Lake says.

Using the US dollar version of the ETF as an example, he says investors can yield 45% extra by shifting duration from zero to five months. In contrast, aggregate bond exposure typically doesn’t go below one-year duration. “You can take on just 8% of the duration risk of the broader aggregate index but still capture 85% of the yield.”

Disadvantages of ETFs

Cash ETFs don’t have the same Financial Services Compensation Scheme (FSCS) protections as money deposited at the bank, instead being treated as an investment, says Laird.

Platforms can be a barrier to client take up of JP Morgan’s ETF products, says Lake. “It just isn’t necessarily a group that has been able to embrace the ETF wrapper because their infrastructure

The biggest barrier JP Morgan encounters among clients is platforms that don’t have the infrastructure to support ETFs. “That’s one area where clients are saying for the time being they’ll stick with what they have because they just don’t have the physical ability to trade it,” he says.

However, most clients are evaluating ETFs and mutual funds on a level playing field, he adds.