Craig Inches, head of rates and cash at Royal London Asset Management, assesses the best investment strategies in a falling rate environment, and when it makes sense to look longer-term.
What are your expectations for another rate cut this year, and how will that affect the yields of cash and liquidity funds?
I think rates will decline, but I don’t think they’re going to fall that far. I think central banks will be nervous about cutting interest rates too far, too quickly. There are different types of funds – pure liquidity and money market funds, and funds that fall into the enhanced cash or liquidity plus type pocket. These are short dated funds that have a mixture of money market instruments and floating rate, things that are highly liquid, with low risk of credit default, that can enhance yield. What these funds also typically have is added duration. They’ve got a bit more interest rate risk but will benefit in a falling rate environment.
If you think that interest rates are going to stay on hold or are going to increase, you probably want to be in those pure money market funds. But if you think that interest rates are going to decline, and you want to take advantage and get some capital gains without too much volatility, with a little more yield, then those enhanced funds are certainly an area that you can look at. Clients should be starting to consider their own view of interest rates now.
Can treasurers maintain the security and liquidity they achieve in their MMF investments whilst increasing their duration and yield, rather than having to lock cash away in term deposits?
If you lock money away in a term deposit, you’ve effectively locked into a yield, which you need to be comfortable with. If you think about funds and how these are structured, we as managers will also be buying into those longer-term fixed rate assets if we think interest rates are going to fall. You’re going to get that similar benefit within a fund. You still have instant access when investing in funds that are doing the same thing as you would do if you bought a fixed rate deposit yourself as a treasurer.
The other big benefit of a fund versus fixed rate deposits is diversification; you are not nailing your flag to the mast of one or two banks. We also seek to build more security into our cash portfolio.
What features in short term fixed income funds or longer term liquidity strategies should treasurers look for in order to get comfort their cash is safe?
At Royal London Asset Management, we make quite large use of covered bonds. They give you a return that’s re-fixed every day, in line with the bank overnight rate (SONIA). Those assets are regulated, and they’re exempt from the bail-in process. They have ‘dual recourse’, so you have the option to go to the bank to get repaid first, and if they won’t repay you, then you get access to the cash flow on the assets, which are prime residential mortgages. The loan-to-value ratios on these houses are 60%, so there’s lots of equity in these properties. The cash flows should keep coming in to pay down your interest rate payments, and also to pay down your final maturity. Covered bonds are very liquid in times of crisis as well.
Should local authorities be considering short dated bond funds?
Bond markets have anticipated interest rates falling, and the yield on those markets has declined because of that future interest rate expectation. When you look at the short dated assets, they’re not going to move until they actually see interest rates fall. You can get a lot of good assets that are yielding anywhere between 5% up to 6% in that space, but with bonds you’re having to take a lot lower yield in a fund on the premise that you’re going to get capital gains from yields falling further.
What are the key considerations and risks for local authorities as they look to ladder their cash and begin re-investing in longer dated instruments?
Although yields are significantly higher on these funds now than where they were before we saw interest rate rises, markets are still volatile, and therefore you need to make sure that your time horizon is appropriate for the fund that you’re choosing. Our RL Short Term Money Market Fund aims to cover daily and weekly cash requirements for treasurers. The next fund in our range, the RL Short Term Fixed Income Fund, has more of a medium term investment horizon – aimed at clients that are investing for six months or longer. Lastly, the RL Short Term Fixed Income Enhanced Fund has a longer term investment horizon of a year or longer. It is important treasurers look to ladder appropriately, and only put the money into those longer dated funds that you’re not going to need for a longer period of time.
What are the main ESG consideration for treasurers when looking at funds?
All our funds have exclusions on them, such as tobacco, arms and fossil fuel. We don’t invest in any issuer that generates more than 10% of revenue from those streams.
When you think about the financial marketplace, governance is important. The liquidity of your fund diminishes as soon as you get a negative ESG event. When we build our portfolios, we look at the ESG as a risk score. If the risk is high, we only hold those instruments with very short maturities. For firms that have a very low ESG risk, we’re happy to own longer dated assets. It’s all about liquidity management, and the probability of ESG risks occurring.
The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested.
For further information on Royal London Asset Management and their range of liquidity investment solutions please visit www.rlam.com
For Professional Clients only, not suitable for Retail Clients.
This is a financial promotion and is not investment advice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change.
Issued in November 2024 by Royal London Asset Management Limited, 80 Fenchurch Street, London, EC3M 4BY. Authorised and regulated by the Financial Conduct Authority, firm reference number 141665. A subsidiary of The Royal London Mutual Insurance Society Limited.
The RL Short Term Money Market Fund, the RL Short Term Fixed Income Fund and the RL Short Term Fixed Income Enhanced Fund are sub-funds of Royal London Bond Funds ICVC, an open-ended investment company with variable capital with segregated liability between sub-funds, incorporated in England and Wales under registered number IC000797. The Company is a UCITS umbrella fund. The Authorised Corporate Director (ACD) is Royal London Unit Trust Managers Limited, authorised and regulated by the Financial Conduct Authority, with firm reference number 144037. For more information on the fund or the risks of investing, please refer to the Prospectus or Key Investor Information Document (KIID), available via the relevant Fund Information page on www.rlam.com
