Ultrashort bonds still shine despite lower returns

For the last several years, ultrashort bond funds have served as a higher-yielding alternative to money market mutual funds, but the gap in returns has rapidly been closing.

With taxable money funds currently offering yields averaging about 3.4 percent, according to the Money Fund Report, savers and investors who want to keep some liquid cash are enjoying better returns than they’ve seen in a long time. The current average is the highest it’s been since July 2001, when it stood at 3.5 percent.

Short- and ultrashort bond funds are still yielding a little more, but their advantage as a place to invest cash has definitely narrowed from the days when they delivered twice the returns of money market funds, as they did from 2002 to 2004. A quick glance at Fidelity’s offerings shows the company’s cash reserve fund (FDRXX) yielding 3.70 percent, while Fidelity Ultra-Short Bond (FUSFX) yields 4.02 percent and Fidelity Short-Term Bond (FSHBX) delivers 4.29 percent. Both have below-average expenses, an important factor in investments with low returns.

What you decide to do with your cash depends on when you plan to use it, said Scott Berry, an analyst with Morningstar Inc. With the yield landscape changing so rapidly, it makes sense to evaluate all the alternatives. Money market funds hold great appeal because they offer increasingly attractive yields with little to no risk to principal. That said, if you don’t plan to touch your cash for at least a couple years, or if you need a place to stash an emergency fund that you hope never to tap, ultra-short funds still make good sense.

“If you look at performance of money market funds versus ultra-shorts, ultrashorts have really held up well,” Berry said. “They’ve done what they were designed to do: They’ve preserved principal and provided more yield than the money market.”

What definitely doesn’t make sense these days when it comes to fixed income investing is taking on added risk with longer durations. Strange things are afoot in the bond universe when two-year Treasurys and five-year Treasurys deliver almost the same yield – both are hovering just above 4.3 percent, not much above the yields on six-month Treasurys.

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