Bridging the Gap between Money Markets and Long-Term Bonds?

Fixed income investors can bridge the gap between money market funds and long-term bond funds with ultra-short bonds like the Vanguard Ultra-Short Bond ETF (VUSB).

In today’s low yield environment relative, investors will often snag more yield by taking on risk with volatile assets or assuming more duration risk. This is where ultra-short bonds can strike a balance between money market funds that can’t offer higher yield and short-term bond funds that have higher duration risk.

With its low 0.10% expense ratio, VUSB’s investment objective is to seek to provide current income while maintaining limited price volatility. The fund invests in a diversified portfolio of high-quality and, to a lesser extent, medium-quality fixed income securities. It offers a dollar-weighted average maturity of 0 to 2 years.

Under normal circumstances, the fund will invest at least 80% of its assets in fixed income securities. The fund is designed to give investors low cost exposure to money market instruments and short-term high quality bonds, including asset-backed, government, and investment-grade corporate securities.

“Vanguard Ultra-Short Bond ETF offers the features of an ETF structure for investors seeking an option for anticipated cash needs in the range of 6 to 18 months,” said Kaitlyn Caughlin, head of Vanguard Portfolio Review Department. “An ultra-short strategy bridges the gap between money market funds offering a stable share price and short-term bond funds, which are meant for longer investment time horizons.”

Although short-term bond funds tend to have a higher yield than money market funds, their share price can flux up and down. Because VUSB will subject investors to principal risk, the fund shouldn’t be viewed as a substitute for a money market fund.

Additionally, increases in interest rates can cause the prices of the bonds in the portfolio, and thus the fund’s share price, to decrease.

Are Inflationary Pressures a Viable Threat?

Bonds and inflation mix like oil and water. Given the recovering economy, will inflationary pressures ward investors away from ultra-short bonds?

“We really don’t see inflation emerging as a major threat, and we think the Fed will continue to demonstrate the patience they’ve shown so far before tapering or tightening,” said John Hollyer, Vanguard’s global head of fixed income, in a CNBC interview.

“We would say that a balanced portfolio with some holdings in bonds is going to achieve some better efficiency in light of potential for equity volatility.”

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