BIL: With Interest Rates Declining, Consider Pairing Back Cash And T-Bills

seekingalpha10-23

T-bills have been outperforming due to Fed rate hikes but will likely underperform as rates decline, making them less attractive than most bonds.Investors overweight cash should consider pairing back ...

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With the Fed finally cutting rates, t-bill yields will decline, and outperformance will likely cease. Although t-bills and other cash instruments will always have a place in an investor's portfolio, these developments do decrease their attractiveness compared to most bonds. As such, investors should consider reducing or replacing their cash investments, especially those overweight on cash. I'll be focusing on the SPDR® Bloomberg 1-3 Month T-Bill ETF (NYSEARCA:BIL) for the remainder of this article, but everything here should apply to other t-bill ETFs, and to the asset class itself. BIL - Quick Overview and Investment Thesis BIL invests in t-bills, securities backed by the full faith and credit of the U.S. Federal Government, the largest, most credit-worthy institution in the world. T-bills have effectively zero credit risk, seeing zero losses during downturns and recessions, compared to significant losses for riskier high-yield bonds and equities. BIL was not impacted by the pandemic, compared to double-digit drawdowns for these asset classes. Data by YCharts Federal Reserve hikes have led to sharply higher interest rates across bonds and fixed-income securities. Short-term and variable rate investments have seen particularly big impacts, including t-bills. BIL itself yields more than treasuries and most investment-grade bonds, less than high-yield bonds. Data by YCharts BIL has outperformed since early 2022, as hikes led to lower prices for most bonds. T-bills were not impacted, as these are ultra-short-term securities. Data by YCharts BIL's above-average dividend yield also played a role in the above, although a smaller one. As an example, BIL has outperformed most bonds YTD even though the Fed has cut rates, partly due to its higher yield (sentiment and expectations also played a role). Data by YCharts T-bills are a comparatively high-yield, low-risk investment opportunity right now, but that won't be the case for long. Federal Reserve cuts will lead to lower t-bill rates, with the Fed already cutting rates 0.50%. A 0.50% decrease in t-bill rates is a given, with more cuts / decreases almost certain. The exact magnitude is, of course, not certain, but the trend definitely is. Current Federal Reserve guidance implies the following t-bill rates: JPMorgan Guide to the Markets As can be seen above, the Fed is guiding for another 0.5% in cuts this year, another 1.0% next year, and 0.5% thereafter. Assuming guidance holds true, t-bill rates should decline below those of investment-grade bonds in early 2025, and 10-year treasuries in mid-2025. Data by YCharts In my opinion, and considering recent Fed cuts, guidance, and current market conditions, t-bill yields will almost certainly decline below those of most bonds in the coming years. The specifics are subject to change, and I could imagine yields above average for a year or two, but not much longer. Conditions are such for that to happen, and it would take a significant Fed pivot for this to change. Due to the above, t-bills should underperform most bonds in the medium and long term moving forward. BIL itself has underperformed since its inception, as expected. T-bills outperforming is uncommon, and the situation should normalize in the coming months. Data by YCharts Many investors chose to overweight cash, t-bills, and similar investments in prior years, as economic conditions seemed (and were) favorable to these. Said decision was proven right, with t-bills and the like outperforming these past few years. Economic conditions are turning less favorable, so investors should consider selling or pairing back their cash or t-bill holdings. Some cash always makes sense, but being overweight cash does not, in my opinion at least. With the above in mind, let's take a look at some possible replacements for cash, t-bills, and BIL. BIL - Replacements The Janus Henderson AAA CLO ETF (JAAA) could be a fantastic replacement for BIL. JAAA focuses on AAA-rated CLOs, with negligible credit and rate risk, and significantly below-average volatility. JAAA almost always trades with a 1.0% - 1.5% spread to BIL, right now sporting a 6.4% dividend yield, 1.2% higher than BIL. Data by YCharts Returns have been much higher too, if a bit more volatile (still much less than average though). Data by YCharts JAAA's 1.2% spread to t-bills should remain the same magnitude as the Fed cuts rates. The importance of said spread should increase though and might make all the difference if rates plummet. Cuts of 5.0% would leave t-bills yielding effectively zero, but JAAA would maintain a 1.2% yield, providing some income to shareholders. As an example, JAAA delivered 2.2% from mid-2020 to early 2022, compared to negative 0.1% for BIL. JAAA delivered some income even though rates were at zero, BIL delivered less than nothing. Data by YCharts JAAA's higher dividend yield and broadly similar characteristics make it a suitable replacement for BIL. Notwithstanding the above, JAAA suffers from many of the same issues as BIL, as the funds are very similar (effectively zero credit and rate risk, directly exposed to Fed rates). Going for funds with a little bit more credit risk and duration seems better, as these have higher, more sustainable yields. I've covered four particularly strong replacement ETFs these past few months, the key table is as follows: Seeking Alpha - Table by Author Of the ETFs above, the JPMorgan Income ETF (JPIE) is closest to BIL, with a duration of 3.0 years, and with the fund focusing on investment-grade / AAA-rated securities. JPIE has underperformed BIL since its inception: Data by YCharts But outperformed YTD: Data by YCharts In my opinion, JPIE will continue to outperform relative to t-bills moving forward, as the interest rates on the latter decrease due to Fed cuts. JPIE is closest to BIL, but the Angel Oak Income ETF (CARY) is my top choice. It has broadly similar characteristics to JPIE, but with a slightly higher 6.6% yield, but greater risk and volatility. Returns have been marginally higher since inception, comfortably so YTD. Data by YCharts Besides JPIE and CARY, the Capital Group U.S. Multi-Sector Income ETF (CGMS) and the iShares Flexible Income Active ETF (BINC) are also solid choices. Do bear in mind that there are lots of even higher-yielding funds than the four above, but these are all comparatively safe, low-volatility choices, and more suitable replacements for BIL than most. Conclusion  Federal Reserve cuts will decrease t-bill rates, and lead to declining dividends for BIL. Investors should consider selling or reducing their exposure to this and similar assets. ETFs focusing on shorter-term, high-quality securities seem like particularly suitable alternatives. These include JPIE, CARY, BINC, and CGMS.","kind":"highlight","is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"analysis","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.3","shortVersion":"4.29.3","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2477552826"}