Ultra-short bond funds appeal to cash and fixed-income investors

With cash yields still hovering near zero — but unlikely to remain there forever — funds that buy ultra-short-term bonds have attracted a following from people with markedly different objectives.

“Investors are looking for more yield than they’ve been getting in constant net asset value (NAV) funds,” said Carol Sullivan, whose Ultra-Short Fixed Income group manages the Northern Ultra-Short Fixed Income Fund and the Northern Tax-Advantaged Ultra-Short Fixed Income Fund. “Meanwhile, investors in longer-term bonds are interested in reducing their risk exposure to the interest-rate hikes that may be on the horizon.”

Sullivan thinks the two Northern ultra-short bond funds could provide relief from those concerns. Both funds buy investment-grade credits that mature within three years for fixed rate and five years for floating-rate bonds, although the target duration of each is actually closer to one year.

Seeking to add income

During a full market cycle, Sullivan estimates that the total return advantage of an ultra-short fund over a traditional money market fund could average about a quarter to half a percentage point per year.

In exchange for taking modest additional interest rate and credit risk, Sullivan believes an ultra-short bond fund may be an appropriate alternative for investing cash with a longer spending horizon.

“An ultra-short bond fund is not a substitute for cash, and it is not the same as cash,” she said. “But it could be a prudent way to put money to work that won’t be needed for a year, yet still belongs in the conservative portion of a portfolio.”

Besides the very short-term nature of the debt obligations, Sullivan said volatility could be dampened by the two Northern Funds’ significant allocations to floating-rate securities, whose yields rise with benchmark interest rates.

Reducing volatility

The rationale is different, but no less compelling, for holders of longer-duration bonds. That group might be willing to take less current yield in exchange for less volatility as interest rates rise.

Importantly, the Northern Tax-Advantaged Ultra-Short Fixed Income Fund is managed to provide tax relief for middle- and high-income taxpayers as well.

“The ultra-short strategy is time-tested,” said Sullivan. “We think it could be a prudent way to put core cash to work for investors willing to take modest additional risk in return for a higher current yield. And equally prudent for bondholders thinking about taking some risk off the table.”

Call it a meeting of the minds.

Past performance is no guarantee of future results.

This Fund is not a money market fund, which maintains a $1.00 NAV, and the Fund’s share price will fluctuate with its returns. An investment in the Fund can result in the loss of principal.

Bond Risk: Bond funds will tend to experience smaller fluctuations in value than stock funds. However, investors in any bond fund should anticipate fluctuations in price, especially for longer-term issues and in environments of rising interest rates.