2 Big Reasons for Ultrashort Bond Funds

Is the asset class the real deal or a flash in the pan?

With ultrashort bond funds, it all depends on the definition of modest.

We don’t cover many of these funds anymore,” said Sarah Bush, senior mutual fund analyst with Morningstar, told ThinkAdvisor recently. "Ultrashorts were yielding too little and got really small, and we just felt we needed to deploy our resources elsewhere.”

But when Bush took a second look, she found a surprise.

“The category has experienced modest inflows really since the beginning of the recovery in 2009,” she explained, adding that this includes the massive bond fund outflows seen in June.

A closer look at Morningstar data reveals modest net flows of $4.4 billion and $2.3 billion in 2010 and 2011, respectively, for corresponding total assets of $35.4 billion and $37.8 billion.

But in 2012 the asset class took off, comparatively, racking up $9.5 billion in net flows and $48.4 billion in total assets. So far, this year looks even better, with $5.4 billion in net flows and $54 billion in assets through July.

So why ultrashorts, and why now? The answer is yield, of course, and interest rates.

In an investing environment where the dual problems of low yield and increasing interest rate risk dominate headlines daily, ultrashort bond funds might be the trick.

“If [investors] have a 10% or 20% allocation to cash because they’re defensive or they’re looking for better entry points into the equity or fixed income markets and they don’t want to earn zero in a money-market fund, then an ultrashort fund makes sense,” says Charles Melchreit, manager of Pioneer Investments Multi-Asset Ultrashort Income Fund (MCFRX).

Another appeal, in particular, is their flexibility.

For instance, Melchreit’s fund, co-managed with Seth Roman and Jonathan Sharkey, is “massively diversified” in that it hits a lot of different levers across a lot of different sectors.

 “I don’t think that’s as unusual now as it once was within this space," he said. "We’re looking to invest in sectors that are not terribly correlated. Most sectors have some correlation, but we’re really trying to take advantage of any imperfect correlations that we can in the short-duration space.”

The fund has a heavy focus on risk management and trying to manage net asset value volatility so it doesn’t experience massive swings.

“The ultrashort world is now using a lot of different sectors in corporates and mortgages and even bank loans, money-market instruments and cat bonds," Melchreit said, "all of which appeal to different investors and present for us as an investment manager different pools of liquidity.”

Meaning if faced with a period of high redemptions, he has a choice of which securities to sell.

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