After months of investor speculation, the Federal Reserve announced a 50 basis point interest rate cut on Wednesday, finally kicking off an easing cycle.
The stock market cheered the news, with tech stocks leading the S&P 500’s 1.7% gain on Thursday.
While interest rate cuts are good news for the stock market, they’re not ideal for money market funds, where investors park their money to take advantage of higher interest rates that will soon fall.
“A 5% yield on a money-market fund is hard to resist,” said Scott Diamond, co-head of municipal fixed income at Goldman Sachs Asset Management. And the numbers show the market agrees. As short-term interest rates rose at the end of 2022, investors poured trillions of dollars into money-market funds, and they’ve been doing so ever since. There’s now a record $6 trillion sitting in those funds.
But those returns are diminishing fast, as one 50 basis point cut has been delivered and the market expects another 75 basis point cut by the end of the year.
Brendan McCarthy, global head of ETF distribution at Goldman Sachs Asset Management, told Business Insider that clients are increasingly concerned about preserving their cash income in a market where interest rates are falling.
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But there are other liquid income opportunities you can take advantage of. According to Goldman Sachs, there are three market areas to move cash around and earn yield as the Fed continues to cut rates:
Three deals aimed at lowering interest rates
For investors concerned about cash yields, one solution may be ultra-short-term bond funds.
As the name suggests, ultra-short term bond funds invest in bonds with very short maturities, usually less than one year. Goldman Sachs selects securities with durations between 0.3 and 0.8 years for the fund.
Ultra-short-term bond funds have minimal interest rate sensitivity but still offer higher returns than money market funds: According to Morningstar, ultra-short-term bond funds have significantly outperformed taxable money market funds over the past 12 months, with an average return of 6.36% compared to money market’s 5.09%.
“This is actually the short part of the curve, but it adjusts dynamically and can last a little longer than regular Treasuries,” McCarthy said. “As the Fed eases, there’s more to gain, so a little bit of extension here is really important.”
For diversification purposes, McCarthy recommends investing in a combination of very short-term securities such as investment-grade corporate bonds, asset-backed securities and government securities.
Nuveen Ultrashort Income ETF (NUSB) and Goldman Sachs Access Ultrashort Bond ETF (GSST) are examples of ultra-short term bond funds.
There are also opportunities in certain areas of the very short-term market. Diamond particularly likes very short-term municipal bonds, which have the added benefit of being highly tax-efficient because they are exempt from federal income tax and, in some cases, state and local taxes.
Diamond says that if investors are anticipating expenses like taxes and college tuition payments next year but want to realize incremental returns on their capital in the meantime, ultra-short-term muni funds are a great choice.
Diamond also believes investors can take advantage of municipal bonds’ favorable credit spreads, or the difference between the yield on a municipal bond and the yield on a risk-free bond. In his view, municipal bonds, even those with a higher risk profile, currently have very strong credit fundamentals.
“First, look at higher-yielding municipal bonds and see if you can get some additional yield by underwriting what you think are really solid bonds,” Diamond said.
Investors can add very short-term municipal bonds to their portfolios through funds such as the PGIM Very Short Term Municipal Bond ETF (PUSH) and the JPMorgan Very Short Term Municipal Bond ETF (JMST).
Finally, McCarthy cites premium income funds as another place investors should consider putting their money.
Unlike the two fixed income opportunities mentioned above, premium income funds invest in equity instruments. These funds generate income by investing in dividend-paying stocks and issuing call options on those holdings. So, even if the stock price falls or remains out of the money, investors receive a premium. If the stock price rises into in-the-money territory, investors can also benefit from the upside.
As a result, these funds provide investors with a steady income every month.
Goldman Sachs believes premium income funds are a good way for clients looking for new ways to deploy cash reserves during a downturn to find profitable opportunities in the stock market.
Investors can gain exposure to premium income funds through the SPDR SSGA US Equity Premium Income ETF (SPIN) and the JPMorgan Equity Premium Income ETF (JEPI).