Keep Invest Capital, Hold Liquidity with Ultra-Short Duration Bond ETF

In times of duress, investors have shifted out of risk assets and relied on cash to sit out the storm. Exchange traded fund investors can also turn to ultra-short duration bond strategies to access a liquid cash alternative in a bid to preserve capital.

For example, the actively managed Aware Ultra-Short Duration Enhanced Income ETF (NYSEArca: AWTM) is one alternative to earnings credits, commercial paper, and money market funds that should help investors preserve capital while maximizing current income.

AWTM tries to achieve a gross yield of 0.75% to 1.00% over the most recently issued 3-month U.S. Treasury Bill Yields. Specifically, the ETF invests in U.S. dollar-denominated investment-grade fixed-income and floating-rate bonds. The fund may include instruments issued by both U.S. and non-U.S. (including emerging markets) government and private sector issuers, including asset-backed securities.

Aware Asset Management has experience overseeing investments for Blue Cross & Blue Shield of Minnesota and rolled out the ultra-short duration bond ETF for insurers and other treasurers who are seeking to streamline cash management.

Dave Nadig, Chief Investment Officer and Director of Research at ETF Trends and ETF Database, recently caught up with John E. Kaprich, Senior Portfolio Manager, Aware Asset Management, to discuss the changing market dynamics and where an ultra-short duration bond strategy may fit in a diversified investment portfolio.

Dave Nadig: One of the benefits of active management is being able to respond to market changes. Can you disclose any moves you’ve made in the portfolio in the past few weeks?

John E. Kaprich: In the past few weeks, we have made several active moves in our portfolios. First, we reduced our exposure to corporates, replacing them with high-quality CLOs. Additionally, we shortened our overall duration, especially in our treasury position. We have also started using more high-quality commercial paper. And finally, we continue to toggle between fixed and floating instruments opportunistically.

Dave Nadig: With ten-year yields under 1%, some are suggesting that the bond market is “done” in terms of investor appetite. Where should investors be positioning with rates here?

John E. Kaprich: The bond market rally could very well continue, as evidenced by the volatility markets reacting to coronavirus. The MOVE Index is at its highest level since 2010; while it had dropped from its peak last week, option protection continues to be expensive. And despite the Fed’s emergency rate cut, last week’s VIX spike has not fully subsided. The market doesn’t seem satisfied with 50bps, though this may be more a reflection of the Fed’s lack of confidence in its own actions, and the scarcity of remaining arrows in its quiver.

We anticipated that the prospect of a Sanders presidency would be scaring the market, but after Biden’s rally on Super Tuesday, it appears the impact was minimal. While treasuries may be fully valued, spread products have widened somewhat, providing buying opportunities at the short end of the yield curve. We are a buyer of spread products at current prices, especially high-quality floating rate CLO and BBB corps in tenors up to 1 year.

Dave Nadig: Is it more important to adjust credit or duration risk in times of volatility in the bond markets?

John E. Kaprich: Credit risk and duration risk are equally important. Portfolio risk is a function of the duration you take, and the credit spreads you incur. Focusing on either one in isolation can lead to a misunderstanding of your overall portfolio. While it is challenging to forecast interest rates, we predict an upturn in the near future. To express this view, we are increasing exposure to floating rate assets to help protect from rising rates. Recently, interest rates have fallen, and spreads have widened. As a spread manager, we welcome wider spreads, as they allow our research and portfolio management teams to construct high quality corporate portfolios at favorable prices.

Dave Nadig: Are you concerned about the “BBB bubble” in investment grade issuances? How are you positioning the fund in credit terms?

John E. Kaprich: We believe the BBB bubble creates buying opportunities, and that A-rated securities present less attractive returns. We have confidence in our corporate research team to separate the wheat from the chaff among the BBBs. Although spreads have widened, our research indicates that corporate fundamentals remain sound and that the recent widening appears to be due more to macro-level uncertainty rather than specific corporate developments. Some sectors may be especially hard hit, such as energy and autos, but near-term risks are limited to high yield credits. The higher quality companies we invest in remain strong. Our research supports the conclusion that a rise in corporate bankruptcies remains a remote scenario for BBB or higher rated firms.

In corporate bonds, we are excited about financials, aerospace and defense, and some areas of tech (software, cloud services), where select credits offer defensive characteristics and attractive yields. Among the structured-product sectors, we are bullish Single-Family Rentals (SFR). We believe there has been a fundamental shift towards delayed homebuying. One of the major drivers in delayed homeownership is the higher levels of student debt that young families face. SFR gives these families the opportunity to enjoy a residential lifestyle while they de-lever their personal balance sheet.

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