Maximizing Returns for Corporate Cash Porfolios in a Rising Interest Rate Environment

Executive Summary

A portfolio of laddered maturities may have better yield advantage over money market funds in a rising rate environment.
Market Cycle Comparison 

• Since 1993, the average net-of-fees yield advantage of 1-year A-rated corporate bonds over the Lipper institutional Money Market Average was 86 basis points annually.
• In the rising rate environment of 1994, 1-year A-rated corporate bonds provided as much as 199 basis points in yield pickup over the Lipper average.

The Risk of Predicting FED Actions

• Trying to predict the direction of interest rates is a futile exercise, which may result in higher interest rate risk as well as lost yield opportunities.
• The opportunity cost of market timing the Fed action was as much as 82 basis points since the last Fed rate cut in June of 2003. The loss would have been over $546,000 for a $100 million portfolio.
• The Fed funds futures market is often premature in predicting the change of direction in the Fed funds rate, and tends to overshoot in both directions when the rate does change.
• In the last 22 years, economist consensus successfully predicted the general direction of interest rates only 28% of the time. The success rate of predicting higher interest rates was even lower at 16%.

Sample Portfolio Comparison 

• Under reasonable assumptions, a laddered portfolio with today’s corporate yield curve will outperform money markets by 54 basis points even if the Fed raises rates by 50 basis points by year-end.
• The pickup will be even greater, at 62 basis points, if the rate stays the same.

CAG Composite Returns History 

• Based on the composite book value returns at CAG, we provided a historical reference of appropriate average maturities for corporate portfolios with cash lives shorter-than two years.
• The five-year comparison of the CAG composite against the Lipper Institutional Money Market Average suggests generally better yield advantage over money market funds as the average maturity of a portfolio is lengthened.

Introduction

Recent concerns with rising interest rates cause some corporate cash managers to consider staying in institutional money market funds in an effort to defend against potential investment losses when the Federal Reserve starts to raise the Fed funds rate.
This article attempts to demonstrate that, a custom liquidity account of high-grade corporate securities with laddered maturities provides higher yield potential than money market vehicles throughout an interest rate cycle. We use historical information to show specifically that, in a rising interest rate environment, a laddered portfolio has had, and may continue to have, better yield advantage over an average institutional money market fund.
DOWNLOAD FULL REPORT

Our research is for personal, non-commercial use only. You may not copy, distribute or modify content contained on this Website without prior written authorization from Capital Advisors Group. By viewing this Website and/or downloading its content, you agree to the Terms of Use.