ICSH Has Outperformed Other Popular Short-Term Bond Funds, Remains Our Favorite

Summary

• We continue to believe that ICSH is one of the better places to park cash to get some return without taking much risk.
• Unfortunately, it has recently delivered negative total returns due to the quick rise in interest rate expectations, but going forward, we believe it can return to delivering positive returns.
• However, should inflation continue to run high for a long time, investors might want to consider instead a short duration TIP bond ETF such as VTIP.

Andrii Yalanskyi/iStock via Getty Images

Last year we recommended ICSH (BATS:ICSH) as a good ETF to consider for placing some cash while waiting for a market correction. We have mixed feelings about the results so far, given that we were right that a market correction was likely, but the ETF total return was negative, so it would have been better to simply leave the cash alone. The reason for this is the massive inflation that forced short-term interest rates up too quickly. The adjustment in the price of the bonds was bigger than the interest they generated, hence the negative return.

Seeking Alpha

As a reminder, ICSH seeks to provide income by investing in a broad range of short-term US dollar-denominated investment-grade fixed and floating-rate debt securities and money market instruments. However, ICSH is not a money market fund, and it is actively managed by BlackRock's Cash Management team. Its investment objective is to provide current income consistent with preservation of capital.

Reasons To Add A Short-Term Bond Fund

For investors worried about a weaker economy and recession risks, ICSH can still be a good place to park cash in our opinion. There is the risk that interest rates might continue rising very fast, reducing the value of bonds to a point where the ETF might actually continue delivering negative returns, but we would be surprised if that dynamic continued to a point where ICSH continues delivering negative returns for an extended period of time, but it is within the realm of possibilities.

In any case, we do see a decelerating economy, as shown below, GDP now is forecasting close to 0% growth for Q1 2022.

FRED

The recession probability according to the Estrella and Mishkin model is still low but not negligible. One should get really worried when the model is at >20%. Above those levels, a recession has usually followed.

Data by YCharts

The bigger problem appears to be rising inflation, which recently reached ~8.5% in the US, and is what is forcing the FED to raise rates so aggressively. If that continues, other ETFs might outperform ICSH, such as short-term TIP ETFs (VTIP).

Data by YCharts

During periods of low inflation, ICSH has tended to outperform VTIP, but during high inflation stretches, VTIP is probably a better idea as can be seen below. One thing in favor of ICSH is that it is a lot less volatile, with VTIP choosing entry point is a lot more important.

Data by YCharts

Year to date, both have had similar total returns, about negative 0.4%, but VTIP with a lot more volatility.

Data by YCharts

Outperforming Similar ETFs

Compared to similar ETFs focused on short/ultra-short debt, such as Invesco Ultra Short Duration (GSY), PIMCO Enhanced Short Maturity Active ETF (MINT), iShares Short Maturity Municipal Bond ETF (MEAR), and iShares 0-5 years Investment Grade Corporate Bond (SLQD), ICSH has performed much better and provided the least bad total return.

Data by YCharts

And given the rapid rise in rates, it is normal that ICSH has outperformed by a much wider margin bond funds with much higher durations. Below are some examples, including the inflation-protected TIPS Bond ETF (TIP), which despite benefiting from inflation protection has suffered due to its very high duration. The popular iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) has performed particularly bad this year.

Data by YCharts

Portfolio Characteristics

The ETF portfolio characteristics are shown below, we would give particular importance to the average yield to maturity, since we believe that is the best indicator of what a long-term investor in the fund can currently expect as a total return when investing in the ETF.

iShares

Sustainability Characteristics

One of the things we like about ICSH is that it is transparent about its sustainability, and that it avoids most controversial industries. The only one where it has a small allocation of 0.28% is oil sands, and we wish it would go all the way to 0%. Last time we covered the ETF, the allocation to oil sands was at 1%, so it is definitely going in the right direction.

iShares

Exposure Breakdowns

The ETF has a very high average credit rating, and it has gone up since the last time we covered it. Now only 23% of its bonds are BBB rated, last time, it was 31%. At the same time, AA-rated bonds have gone up to 24% from 15% and AAA to 1.3% from 0.5%.

iShares

Morningstar Rating

Morningstar gives ICSH a four star rating, and it shows that it has outperformed its category and its index.

Morningstar.com

Morningstar

Risks

BlackRock's iShares makes clear that ICSH is not a money market fund and that it is actively managed by BlackRock's cash management team. While we believe the risk of significant permanent capital loss for long-term investors is low, there is risk in that the ETF holds investments with non-negligible risk. The diversification and credit quality mitigate these risks, but it is not zero. There is also interest rate risk and inflation risk when investing in this ETF.

Conclusion

We continue to believe that ICSH is one of the better places to park cash to get some return on this capital without taking much risk. Unfortunately, it has recently delivered negative total returns due to the quick rise in interest rate expectations, but going forward, we believe it can return to delivering positive returns to investors. However, should inflation continue to run high for a long time, investors might want to consider instead a short duration TIP bond ETF such as VTIP.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling shares, you should do your own research and reach your own conclusion, or consult a financial advisor. Investing includes risks, including loss of principal.

Comments

[jazznut]

FYI-- The 30-day SEC yield of SLQD is about 3 times that of ICSH. The choice is between higher yield or lower volatility.