After months of investor speculation, the Federal Reserve finally kicked off an easing cycle with its announcement of a 50-basis-point rate cut on Wednesday.
Equity markets rejoiced at the news, with tech stocks leading a 1.7% rally in the S&P 500 on Thursday.
While a rate cut is good news for stocks, it’s not ideal for money market funds, where investors have been parking their cash to take advantage of high rates that will soon be falling.
“It’s hard to resist a 5% yield on a money-market fund,” said Scott Diamond, co-head of municipal fixed income at Goldman Sachs Asset Management. And the numbers show the market agrees. Investors poured trillions into money market funds as short-end interest rates rose at the end of 2022 and have continued to invest in them since. There’s an all-time high of $6 trillion sitting in the funds right now.
But with one 50 basis-point-cut down and the market anticipating another 75 basis points by the end of the year, that return is quickly eroding.
Brendan McCarthy, global head of ETF distribution at Goldman Sachs Asset Management, told Business Insider that his clients are increasingly concerned about preserving income on their cash in a market where rates are decreasing.
However, there are other highly liquid income opportunities to take advantage of. Below are three areas of the market to move your cash to and find yield as the Fed continues to cut rates, according to Goldman Sachs.
3 trades for falling interest rates
For investors concerned about the yield on their cash, one solution might be ultrashort bond funds.
Like the name suggests, ultrashort bond funds invest in fixed-income securities with very short maturities, usually less than a year. For its funds, Goldman Sachs selects securities with durations ranging anywhere from 0.3 to 0.8 years.
Ultrashort bond funds have minimal interest-rate sensitivity but still offer more return than a money market fund. In the last 12 months, ultrashort bond funds have materially outperformed taxable money market funds, returning an average of 6.36% compared to 5.09% for money markets, according to Morningstar.
“It’s really that shorter end of the curve, but it has the ability to dynamically adjust and go out a little bit longer than you might normally get in Treasurys,” McCarthy said. “Every little extension really matters here because you’re going to earn more as the Fed is easing.”
McCarthy recommends investing in a mix of ultrashort securities such as investment-grade corporates, asset-backed securities, and government securities for diversification purposes.
The Nuveen Ultrashort Income ETF (NUSB) and the Goldman Sachs Access Ultrashort Bond ETF (GSST) are examples of ultrashort bond funds.
There are opportunities in specific areas of the ultrashort market as well. Diamond likes ultrashort municipal bonds in particular. Municipal bonds have the added benefit of being tax-efficient, as they are exempt from federal income tax, and in some cases, state and local taxes.
If investors anticipate an upcoming expense in the next year — such as a tax or college tuition payment — but still want to realize some incremental yield on their money in the meantime, an ultrashort municipal bond fund is the way to go, according to Diamond.
Diamond also thinks investors can take advantage of municipal securities’ favorable credit spreads, or the gap between their yields and the yields on risk-free bonds. Municipal securities, even those higher up on the risk profile, currently have very solid credit fundamentals, in his view.
“Let’s start to look at maybe some higher yield municipal credits and see if we can get some additional yield for taking on what we think are really solid credits,” Diamond said.
Investors can add ultrashort municipal bonds to their portfolio through funds such as the PGIM Ultrashort Municipal Bond ETF (PUSH) and the JPMorgan Ultrashort Municipal Income ETF (JMST).
Lastly, McCarthy identifies premium income funds as another place for investors to consider putting their money.
Unlike the two fixed-income opportunities above, premium income funds invest in equity instruments. These funds generate income through investing in dividend-paying stocks and writing call options on those holdings. That way, if the stock falls or stays out-of-the-money, investors still collect the premium. If the stock rises to in-the-money territory, they still benefit from the appreciation.
As a result, these funds deliver consistent monthly income to investors.
For clients who are looking for new ways to deploy cash reserves in a cutting cycle, Goldman Sachs believes premium income funds are a good way to find income opportunities in the equity market.
Investors can gain exposure to premium income funds through the SPDR SSGA US Equity Premium Income ETF (SPIN) and JPMorgan Equity Premium Income ETF(JEPI).
