July 20, 2018

Ultra-Short Obligation Funds Record Their Highest Net Inflows Ever in Back-to-Back Weeks

by Patrick Keon.

For the fund-flows weeks ended July 11 and July 18, 2018, the Thomson Reuters Lipper Ultra-Short Obligation Funds (USO) peer group had its two largest net-positive weekly flows (+$1.1 billion and +$1.2 billion, respectively) since Lipper began tracking the data in 1992. These last two weeks represented the continuation of a long-term trend, with the group experiencing 19 straight weeks of net inflows—for a total intake of $11.7 billion. Year to date the USO peer group has had net-positive flows of $23.1 billion, which is just behind the group’s all-time high of annual net inflows (+$24.7 billion) that it set last year. To put the level of this current run of net inflows into perspective: the group’s next highest annual net inflows were $11.3 billion for 2013.

Considering today’s interest-rate environment, it is logical that we’ve seen this spike of investor interest in the USO group. There have been consistent changes to both the level and the shape of the yield curve over the last couple of years that are expected to continue in the foreseeable future. The Federal Reserve has raised interest rates seven times (its most recent being last month) since it moved to a more restrictive monetary policy starting in December 2015. It is believed the Fed will raise rates two more times this year and three times in 2019.

The yield curve has continued to narrow. The two-/ten-year spread tightened for the sixth consecutive quarter in Q2 2018 and closed the quarter at 33 basis points, its flattest level since August 2007. As of July 19 the two-/ten-year spread had shrunk to 24 basis points. In a recent poll conducted by Reuters approximately 65% of bond market experts believe the yield curve will continue to flatten and eventually invert within the next one to two years.  As interest-rate risk increases higher-quality investments with shorter maturities become more attractive. USO funds meet this requirement, since they invest primarily in investment-grade debt with maturities shorter than one year.

The ISO group’s net inflows over the last two weeks have been heavily concentrated, with three products accounting for 65% of the total net-positive flows. The beneficiary of the largest net inflows for the past two weeks has been iShares Short Maturity Bond ETF (NEAR) (+$601 million), while Lord Abbett Ultra Short Bond Fund and Morgan Stanley Inst Ultra-Short Income Portfolio are recipients of $537 million and $347 million net.

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