Many investors are moving toward short-term investments, particularly ultra-short bond funds, as concerns grow about a potential equity market downturn and the reduced diversification benefits of long-term bonds in current market conditions.
The S&P 500 has delivered strong returns over the past decade, driven in recent years by major technology companies and the artificial intelligence boom. However, some investors are becoming increasingly cautious after the extended market rally.
“Investors have enjoyed one of the strongest equity markets in history, and they’re starting to get worried about downside risk,” said Christopher Coolidge, chief investment officer at Brookwood Investment Group.
As investors seek alternatives, traditional bank deposits are offering low yields, while long-term bonds have struggled amid uncertainty around interest rates. Short-term investments are gaining attention because they provide income potential with less exposure to interest rate volatility.
More Investors Are Moving Toward Cash-Like Investments
Some financial professionals have increased allocations to cash-like investments within client portfolios. Brookwood Investment Group’s model portfolios, for example, typically held around 5% cash, up from about 2% in June.
The firm uses a combination of ultra-short ETFs that include Treasury exposure, floating-rate securities, actively managed credit strategies and option-enhanced income approaches. Clients can also choose to allocate a larger portion of their portfolios to the ultra-short basket depending on their preferences.
Cyrus Amini, chief investment officer at Hyphen Wealth Management, also uses short-duration bond funds and money market funds for liquidity, saying he does not see a need to take additional duration risk in the current environment.
Why Ultra-Short Bond Funds Are Gaining Popularity
Ultra-short bond funds invest primarily in fixed-income securities with maturities generally under one year. These may include government bonds, investment-grade corporate debt, asset-backed securities and commercial paper.
While many investors traditionally turn to bonds during periods of equity market uncertainty, long-term bonds have faced challenges from inflation concerns, geopolitical risks and uncertainty around future Federal Reserve policy.
Ultra-short bond ETFs received $12.8 billion in inflows in July, according to Morningstar Direct. Financial strategists say these funds can provide higher yields than money market ETFs or mutual funds while adding only slightly more risk.
Christopher Coolidge said ultra-short funds can provide between 75 and 110 basis points of additional yield over money market ETFs with similar duration and interest rate sensitivity.
Some of the ultra-short bond funds highlighted among leading options include the Baird Ultra Short Bond Fund and the JPMorgan Ultra-Short Income ETF, according to Morningstar.
Money Market Funds Offer an Alternative
For investors looking to avoid interest rate risk entirely, money market ETFs and mutual funds remain another option. These investments generally provide liquidity while reducing exposure to changes in bond prices.
Money market ETFs are a relatively new category, with the first products launching in 2024. By the end of July, assets across nine U.S. money market ETFs totaled $24 billion, compared with $7.7 trillion held in money market mutual funds.
Money market ETFs recorded $18.7 billion in net inflows from January through July, compared with $2.8 billion for money market mutual funds during the same period.
The largest money market ETF is the ProShares GENIUS Money Market ETF, which held $17.4 billion in assets at the end of July, according to Morningstar Direct.
Rebalancing After Strong Stock Market Gains
The strong performance of equities has caused some investors’ portfolios to move away from their original target allocations. Financial advisors say this may be an opportunity to rebalance and reduce risk.
Amini said investors may consider moving some gains from equities into short-duration fixed income or money market funds, particularly if their financial goals or timelines have changed.
For example, money needed for a near-term goal such as a home down payment should generally not be exposed to stock market volatility, according to Mike Bisaro, president and chief executive at StraightLine.
He noted that ultra-short bond funds and money market funds can help investors preserve purchasing power better than low-yield bank accounts.
Investors Should Avoid Moving Entirely to Cash
Although demand for safer investments has increased, the overall share of assets held in money market funds has remained relatively stable in recent years.
According to Morningstar data, at the end of June around 64% of assets were held in stock funds, 18% in bond funds and 17.5% in money markets.
Financial professionals caution investors against moving completely out of equities. The right allocation depends on factors such as age, financial goals, assets, liabilities and risk tolerance.
“The problem with going completely to cash is that you’ve introduced the element of timing to your portfolio,” Bisaro said, noting that investors may struggle to determine when to return to the market.
