Looking for an alternative to Money Market Funds? Check out this ultra-short fund from HSBC!

• We continue to recommend short-duration products, primarily due to the prevailing inverted yield curve environment.
• Floating rate instruments can also serve as short-duration alternatives, given the use of daily reference rates embedded in their coupon calculations.
• The HGIF Ultra Short Duration Bond Fund primarily uses floating rate instruments to keep its duration exposure light, while maintaining a high average credit quality.
• Risk-averse investors who are willing to take a small amount of extra risks while looking for a small yield pickup over traditional money market funds can consider this HSBC fund!

We generally continue to recommend shorter-duration fixed income products, based on our expectations for higher-for-longer interest rates as well as some normalisation of the yield curve (currently still inverted). The inverted yield curve, particularly for USTs, also points towards the highest levels of nominal yields being found only at the shortest tenors, especially those under 6 months (Chart 1).

Related article: All you (bond investors) need to know after a Trump election and a Fed cut last week

Some of our recommendations over 2024 have included short-duration bond funds and money market funds. In this article, we take a deeper dive into the HGIF Ultra Short Duration Bond Fund, available with monthly-distributing share classes in USD and SGD. We think this fund should be a strong consideration for investors looking to achieve a yield enhancement over traditional money market funds while maintaining a low-risk profile.

Chart 1: Yield curve remains deeply inverted, highest nominal yields at the shortest tenors

About floating rate instruments

Before we dive into the fund, we briefly summarise what floating-rate instruments entail, given that a large part of the fund’s holdings (57% as of 30 September 2024) are in floating-rate instruments.

Floating-rate instruments have a different coupon structure compared to fixed-rate instruments. While actual coupon payments (i.e. cash payments given to bondholders) are paid quarterly, the exact coupon percentage will typically be calculated based on a daily basis (e.g. using an average of reference rates across the period), followed by the addition of a pre-determined spread. Since the calculated coupon will adjust alongside market reference rates, this reduces the mark-to-market price impact. Hence, floating-rate instruments usually have low duration profiles with little price sensitivity to benchmark rate fluctuations.

However, the performance of such instruments will still be susceptible to changes in credit spreads. These floating rate instruments (especially those held by the fund) are typically issued by corporates, which will come with their respective credit profiles. If markets judge that a company’s credit profile has weakened, its bond prices could decline even if benchmark rates and coupons remain unchanged. This makes the HSBC fund’s approach of selecting high-quality credits important, as these credits and issuers will be less likely to suffer from widening spreads.

We summarise the two points above floating rate instruments usually have (i) less sensitivity to benchmark rate fluctuations, but (ii) will still be affected by changes in credit spreads. This is clear if we compare two similar indices which focus on investment-grade USD-denominated bonds: Bloomberg US Corporate 0-5 Year Index, and Bloomberg US FRN < 5 Years Index (Chart 2).

• In 1Q20, both indices dropped by similar extents in 1Q20 (COVID) due to widening corporate IG spreads. Both indices also declined similarly in 2008 (GFC) due to widening spreads even though we excluded this from the chart for clarity.
• In the following Fed hike cycle (which started in early 2022), the FRN Index saw a much more stable performance compared to the US Corporate Index’s declines. This showcases the former’s significantly lesser duration exposure.

(Note: The former Bloomberg US Corporate Index only includes fixed-rate bonds, while the latter Bloomberg US FRN Index refers to an index of only floating-rate notes (FRNs), which have maturities of 4.999 years and under.)

Chart 2: FRN Index has been more resilient to a rising-rates environment, but is still affected by widening spreads

Fund objective

The HGIF Ultra Short Duration Bond Fund aims to achieve a combination of short-term capital growth and income by investing in bonds and money market instruments. The target level of distributions from its PM2 share classes is not fixed at a specific number; instead, it will depend on the underlying portfolio yield as HSBC seeks to make distributions sustainable.

The fund – in line with the ‘ultra short’ in its name - targets an effective duration of up to 0.5 years, with a duration typically ranging from 0.3 years to 0.5 years. We note that it does not have restrictions on its maturity, which could go well over 0.5 years due to the substantial use of floating rate instruments. However, investors should rest assured that the portfolio’s duration will generally remain low, and we do not expect major NAV moves arising from fluctuating benchmark rates.

The fund also maintains a high-quality tilt. Bonds must be investment-grade rated at the time of purchase, and the fund will maintain an average rating of at least A-. In terms of currency, it will primarily invest in USD returns, though it is allowed to invest in non-USD bonds with a full hedge back to USD; the fund managers have shared that the latter helps to add a few basis points of yield to the fund.

