Last year we recommended ICSH (BATS:ICSH) as a good ETF to consider for investing while waiting for a market correction. We have mixed feelings about the results so far, given that we were right that a market correction was likely, but the ETF’s total return was negative, so it would have been better to just leave the money alone. The reason for this is massive inflation which has driven up short-term interest rates too quickly. The price adjustment of the bonds was greater than the interest they generated, hence the negative return.
As a reminder, ICSH seeks to generate income by investing in a wide range of short-term investment grade fixed and floating rate debt securities denominated in US dollars and money market instruments. However, ICSH is not a money market fund and is actively managed by BlackRock’s cash management team. Its investment objective is to provide current income consistent with the preservation of capital.
Reasons to add a short-term bond fund
For investors worried about a weaker economy and recession risks, ICSH may still be a good place to park cash in our view. There is a risk that interest rates will continue to rise very rapidly, reducing the value of bonds to a point where the ETF could actually continue to generate negative returns, but we would be surprised if this momentum continues until to a point where the ICSH continues to generate negative returns for a long period of time, but that is within the realm of possibility.
In any case, we are seeing a deceleration in the economy, as shown below, GDP now forecasts growth close to 0% for the first quarter of 2022.
The probability of recession according to the Estrella and Mishkin model is still low but not negligible. You really have to worry when the model is > 20%. Above these levels, a recession usually followed.
The biggest problem seems to be rising inflation, which recently hit around 8.5% in the US, and this is what is forcing the FED to hike rates so aggressively. If this continues, other ETFs could outperform ICSH, such as short-term TIP ETFs (VTIP).
During periods of low inflation, ICSH has tended to outperform VTIP, but during periods of high inflation, VTIP is probably a better idea, as seen below. One thing in favor of ICSH is that it is much less volatile, with VTIP the choice of entry point is much more important.
Year-to-date, both have had similar total returns, around -0.4%, but VTIP with much more volatility.
Outperform similar ETFs
Compared to similar ETFs focused on short/ultra-short debt, such as Invesco Ultra Short Duration (GSY), PIMCO Enhanced Short Maturity Active ETF (MINT), iShares Short Maturity Municipal Bond ETF (MEAR) and iShares 0-5 years Investment Grade Corporate Bond (SLQD), ICSH performed much better and provided the least bad total return.
And given the rapid rise in rates, it’s only fitting that ICSH outperformed bond funds with much longer durations by a much wider margin. Below are a few examples, including the inflation-protected TIPS Bond ETF (TIP) which, despite being inflation-protected, suffered due to its very high duration. The popular iShares iBoxx $Investment Grade Corporate Bond ETF (LQD) has performed particularly poorly this year.
The characteristics of the ETF portfolio are presented below, we will place particular emphasis on the average yield to maturity, as we believe this is the best indicator of what a long-term investor in the fund can currently expect as total return when investing in the ETF. .
One of the things we love about ICSH is that it’s transparent about its sustainability and eschews the most controversial industries. The only one where it has a small 0.28% allocation is the oil sands, and we want it to go all the way to 0%. Last time we covered the ETF, the oil sands allocation was 1%, so that’s definitely going in the right direction.
Breakdown of exposures
The ETF has a very high average credit rating, and it has risen since we last covered it. Now only 23% of its bonds are rated BBB, last time it was 31%. At the same time, AA-rated bonds fell from 15% to 24% and AAA to 1.3% from 0.5%.
Morningstar gives ICSH a four-star rating, and that shows it has outperformed its category and index.
BlackRock’s iShares makes it clear that ICSH is not a money market fund and is actively managed by BlackRock’s cash management team. Although we believe the risk of significant permanent capital loss for long-term investors is low, there is a risk as the ETF holds investments with significant risk. Diversification and credit quality mitigate these risks, but it is not zero. There is also interest rate risk and inflation risk when investing in this ETF.
We continue to believe that ICSH is one of the best places to put cash to get a return on that capital without taking on too much risk. Unfortunately, it has recently generated negative total returns due to rapidly rising interest rate expectations, but going forward, we believe it can once again generate positive returns for investors. However, if inflation were to continue to be high for an extended period, investors might instead consider a short-duration TIP bond ETF such as VTIP.