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Recession risk is rising which often leads investors to allocate more to cash
Summary
We believe now is a great time to review your portfolio’s cash allocation and ensure you are well-placed to take advantage of the rise in yields.
Our Fidelity’s Institutional Liquidity Fund could be the Fund to meet your needs;
- The funds are short term LVNAVs, rated AAAm by S&P and AAA-mf by Moody’s, reflecting the portfolio managers’ conservative philosophy and disciplined approach to risk management.
- With sustainability becoming increasingly important to our investors, the Fund integrates sustainability assessments into the investment process, leveraging Fidelity’s specialist sustainable investing capabilities and is compliant with Article 8 under SFDR.
In a recessionary environment, risky assets are likely to perform poorly, which sees investors seeking safer haven assets such as money market funds. Cash funds become more attractive on the downside given their low credit and rate risk. We expect that the inflation concerns narrative will slowly transition into falling growth and recession fears territory which may eventually lead the Federal Reserve and ECB to hike less than is currently on the cards¹.
Our view is we will see a significant growth slowdown, with inflation starting to fall by year-end. In the third quarter of this year, the market begun to focus less on the stickiness of inflation and slightly more on how central bank tightening will hit economic activity.
In this article we highlight three reasons why now is a good time to review your portfolio’s cash allocation and why our Fidelity’s Institutional Liquidity Fund Plc (ILF) funds2 could fit the bill:
1. Yields are on the rise: our Funds are nimble to respond and pick up higher yields on offer
2. Cash funds provide diversification and our conservative approach can help protect capital in a downturn
3. ESG is often neglected within cash investments but our Funds can play a vital role in assessing risk and adding value. The ILF funds are compliant with Article 8 of SFDR
Risk warning
The value of investments and the income from them can go down as well as up, so clients/you may get back less than the amount invested. Past performance is no reliable indicator for future returns. Returns may increase or decrease as a result of currency fluctuations. The investment policy of these funds mean they invest mainly in other funds or in units in collective investment schemes. The value of shares may be adversely affected by insolvency or other financial difficulties affecting any institution in which the Fund’s cash has been deposited.
Bond investments: These funds invest in bonds whose price is influenced by movements in interest rates, changes in the credit rating of bond issuers, and other factors such as inflation and market dynamics. In general, as interest rates rise the price of a bond will fall. The risk of default is based on the issuer's ability to make interest payments and to repay the loan at maturity. Default risk may, therefore, vary between different government issuers as well as between different corporate issuers.
Corporate bonds: Due to the greater possibility of default an investment in a corporate bond is generally less secure than an investment in government bonds.
Money Market Funds (MMF): A MMF is not a guaranteed investment. Investment in an MMF is different from an investment in deposits. The principal invested may fluctuate, and the risk of loss of the principal is to be borne by the investor. The MMF does not rely on external support for guaranteeing the liquidity of the MMF or stabilising the NAV per share.
ESG: This fund promotes environmental and/or social characteristics. The focus on securities of companies that take sustainability features into account may have a positive or negative impact on performance, even compared to investments that do not have such a focus. The sustainability characteristics of securities may change.
In a risk off scenario, asset correlations that for the most part are negative, such as equity and fixed income or even credit and rates within fixed income, can actually turn positive. This exacerbates portfolio drawdowns and highlights the importance of having an allocation to uncorrelated assets such as cash. A low duration fixed income strategy that invests in short maturity instruments will outperform longer duration portfolios in this scenario and can also help to reduce portfolio volatility³.
1. Yields are on the rise: our Funds are nimble to respond and pick up higher yields on offer
As central banks around the world and the Federal Reserve and ECB have begun hiking rates, money market fund yields have shot up and total returns are back into positive territory again. Yields in US Dollar and Euro markets especially, are back to levels not seen in the last decade or so (see chart below).
Our strategy from here is to be nimble with our weighted average maturity (WAM). It seems like all investors are just waiting like a coiled spring for the Fed pivot when it does arise, but it’s taking longer than expected. We continue to think that terminal pricing has peaked and the snap back in rates could happen at any time, and we want to be on the right side of the trade when that does occur.
