Money Market Funds vs. Short-Term Municipals: Time and Yield Work in Investors’ Favor, If They Have the Time and Yield

Some of our clients are concerned with the stock market's valuation and are searching for lower-risk options for protecting their gains.  

Should they move a portion (or all) of their liquid assets to cash? Are money market funds the next logical step?

We have a Short-Term Muni Separately Managed Account (SMA) strategy that may be a better option. We've simulated returns for our laddered strategy and a taxable money market fund given a variety of interest rate scenarios over the next two years.  

Our predicted cumulative return projected for the period December 6, 2021, through December 5, 2023, given the assumptions outlined below, are higher in our SMA (net of fees) vs. in a money market fund (cash) in three of the four scenarios presented, including in our base case, a 1% rise in interest rates.  The key?  Staying power.  

To immunize the duration impact of a 1% increase in rates (when interest rates increase, bond prices decrease), we believe you need to hold on to our laddered strategy for close to the entire two-year period.  Our SMAs provide liquidity on demand.  But a holding period shorter than two years could result in losses if interest rates move higher.                

 

Assumptions:

1. We assume a parallel shift across the investment universe: one day to one year for the money market fund and one day to 5 years for the SMA, occurring month 13 of the forecast period.
2. The hypothetical money market fund's analysis is net of all fees. The SMA analysis is net of a 0.25% annual management fee accrued monthly.
3. The SMA analysis utilizes a representative CDI Short-Term Muni SMA. City Different Investments conducted the analysis on 11/15/21 – all data reflects the market on that day.
4. The SMA includes revenue (52%) and general obligation (48%) municipal bonds, both taxable (67%) and tax-exempt (33%). The ratio of taxable to tax-exempt municipal bonds is assumed to be constant throughout the holding period.  The account includes only investment-grade credits (AAA – 15%, AA – 58%, and A – 25%).
   
   

Conclusion:

• If you have a projected holding period of at least two years, our Short-Term Muni SMA may outperform other cash alternatives in a rising rate environment.
• The investment horizon (2 years) roughly matches the effective duration of the short-term SMA.
• The SMA is expected to earn more income than the money market fund. 
• As bonds mature, they are reinvested at higher rates.  Theoretically, 20% of the SMA's assets are reinvested each year or 40% over the investment horizon (2 years).  
• The rise in rates is expected to produce market losses, but some of these losses are expected to be recovered as the assets mature or "roll down the yield curve."

Looking for a place to retreat from a high-flying market? Learn more about our fixed income strategies or contact us to answer your questions about short-term muni bonds.

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Important Disclosures: The illustration shown above is hypothetical and does not represent actual performance results. The results shown do not guarantee future investment results. Markets will likely perform better or worse than shown in the projections; the actual results of an investor who invests in the manner these projections suggest will be better or worse than the projections, and an investor may lose money by investing in the manner the projections suggest. The information and statistics contained in this report have been obtained from sources we believe to be reliable but cannot be guaranteed.  Any projections, market outlooks, or estimates presented herein are forward-looking statements and are based upon certain assumptions. Other events that were not taken into account may occur and may significantly affect the returns or performance of these investments.  Any projections, outlooks, or assumptions should not be construed to be indicative of the actual events which will occur. These projections, market outlooks, or estimates are subject to change without notice.  Please remember that past performance may not be indicative of future results.  Different types of investments involve varying degrees of risk. There can be no assurance that the future performance of any specific investment, investment strategy, or product or any non-investment related content, made reference to directly or indirectly herein will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation or prove successful.  Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions.   CDI has provided the Short-Term Muni Separately Managed Account (SMA) strategy to clients since August 1, 2021. Actual portfolio returns may vary due to the timing of portfolio inception and/or investor-imposed restrictions or guidelines. Actual investor portfolio returns would be reduced by any applicable investment advisory fees and other expenses incurred in the management of an advisory account. You should not assume that any discussion or information contained herein serves as the receipt of, or as a substitute for, personalized investment advice from City Different Investments. To the extent that a reader has any questions regarding the applicability above to their individual situation or any specific issue discussed, they are encouraged to consult with the professional advisor of their choosing.  City Different Investments is neither a law firm nor a certified public accounting firm, and no portion of this content should be construed as legal or accounting advice. A copy of City Different Investments' current written disclosure statement discussing our advisory services and fees is available for review upon request. Unless otherwise noted, City Different Investments is the source of information presented herein.