Latest portfolio metrics (Oct 2024)

(Data below as of 31 October 2024 [factsheet] unless otherwise stated.)

The fund maintains a well-diversified portfolio of 791 holdings (excluding cash), including around 300 issuers. The fund’s geographical exposure is well-diversified - while the US accounts for 55% of the fund’s allocation, this is fairly typical of the broader bonds universe (Chart 3). Sectorally, the fund’s largest allocation is into banking (42%), though this is again mostly a function of the bonds universe, as banking companies are typically the largest issuers of short-term paper (Chart 4).

(Note: While the fund’s geographical allocation is just 55% to the US, its FX exposure was 99.8% to the USD as of 31 October 2024, in line with its FX mandate stated above.)

In addition, its portfolio remains high in credit quality, with a majority of its holdings rated investment-grade – this is expected considering the fund’s mandate and objective highlighted above. For instance, its largest allocation is to credits rated A (44%), with only a very small allocation to unrated securities (0.02%) (Chart 5), suggesting its average credit rating likely lies around the A region. We think this commitment to maintaining a high (average) credit quality is clear and underscores the fund’s suitability for more risk-averse investors.

The fund’s latest duration (option-adjusted) was reported at 0.49 years, while the average maturity of its holdings was 1.50 years. We think the large discrepancy between the duration and maturity could be due to the fund’s large allocation to floating-rate instruments (see section above on such floating-rate instruments), whose eventual yields may be very closely tied to short-term rates (e.g. overnight SOFR). For us, duration is generally our key focus – with its light duration profile (0.5 years), the fund should continue exhibiting limited sensitivity to benchmark rate fluctuations, resulting in smaller price or mark-to-market movements.

Finally, we look at the fund’s top 10 holdings to get a more concrete sense of what the fund primarily invests in (Table 1). Some of the themes highlighted above can be observed from these top holdings including (i) a large allocation to US and Financials names; (ii) a fairly high credit rating; and (iii) a large allocation to floating-rate instruments.

Summarising the above, we think investors in this HSBC fund can expect a well-diversified portfolio with fairly small credit and interest rate risks.

Chart 3: Over 50% of the fund is invested in US fixed income

Chart 4: Fund’s largest allocation is to banking names

Chart 5: Fund remains high in credit quality

Table 1: Top 10 holdings of the fund

HSBC fund’s track record and peer comparison

We see this HSBC fund as a decent alternative to traditional money market funds, though it is technically not a money market fund itself. While both generally have very short duration profiles, the key difference lies in credit spreads – the HSBC fund takes on a little more spread-related risks with the potential upside of delivering stronger yields.

The fund has delivered a decent performance since its inception in 2021 (Chart 6). The chart shows that the fund has delivered stable and positive performances over time, about 13% so far (as of 5 Dec) translating to annualised returns of around 3.7%. In addition, it has managed to deliver slightly improved returns over a composite of money market funds we have selected (which returned closer to 12% non-annualised or 3.3% annualised).

However, we also highlight that the HSBC fund will technically be more ‘risky’ compared to traditional money market funds. We observe in Chart 6 that the HSBC fund saw negative performances in mid-2022, though this was limited and did not even cross -1%. In contrast, the money market funds we have highlighted in our previous articles typically see even lower drawdowns (less than 0.2%). We provide some summary metrics for the HSBC funds and some peers below, which underscores our point that (i) the HSBC fund has managed to deliver some performance uplifts over traditional money market funds; but (ii) this has come with slightly higher but still-manageable volatility (Table 2).

Looking ahead, we can estimate the net yields of the HSBC fund using its stated indicative yield-to-worst and its expense ratio. We estimate its net yields at around 4.99% (as of 31 October), just slightly higher than its money market fund peers on our platform which are generally around the 4.5% area. Once again, this highlights the potential for this HSBC fund to potentially deliver enhanced yields compared to traditional money market funds.

Chart 6: Performance comparison (HSBC against MMF peers)

Table 2: Fund metrics against peers

Who should consider this HSBC fund?

We think this HSBC fund is suited for investors who are looking for a potentially higher-yielding alternative to traditional money market funds. Higher potential yields do come with slightly higher volatility and credit risks, however, though we think these remain manageable, especially considering its track record and its overall portfolio positioning towards only high-quality credits.

This fund is available in two share classes: HGIF – Ultra Short Duration Bond PM2 USD, and HGIF – Ultra Short Duration Bond PM3H SGD. Both are distributing share classes: the former offers a monthly distribution last reported at 5.45% annualised in USD terms, while the latter also offers a monthly distribution last reported at 3.51% annualised in SGD terms.

Declaration: For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) hold a NIL position in the abovementioned securities.