" By increasing liquidity and shortening our maturity profile ahead of central bank meetings we can reinvest our cash quickly to pick up the higher yields on offer."
Most importantly, we want to pass these higher yields on to clients as quickly as possible. This has put us in a strong position relative to peers in terms of both yields and total returns.
| Net returns % | 30.11.17-30.11.18 | 30.11.18-30.11.19 | 30.11.19-30.11.20 | 30.11.20-30.11.21 | 30.11.21-30.11.22 |
|---|---|---|---|---|---|
| USD 3 m Libor | 2.2 | 2.4 | 0.8 | 0.2 | 2.0 |
Source: Fidelity International, Bloomberg, 30th November 2022.
| Net returns % | 30.11.17-30.11.18 | 30.11.18-30.11.19 | 30.11.19-30.11.20 | 30.11.20-30.11.21 | 30.11.21-30.11.22 |
|---|---|---|---|---|---|
| 3m Euribor | -0.3 | -0.4 | -0.4 | -0.6 | 0.1 |
Source: Fidelity International, Bloomberg, 30th November 2022.
Fidelity Institutional Liquidity Fund (US Dollar and Euro) - our yields have been very responsive to rising rates
Past performance is no reliable indicator for future returns
Source: Fidelity International, 30th November 2022. 7-day simple, net of fees yield shown.
| Net returns % | 30.11.17-30.11.18 | 30.11.18-30.11.19 | 30.11.19-30.11.20 | 30.11.20-30.11.21 | 30.11.21-30.11.22 |
|---|---|---|---|---|---|
| USD ILF | 1.9 | 2.3 | 0.7 | 0 | 1.3 |
Source: Fidelity International, 30th November 2022.
Past performance is no reliable indicator for future returns
Source: Fidelity International, 30th November 2022. 7-day simple, net of fees yield shown.
| Net returns % | 30.11.17-30.11.18 | 30.11.18-30.11.19 | 30.11.19-30.11.20 | 30.11.20-30.11.21 | 30.11.21-30.11.22 |
|---|---|---|---|---|---|
| EUR ILF | -0.5 | -0.5 | -0.5 | -0.6 | -0.2 |
Source: Fidelity International, 30th November 2022.
Money market funds can extend the term of the paper they hold (out to one year) and therefore take advantage of the higher yields on offer. With a maximum WAM of 60 days, money market funds can invest longer term than overnight cash, so investors get a term premium for those longer term investments. Bank deposit rates are often less responsive to rising interest rates than money markets yields, as banks are less willing to take on more deposits than needed given they are leverage constrained, so we can expect money market yields to be much more attractive relative to bank rates⁴.
2. Cash funds provide diversification and our conservative approach can help protect capital in a downturn
Compared with some of our peers, at Fidelity we tend to prefer a more conservative approach to money market fund management. We focus on high quality developed market issuers and although we have the ability to invest in asset backed securities, we choose not to. During periods of market stress, such as the Global Financial Crisis and recent Covid crisis, this strategy, focussing on liquidity and high quality issuers and instruments has proven credible.
" Focussing on liquidity and high-quality issuers and instruments has proven credible."
In a recessionary environment, default risk rises which makes diversification across issuers more important, especially for depositing cash. A money market fund makes an appropriate choice to reduce potential bank default risk, as it spreads assets across a number of different issuers, regions and instrument types, as our example below suggests.
3. ESG is often neglected within cash investments but our Funds can play a vital role in assessing risk and adding value. The ILF funds are compliant with Article 8 of SFDR
With all this in mind, investors may wonder how sustainability can fit into their cash asset allocation. With a regulatory backdrop that already constrains the universe of money market funds (including liquidity, concentration rules and credit rating constraints), adding lots of negative screens in the form of exclusions can limit diversification potential. The good news is that by integrating ESG into research decisions using our proprietary insights and through engagement, sustainability considerations can play an important role throughout investors’ entire portfolio.
The Fidelity Institutional Liquidity Funds recognise the increasing demand for ESG within money market funds and growing importance placed on sustainability by our clients.
" We believe that sustainable investment makes good business sense and helps to protect and enhance investment returns. In a money market strategy which prioritises capital preservation and liquidity, integrating non-financial risks is even more important, as these can have a material impact on investment performance."
