Looking to put cash to work? ‘High for longer’ rates point to alternatives

Key takeaways:

• Uncertainty around stock vs. bond correlation suggests elevated needs for portfolio diversification and additional sources of return.
• Higher for longer interest rates can structurally benefit ‘cash plus’ alternative strategies, which have historically performed better when cash rates are high.
• Alternative funds have performed better, while providing better diversification compared to past decades.

These are challenging times for advisors with clients looking to put cash to work. The recent ebullience in stocks and uncertainty in both politics and geopolitics might tempt investors to increase exposures to fixed income or stick with cash. But bonds have struggled amid diminishing hopes for aggressive Fed rate cuts; furthermore, elevated stock-bond correlations mean bonds aren’t providing the diversification benefits investors have historically relied upon.

The traditional playbook when dollars come out of cash accounts tends to start with bonds; the short-term bond category in particular was the best-selling category the last time cash came off the sidelines in a big way ($900 billion in 2009). There are lots of good opportunities now in bonds, as detailed in Capture today’s yields with bond ETFs | iShares - BlackRock or Put cash to work with short-term bond ETFs | iShares – BlackRock by my colleague Karen Veraa.

In this unconventional environment, we recommend advisors also think beyond the traditional putting cash to work playbook and consider diversifying risk with nontraditional bonds and alternatives, particularly those that can capitalize on high cash rates.

It may seem counterintuitive, but certain alternative strategies known as “cash plus” tend to perform best when money market yields are higher, as is the case today. These “cash plus” alternative strategies employ futures and options, but only a portion of the original investment needs to be deployed -- the rest sits in cash, currently earning the highest rates in over 15 years. The tailwind of higher cash yields has historically helped alternatives outperform other strategies. (See Figure 1)

Alternative asset classes have historically done better when the return on cash is higher (Figure 1)
Alternative index performance in different cash return environments, median return since 1/1/1994

Source: Morningstar as of 5/31/24. Cash represented by the Taxable Money Market fund category as defined by Morningstar. Hedge Funds are represented by the Credit Suisse Hedge Fund Index, Equity Market Neutral by the Credit Suisse Equity Market Neutral Index, Global Macro by the Credit Suisse Global Macro Index, and Multi-Strategy by the Credit Suisse Multi Strategy Index. Past performance does not guarantee or indicate future results.

Alternatives strategies might be a better play if rates stay higher for longer amid more volatility around their direction. Alternative strategies often exhibit a low correlation to other asset classes and even other alternatives. This is especially important as the path of inflation remains uncertain. If inflation stays higher for longer, the expectation for traditional stock-bond diversification benefits may remain less reliable (currently at record highs, see figure 2), meaning that stocks and bonds may once again decline simultaneously, as occurred in 2022.

3 year rolling correlation of stocks and bonds is now the highest in history (Figure 2)
(1928 – 5/31/24)

Source: Morningstar as of 5/31/24. U.S. stocks are represented by the S&P 500 TR Index from 3/4/57 to 5/31/24 and the IA SBBI U.S. Lrg Stock TR USD Index from 1/1/26 to 3/4/57. U.S. bonds are represented by the IA SBBI US Gov IT Index from 1/1/26 to 1/3/89 and the Bloomberg U.S. Agg Bond TR Index from 1/3/89 to 5/31/24. Past performance does not guarantee or indicate future results. Index performance is for illustrative purposes only. You cannot invest directly in the index.

Alternatives strategies available to investors have improved over the years

For many investors, alternatives might be a new endeavor. Many advisors have been exposed to alternatives over the years, but the experience has been a mixed bag of both performance (or lack thereof) and varied diversification benefits. But there is evidence today that the alternatives strategies available to mutual fund and ETF investors have improved over the years on both fronts (See Figure 3). 

When many of these alternatives became available post the global financial crisis, the firms that brought them to market were very likely better marketers of why alternatives than actual managers of alternative strategies. Today, you see a much broader and deeper bench of alternative strategy managers. Many of these managers have experience in managing these alternative strategies in other vehicles outside of mutual funds or ETFs usually only available to ultra-high net worth investors. This improved competitive landscape and higher for longer interest rates sets up a very favorable environment for investors looking to put cash in alternative strategies.

Alternative mutual funds have seen better performance vs. 20+ years ago while correlation to stocks for alternative mutual funds has declined in recent years. (Figure 3)
Average annual decade-to-date returns as of 5/31/24

Morningstar as of 5/31/24. Alternative mutual funds are represented by the Morningstar broad alternatives category, oldest share class only. Past performance does not guarantee or indicate future results. Index performance is for illustrative purposes only. You cannot invest directly in the index.

The good news is we believe the time is right for investors to reinvest their cash, given the past pattern of what happened to money market yields when the Federal Reserve started cutting rates (The opinions expressed are as of 5/31/2024 and may change as subsequent conditions vary.). The Fed kept rates on hold at its June meeting while reaffirming its forecast for rate cuts at some point in 2024. If recent history is any guide, that may result in a fall in money market yields, setting up outperformance of a well-diversified portfolio including stocks, bonds and alternatives. BlackRock can help you manage risk in today’s markets. Contact your BlackRock representative or explore our online investment tools and resources.

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