As Rates Decline, What To Do With Excess Cash?

Rising and elevated rates led to an abundance of cash parked in money markets in the last two years. Now, as rates decline, advisors and investors must consider how to reallocate their cash. KraneShares hosted a webinar earlier this month to discuss this cash reallocation and their fund, the KraneShares Sustainable Ultra Short Duration Index ETF (KCSH ).KraneShares offers a number of notable ETFs in China and emerging markets as well as within alternatives. The firm also continues to prove a pioneer within the climate category. KraneShares is responsible for funds like the KraneShares Global Carbon Strategy ETF (KRBN ), the first of its kind to bring carbon allowance investing to ETFs.How to Think About Cash as Rates DeclineAs an asset manager, KraneShares faced a similar cash quandary that many investors currently face. And that is, where do you turn for lower-risk allocations when money market yields decline as interest rates fall? “We’re always thinking about ways to optimize and maximize the returns that are produced by our liquid part of the portfolio,” explained Jonathan Shelon, COO of KraneShares. “The things that we were thinking about for ourselves and how we manage cash internally are the very things that led to the development of this ETF, KCSH.” KCSH seeks to track the Solactive ISS Sustainable Select 0-1 Year USD Corporate IG Index. The index measures the performance of investment-grade corporate bonds with maturities up to one year. These bonds offer a historically lower risk of default compared to noninvestment-grade bonds. IG bonds also offer the potential for reliable yields for investors, an attractive quality during periods of pronounced, ongoing market volatility. The bonds are U.S.=dollar-denominated, and the strategy seeks to offer similar credit and interest rate risk as ultra-short duration IG bond benchmarks. “By focusing on investment-grade, we’re getting a spread over Treasuries,” Luke Oliver, head of Climate Investments at KraneShares, revealed. And, “at the same time, we’re buying 200 [of the] strongest, best credit companies in the world. And then on the duration side, we’re taking duration less of than six months in that 0-1 category.”Investing for Yield in Unprecedented TimesThe strategy also strives to generate yields and a risk premium over that of Treasuries as well as money markets. Although the yield curve is beginning to normalize, Shelon underscored that it remains an unconventional one. Currently, investors are not rewarded for taking on added duration risk with higher yields. “While it’s true that reaching for duration could achieve capital appreciation benefits, reaching for duration today also actually reduces yield,” he noted.KraneShares sourced data from www.ustreasuryyieldcurve.com, as of 09-11-2024 Image source: KraneShares What’s more, the historical precedent exists for the use of cash alternatives in declining rate regimes. Ultra-short duration exposures proved popular during the rate cuts that followed the dot-com crash in 2000. Interest in ultra-short duration funds also spiked in the wake of the great financial crisis as rates fell from slightly above 5% to near-zero, Shelon explained.Screening for Sustainability Enhances Portfolio BenefitsKCSH goes one step further in screening for those issuers that align with the Paris Agreement. It includes climate analysis by Institutional Shareholder Services in its security selection screen. This means companies whose bonds are included must work to curtail global emissions to 1.5° Celsius by 2050. Issuers must demonstrate self-decarbonization of 7% or greater each year before their inclusion in the portfolio. The strategy also excludes issuers whose revenues are derived from fossil fuels and other sources. “If you took an equity portfolio and you screened out companies with revenue in oil, you would materially change the dynamics of that portfolio,” explained Oliver. “In a bond portfolio … as you screen out, what you’re really optimizing to is the credit quality, yield, and duration.” In KCSH, it results in a portfolio that generates a similar risk and return profile as the broader benchmark while still screening for alignment with the Paris Agreement. KCSH currently offers a 30-day SEC yield of 5.15% as of 09/24/24 and carries a management fee of 0.20% with fee waivers that expire 08/01/25. For more news, information, and analysis, visit the Climate Insights Channel.