The strategy seeks to integrate ESG issues in its investment and risk monitoring process to help achieve an overall sustainable investment approach. We have implemented additional sustainability requirements for the strategy, in line with Fidelity’s best in class ESG integration framework.
¹ Fidelity Institutional 2022.
² The Euro Fund and the United States Dollar Fund are sub-funds of Fidelity Institutional Liquidity Fund Plc.
³ Fidelity International 2022
⁴ Fidelity International 2022
Important information
This is a marketing communication. This information must not be reproduced or circulated without prior permission. It is intended for professional clients only and not a suitable basis for the general public or private investors.
Fidelity Institutional Liquidity Fund plc (the 'Company') is an open-ended investment company with variable capital organised under the laws of Ireland and is authorised by the Central Bank of Ireland as a UCITS fund under the European Communities (Undertakings for Collective Investment in Transferable Securities) Regulations 2011 (as amended). FIL Investment Management (Luxembourg) S.A. reserves the right to terminate the arrangements made for the marketing of the sub-fund and/ or its shares in accordance with Article 93a of Directive 2009/65/EC and Article 32a of Directive 2011/61/EU. Prior notice of this cessation will be made in Ireland. The Funds are not and will not be offered or sold in the United States, or to or for the account of U.S. persons as defined by U.S. securities laws. Each purchaser of a Fund will be deemed to represent that such purchaser is not a U.S. person, is not receiving the Fund in the United States, and is not acquiring the Fund for the account of a U.S. person except as otherwise authorised by the Directors of the Company. All investments must be made on the basis of the terms set out in the Companyís current prospectus, key investor information document, share purchase agreement form and any other document provided or agreed with the Company, the Manager of the Company or Fidelity International (collectively the 'Documents').
The sub-funds of the Fidelity Institutional Liquidity Fund Plc are low volatility net asset value short-term money market funds. An investment in a money market fund is different from an investment in deposits, as the principal invested in a money market fund is capable of fluctuation. Fidelity’s money market funds do not rely on external support for guaranteeing the liquidity of the money market funds or stabilising the NAV per unit or share. An investment in a money market fund is not guaranteed.
Investments should be made on the basis of the current prospectus (in English) and the Key Investor Information Document (KIID), which is available in German along with the current annual and semi-annual reports free of charge from FIL Investment Services GmbH, Postfach 200237, 60606 Frankfurt/Main or through http://www.fidelity.de.
Fidelity only offers information on products and services and does not provide investment advice based on individual circumstances, other than when specifically stipulated by an appropriately authorised firm, in a formal communication with the client.
Fidelity International refers to the group of companies which form the global investment management organisation that provides information on products and services in designated jurisdictions outside of North America. This communication is not directed at and must not be acted upon by persons inside the United States and is otherwise only directed at persons residing in jurisdictions where the relevant funds are authorised for distribution or where no such authorisation is required. It is your responsibility to ensure that any service, security, investment, fund or product outlined is available in your jurisdiction before any approach is made to Fidelity International.
Unless otherwise stated all products and services are provided by Fidelity International, and all views expressed are those of Fidelity International. Investors should note that the views expressed may no longer be current and may have already been acted upon. Fidelity, Fidelity International, the Fidelity International logo and F symbol are registered trademarks of FIL Limited.
Any performance disclosure is not compliant with German regulations regarding retail clients and must therefore not be handed out to these.
For German Wholesale clients issued by FIL Investment Services GmbH, Kastanienhöhe 1, 61476 Kronberg im Taunus.
For German Institutional clients issued by FIL (Luxembourg) S.A., 2a, rue Albert Borschette BP 2174 L-1021 Luxembourg.
For German Pension clients issued by FIL Finance Services GmbH, Kastanienhöhe 1, 61476 Kronberg im Taunus.
Investors/ potential investors can obtain information on their respective rights regarding complaints and litigation in English here: Complaints handling policy (fidelity.lu) and in German here: Beschwerdemanagement (fidelity.de). The information above includes disclosure requirements of the fund’s management company according to Regulation (EU) 2019/1156.
Unless stated differently, information dated as of 30.11.2022.
MK14688
