Why an increase in interest rate yield for cash management accounts isn’t always a good thing for investors
In a recent update of interest rate changes projected by cash management accounts in Singapore, we observed that almost all major cash management accounts offered by financial institutions and robo-advisors in Singapore have recently increase.
This is no surprise. Thanks to the US Federal Reserve raising its benchmark interest rates, interest rates in the financial sector have also risen. This, in turn, means that borrowing has become more expensive while lending rates are more attractive. As a result, the money market funds and short-term bond funds that cash management accounts invest in now offer higher rates.
One might think that rising interest rates are good for investors. After all, higher yields are definitely better than lower yields, right?
Not necessarily. Let’s explain.
Interest rates projected by cash management accounts are not the same as interest rates offered by bank deposits
Whether it’s cash management accounts or bank deposits, the main reason many of us put our money in these accounts is usually the same: to earn higher interest on our excess savings than we do not intend to use in the short term.
However, unlike high-interest savings accounts, where banks are obligated to give you the interest rate they advertise and protect your savings, the same is not true for cash management accounts. .
For cash management accounts, it is the money market funds and short-term bond funds that cash management accounts invest their money in that give us the returns we get. The advertised interest rates shown in the cash management accounts are only a projection, not the actual returns we earn. Like any investment, the actual returns we get may go up or down in value, depending on market conditions.
This implies that the advertised projected return is a function of how the cash management account is constructed.
Using Endowus Cash Smart as an example. Even within Endowus itself, we can see that the company offers three different cash management account portfolios designed to meet the risk tolerance and cash management needs of individual investors.
Endowus Secure currently gives a projected return of between 1.5% and 1.6%, while the higher risk portfolios, Enhanced and Ultra, give us a projected return of between 2.3% to 2.6% and 2 .9% to 3.3% respectively. However, we cannot say that Ultra is better than Secure. Different levels of risk affect returns and what is best for individual investors will depend on their preferences.
There are overlaps between the three wallets when we look at how each is constructed.
The LionGlobal SGD Enhanced Liquidity is an underlying fund that is part of the three portfolios. Thus, its performance will affect all three portfolios, although to varying degrees, since the three portfolios are constructed differently.
Ironically, the fund – LionGlobal SGD Enhanced Liquidity – is also an underlying fund in many other cash management accounts today. These include FSMOne Auto Swipe Account, Stashaway Simple and Syfe Cash+.
Remember that it is the fund and other similar funds that are invested in that give us our performance, not the robo-advisors.
Changing the structure of cash management accounts can alter projected returns
In addition to underlying funds offering higher returns, changing the way cash management accounts are constructed can also change projected returns.
As Endowus Cash Smart already shows, different wallets can give different returns. A company can increase the returns of its cash management account by changing the underlying funds in its portfolio.
To my knowledge, at least two robo-advisors – Syfe and Stashaway, changed the structure of their cash management accounts earlier this year. Syfe removed one of its underlying funds – Lion Global Short Duration Bond Fund, which previously comprised 35% of the portfolio at 0%.
Stashaway also recently reallocated its portfolio to Stashaway Simple.
The reason, as Stashaway explains in this article, is simple.
“As you may have seen with our recent updates to Simple’s projected rate, the current rising rate environment has benefited both the underlying funds, LionGlobal SGD Enhanced Liquidity I Acc (LGI ELF ) and LionGlobal SGD Money Market Fund Class A (LGI MMF).However, LGI ELF has a higher yield than LGI MMF, so by having more exposure to ELF you get a better yield for Simple.”
The company, to its credit, also explained what this means for its wallet.
“LGI ELF’s higher yield comes with a longer duration (meaning it’s more sensitive to changes in interest rates) and higher credit risk than LGI MMF, because LGI ELF is more exposed to corporate bonds. So does that mean you have to worry about the higher risks? The short answer is no. We did our due diligence on LGI ELF and based our decision on the following”
By changing the portfolio allocation, the projected returns are now higher. But it’s not necessarily a free lunch for investors. For better or for worse, we get a (slightly) different product.
Coincidentally (or maybe not), Stashaway Simple and Syfe Cash+ now offer the same underlying funds and weighting in their portfolios. Both currently have a projected return of 1.5%.
Projected returns may also increase if the underlying value of the funds has fallen
Last, but not least, we must remember that, like traditional equities and fixed income securities, money market and short-term funds can fluctuate and lose value, especially when interest rates of the market increase unexpectedly.
As shared by Endowus in its performance review, Cash Smart Enhanced and Cash Smart Ultra returned -0.81% and -1.69 respectively in 1Q2022. This means that the underlying funds in these portfolios must have declined in value during this period.
As explained by Endowus.
“Endowus Cash Smart Enhanced The portfolio ended the second quarter flat, while the Endowus Cash Smart Ultra Portfolio posted a negative return of -1.0%. The allocations of the Cash Smart Enhanced and Cash Smart Ultra portfolios to bonds and other short-term fixed income instruments subjected these portfolios to mark-to-market adjustments in the fixed income markets. They were also affected by the unprecedented speed at which interest rates rose, which triggered a revaluation of bonds.
Despite the shorter duration and damped performance allocation of the LionGlobal Enhanced Liquidity Fund, which anchors most of our Cash Smart solutions, the remaining allocations of the Cash Smart Enhanced and Cash Smart Ultra portfolios were negatively impacted by the rise in interest rates and high inflation. Additionally, exposures to the Asian credit market detracted from performance as this market continues to be challenged.
All other things being equal, this decline also means that the projected return in the future will increase. For new investors, coming at a lower price means having a higher projected return.
For existing investors, this is not so attractive because they would have already lost value in their cash management accounts. So even though the projected return is now higher and the funds should eventually rally in the medium term as long as there is no default, these investors would have already been through a period of low/negative return.
For investors who intend to invest in cash management accounts, we strongly suggest that you not only look at the projected return that a portfolio offers, but also at past track records. Remember that higher returns are not necessarily better, and higher projected returns may come with higher risks.
Read also : Complete Guide to Cash Management Accounts in Singapore
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