- With the yield curve flat-to-inverted, short-term bonds offer a much better risk-reward profile than long-term bonds.
- The negative beta of long-term bonds can be enticing, but with inflation on the rise, potential drawdowns could be jarring.
- The PIMCO enhanced maturity short-term bond ETF MINT has historically outperformed other money market ETFs and offers far more yield-for-risk than most fixed-income funds.
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Investors today are stuck in a difficult situation. Most invest in assets with high historical performance like stocks and long-term bonds which come with considerable downside risk, particularly if inflation continues to rise. Yields are generally though and risk is generally high, making for a poor investing environment.
While yields are low, the flatness of the yield curve brings safe opportunity in short-term bonds. The yield on a nearly risk-less one year bond is often the same as it is on an extremely volatile 20-year bond. One ETF investors may want to consider is the PIMCO Enhanced Short Maturity ETF which trades under the ticker (NYSEARCA:MINT).
Beating the Money Market
MINT is an ultra-low duration low-risk bond fund with an effective maturity of three months and an estimated yield-to-maturity of 1.56%. While such a yield is nothing to write home about, it is nearly equal to the highly volatile 20+ year Treasury ETF (TLT) which has a YTM of 1.65%. Even more, it is superior to that of the SPDR T-Bill ETF (BIL) which has a yield of around 1-1.25% following the recent emergency Fed cut.
In fact, MINT has outperformed all of its major peers (taken from the top AUM money market ETFs) over the past five years:
Obviously, there is no guarantee that such outperformance will continue, but the fact is that MINT has managed higher returns with less volatility than its peers.
A Look At MINT's Exposure and Strategy
Unlike many money-market funds, MINT takes a diversified approach that seeks to enhance returns while maintaining a very low level of risk. Currently, 65% of the fund is invested in the U.S and the remaining 35% is invested abroad in U.S-short-term debt.
Little of that debt is invested in U.S T-Bills. Currently, about a fifth is in securitized debt, slightly over half in investment-grade credit, and the rest in a mixture of other short-term securities. This is detailed below:
This exposure gives the fund high diversification and demonstrates its active management strategy. Overall, I do not see any particularly high credit risks in any of the areas or assets MINT is exposed to, at least not high enough that they are likely to materially impact MINT.
The Case for Short-Term
As I mentioned earlier, with the curve this flat expected return does not vary with maturity length. That said, inflation and interest rate risk (i.e duration) remain much higher for long-term bonds. In fact, MINT has a duration of about 0.25 while TLT has one of 18 though they both have similar yields.
To demonstrate, I made a table of the most popular fixed-income ETFs and divided their TTM dividend yield by their TTM volatility. This gives us a simple gauge of which funds offer the best return-for-risk. As you can see below, MINT comes in second place matched only by the iShares T-Bill fund (SHV):
|Ticker||TTM Dividend||TTM Price Standard Deviation||Dividend/STD|
(Data Source - Google Finance)
As you can see, short-term funds generally place toward the top while long-term funds like TLT or high-risk funds like EMB and HYG place toward the bottom.
I find the current rally in long-term bonds a bit strange as it seems to be slightly mechanical. The fact is that inflation is rising and evidence suggests that the supply-chain impacts of the Coronavirus will continue to push it higher. This is very bearish for any bond with a maturity over 20 years and is moderately bearish for those in the 5-20 year range. In fact, a 1% increase in inflation should theoretically bring TLT 18% lower given its current duration.
Of course, long-term bonds carry a much higher historical negative beta than short-term bonds like those in MINT. Thus, asset allocators and likely algorithms are increasing their exposure to long-term bonds as a way to mitigate equity risk. Of course, historical exposure to future exposure is not necessarily the same and a 'correlation flip' is possible.
If the yield curve steepens while equities drop, which has happened, it could cause excess returns for MINT and other short-term bond funds. In my opinion, the fact that short-term bonds carry the same yield as those with much higher volatility is enough to make them a good deal today.
The Bottom Line
It appears that we are headed into a recession. Equities cannot catch a break, and the fundamentals turned bearish before the COVID virus began to rapidly spread. The virus is the most likely candidate for a catalyst needed to spark the recession.
In my opinion, precious metals are the best overall place to put your money as they will gain from rising inflation and act as a hedge against financial assets. That said, they come with higher volatility than most would like, so ETFs like MINT is perhaps a better alternative for conservative investors.
Because MINT has historically very low drawdowns and has managed to outperform its other money-market peers, I believe that it is a solid "buy". Compared to putting cash in your savings account where it will often get a 50 bps or lower return, MINT is a far better deal.
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