Ultra-Short Obligation Funds Take in Net New Money at a Record Setting Pace

Lipper’s Ultra-Short Obligation Funds (USO) peer group continued to experience positive net flows with the yield curve and interest rate risk being contributing factors. Funds in the USO classification have had net inflows for 39 straight weeks which have grown its coffers by $36.6 billion. This run brings the group’s year to date net inflows to +$54.4 billion, which more than doubles their next largest annual net positive flow of +$24.7 billion during 2017. The volume of the net inflows have intensified since Q2 with the fourteen largest weekly net inflows in the group’s history (Lipper tracks this data back to 1992) occurring since July of this year, with the largest being the +$2.5 billion for the fund-flows week ended November 21, 2018. Of note, the only consecutive net inflow streak for USO funds that was longer than the current one occurred from August 2006 through July 2007 (50 weeks). While longer in duration the previous streak was less intense as it took in only +$5.6 billion total compared to the current +$36.6 billion.

The two-/ten-year spread on the yield curve narrowed to its slimmest margin (12 basis points as of the close on December 6) since June 2007. The yield curve has been tightening for over seven quarters or ever since the two-/ten-year spread hit its recent peak of 1.25% at the end of 2016. Shorter-tem maturity investment grade debt becomes more attractive as spreads narrow because investors can receive a return similar to the longer-dated maturities but with substantially less risk. The current spread does bring up the concern of yield curve inversion, which is when shorter-term maturities yield more than longer-term. An inverted yield curve is a potential problem because it has been a reliable predictor of past recessions. Interest-rate risk has also been a contributing factor to the current streak of net inflows for USO funds. 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 Federal Reserve has raised interest rates eight times since it moved to a more restrictive monetary policy starting in December 2015 with one more rate hike forecast for 2018 and three more in 2019. There has been some speculation as of late that the Fed may take their foot off the pedal so it bears watching as to if the forecasts come true.

Within the USO group the largest net inflows at the fund level during the current streak belong to Lord Abbett Ultra Short Bond Fund (+$9.2 billion), Putnam Short Duration Income Fund (+$5.8 billion), and iShares Floating Rate Bond ETF (FLOT, +$5.0 billion).