CONTRIBUTORS
David Zahn, CFA, FRM
Head of European Fixed Income,
Franklin Templeton Fixed Income
Julia Peukert
Client Portfolio Manager
Franklin Templeton Fixed Income
Juan Gerardo Cruz
Client Portfolio Analyst
Franklin Templeton Fixed Income
An ever-changing fixed income landscape can be challenging for investors seeking the right opportunities to achieve their financial goals. While money market funds have long been a staple for conservative investors, we believe that now is a good time to consider short maturity funds as a potentially superior alternative.
Short maturity bond funds come with higher yield potential
Short maturity funds have typically offered higher yields compared with their money market counterparts. The latter are constrained by numerous regulatory requirements, while the former have a greater degree of flexibility to choose securities across maturities, issuers (including both sovereign and corporate issuers) and the credit spectrum. Exhibit 1 illustrates that the average yield-to-worst on euro-denominated short maturity bonds has historically been higher than the yield on euro-denominated money market funds.
Exhibit 1: Yield comparison between euro short maturity bonds (as per the ICE BofA 0–1 Year Euro Broad Market Index) and money market funds (using the three-month German government bonds as proxy)
Source: Bloomberg. Analysis by Franklin Templeton Fixed Income. As of September 30, 2024. The ICE BofA 0-1 Year Euro Broad Market Index is a broad-based benchmark that measures the investment grade, euro-denominated fixed income securities with less than one year maturity. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or guarantee of future results. See www.franklintempletondatasources.com for additional data provider information.
Short maturity funds can provide attractive diversification benefits
Not only are short-maturity fund managers able to look for more compelling yield opportunities, they can also search for securities that might help diversify portfolio holdings. Adding allocations to securities that have a low correlation with existing holdings can help reduce the return volatility of a portfolio.
An additional benefit of investing in short maturity bonds is that this asset class can exhibit some defensive characteristics. Exhibit 2 shows that during periods of high volatility (as measured by the Merrill Lynch Option Volatility Estimate [MOVE]1 index), the flight of capital from the sector was often not very severe. In fact, investors tend to view short maturity bonds as a sort of “safe haven” in times of uncertainty, which is reflected by the many instances when the total assets invested in this market increased even as fixed income volatility was rising.
Exhibit 2: Comparison of fixed income volatility (as measured by the MOVE Index) and the total net assets invested in euro-denominated ultra short bonds*
Sources: Bloomberg, Morningstar. Analysis by Franklin Templeton Fixed Income. As of September 30, 2024. *Note: Shows estimated net flows into the Morningstar category: EUR Ultra Short-Term Bond.
Short maturity bond funds benefit from professional investment management
The experienced, active asset managers who run short maturity funds have deep resources at their disposal, which can support improved performance potential and more efficient risk management, especially when compared with the more passive approach often seen in money market funds.
Our portfolio managers closely follow bonds that are no longer part of most indexes due to maturity constraints (since most require eligible securities to have at least 12 months to maturity). Bonds that fall out of these indexes as their maturity date approaches may be appropriate for money market funds. However, if they are not appropriate for money market funds, these securities are less in demand since they have fewer buyers, which can create attractive opportunities for active fund managers.
Conclusion
For investors looking to optimize their portfolios via a combination of higher yield potential, defensive characteristics and diversification benefits, we believe short maturity funds present a compelling alternative to traditional money market products. On top of this, we believe that an active investment management approach can help investors achieve their financial goals more effectively.
Endnotes
1. MOVE index reflects the level of interest rate volatility in the US Treasury market.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal.
Fixed income securities involve interest rate, credit, inflation and reinvestment risks, and possible loss of principal. As interest rates rise, the value of fixed income securities falls. Changes in the credit rating of a bond, or in the credit rating or financial strength of a bond’s issuer, insurer or guarantor, may affect the bond’s value.
International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility.
Active management does not ensure gains or protect against market declines.