CBIS Announces Changes to RCT Flex Cash Fund and RCT Short Bond Fund
Interest rates reached historically low levels in late 2011 after months of grinding pessimism about global GDP growth, the U.S. debt drama, the EU sovereign debt crisis, and the perceived failure of developed nation governments to grapple with an intransigent set of political and economic challenges. As of November 7, the three-month Treasury yield stood at zero and extension out to two years produced a yield of only 0.23%.
Federal Reserve statements suggest that its zero Fed Funds rate policy is unlikely to change before mid-2013. Deflationary pressures will likely continue to prevail as monetary and fiscal stimulus seem unable to address balance sheet and solvency issues. Concerns about the ability of European banks to access short-term lending, and potential runs on deposits, recently reached levels not seen since mid-2008. And protracted low interest rates and heightened volatility, driven by the uncertainty attendant with this period in financial markets (the likes of which have not been seen since the 1930s) seem likely to persist.
As a result of these market conditions, CBIS is making changes to the RCT Flex Cash and Short Bond Funds' investment strategies effective in late 2011.
RCT Flex Cash Fund
The Flex Cash Fund’s maximum average maturity, which was extended from its 90-day limit to a maximum of 180 to increase the Fund’s yield, will revert to 90 days or less. The yield curve is presently so flat for yields ranging from overnight to three years that maturity extensions provide little additional return. On the other hand, should the Federal Reserve unexpectedly raise the Fed Funds rate earlier than expected, price declines among longer-dated holdings might cause a decline in NAV below $1. While this would be very unlikely, the risk has increased with the decline of money market rates to near zero. We believe it is also prudent to reduce duration risk at this time due to the uncertainty over the European banking crisis and the event risk that affects all short- term financial paper.
RCT Short Bond Fund
We have authorized Longfellow Investment Management, the sub-adviser for the RCT Short Bond Fund, to invest up to 10% of the portfolio in short-maturity bonds rated below investment grade. While this might be perceived as risky, we believe it is a compelling strategy for actually reducing the volatility and duration risk inherent in short-duration bonds. When the Fed once again raises short-term rates, short-maturity bonds are very much at risk as the yield curve is unusually flat for maturities under three years (while historically steep from three years to nearly 30 years, three times the historical average spread). Portfolio yield offsets interest rate risk, thus the addition of higher-yielding securities can dampen some of the risk of rising rates and yield curve re-shaping.
We expect Longfellow to use high-yield bonds opportunistically due to the cyclical nature of credit spreads. Such positions can offer the prospect for price gains as spreads tighten in addition to the benefit of favorable issue selection within the array of high-yield offerings. Longfellow’s relatively small size ($4 billion in assets) permits it to be nimble when acquiring positions sold as larger high-yield investors raise cash to finance purchase of longer, higher-yielding new issues and when buying small “tail” positions that appear attractive.
We continue to believe that the RCT Short Bond Fund can provide valuable yield enhancement for cash pools that do not require immediate liquidity. Although the Fund offers daily withdrawals, the current low level of absolute yields and high degree of daily volatility make it increasingly likely the Fund will experience negative total returns over a quarter or more. Nevertheless, we believe that a positive return is probable over a year or longer.
The extraordinary environment for bond investing that began in the early 1980s when interest rates and inflation began their two-decade-long decline — a period in which cash and bond yields were generous and cash management decisions seemed relatively easy — is a thing of the past. We now must deal with conditions as they exist today in order to continue to be good stewards of your assets. CBIS will focus on providing solutions to not only help you grow your assets, but equally importantly, to help you preserve your assets.
Should you have further questions about these changes, please contact your CBIS Investment Advisor.
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