Why You May Wish to Consider
Ultra-Short Bond Strategies
for Your Clients’ Portfolios
EXECUTIVE SUMMARY
This paper details why financial advisors and their clients should consider ultra-short bond
strategies in today’s market climate:
The current regulatory environment surrounding money market funds is uncertain.
The federal government’s Transaction Account Guarantee (TAG) program has expired and
regulators are under pressure to implement new money market reforms.
A relatively conservative diversification tool. Ultra-short bonds have demonstrated
consistently low volatility versus stocks, commodities and longer-term bonds, delivering
only relatively negative returns even in the most challenging periods, such as the years
of the financial crisis and Great Recession of 2008 - 2009.
Defensive duration exposure. Ultra-short bonds have generally offered more price
protection than longer-term bonds in rising interest rate environments, which may be an
important factor to consider given that the current interest rates are at historic lows.
Exhibit 1: The Potential Risk vs. Potential Return of Various Asset Classes
Higher Potential
Potential Returns
Other Specialty Investments
International Equities
U.S. Large Cap Equities
U.S. Intermediate-Term Bonds
Municipals
U.S. Treasury Bills
Commodities
U.S. Small Cap Equities
U.S. High Yield Bonds
10-Year U.S. Treasury Bonds
Ultra-Short Bonds
Money Market Funds
Lower Potential
Potential Risk
Source: RidgeWorth Investments, as of 2/13/2013
The assertions in this whitepaper are based on RidgeWorth’s opinion. Performance information regarding ultra-short bond
strategies reflect historical data and may not be predictive of future performance.
Cash equivalents such as money market funds generally offer lower risk and lower return potential. Bonds offer a relatively stable
level of income, although bond prices will fluctuate providing the potential for principal gain or loss. Intermediate-term, higher
quality bonds generally offer less risk than longer term bonds and a lower rate of return. Generally, a fixed income securities will
decrease in value if interest rates rise and vice versa. Stocks are more volatile and carry more risk and return potential than other
forms of investments.
CONSIDER ULTRA-SHORT BOND STRATEGIES FOR YOUR CLIENTS’ PORTFOLIOS
MARCH 2013
THE CURRENT REGULATORY ENVIRONMENT
FOR MONEY MARKET FUNDS
December 31, 2012 marked the conclusion of the federal government’s TAG program. Congress
launched the program during the financial crisis to provide banking system liquidity. Prior to TAG,
the Federal Deposit Insurance Corporation (FDIC) guaranteed deposit accounts up to $100,000. TAG
altered this coverage by providing unlimited insurance protection on non-interest-bearing deposit
accounts. By year-end 2012, assets in such accounts totaled nearly $1.5 trillion. Now, absent
the unlimited government guarantee (combined deposits in interest- and non-interest-bearing
accounts up to $250,000 remain FDIC insured) and negligible rates, such accounts offer little
incentive for holders of large cash deposits, who may consider other alternatives, including money
market funds.
But, money market funds come with their own set of challenges. The federal government’s Financial
Stability Oversight Council (FSOC) is encouraging the Securities and Exchange Commission (SEC)
to implement money market reforms aimed at stemming any potential “run on funds.” Although
the SEC has not yet outlined its version of the specific industry reforms, a measure it is likely to
propose is floating net asset values (NAVs) for money market funds. In fact, the floating NAV is
one of the suggested options in the current FSOC reform proposal of November 13, 2012. Other
suggested options include potential capital buffers and liquidity restrictions. Comment letters on
the recommended reforms are currently being reviewed by FSOC. It is likely that the SEC proposal, if
one comes out, will be similar to the FSOC proposal.
Money market funds face
an uncertain regulatory
environment, with possible
industry reforms proposed.
One of the features setting a money market fund apart from other types of mutual funds is its
commitment to safety of principal by seeking a stable NAV of $1. Converting to a floating NAV
standard would eliminate that safety element and make money market funds slightly more risky
than they are today.
Despite the extremely low yields currently available on money market funds, along with the likely
ramifications of new money market reforms, investors with immediate cash needs may wish to
continue to hold cash and cash-equivalent vehicles such money market funds.
Those investors with more intermediate liquidity needs may want to move out on the risk/return
spectrum shown in Exhibit 1 and consider ultra-short bond strategies as an option. With the
expiration of the TAG program and the mounting pressures on money market funds, the mutual
fund industry has seen a dramatic increase in the number of ultra-short bond funds in the market.
Such strategies typically invest primarily in investment-grade debt issues and maintain a portfolio
dollar-weighted average maturity between 91 days and 365 days. Based on these characteristics,
ultra-short bonds are generally considered to reside at the conservative end of the risk/return
spectrum and seek to provide relative safety and low volatility versus stocks, commodities
and longer-term bonds. In addition, they generally offer incremental yield advantages—and a
corresponding higher degree of risk—compared with money market securities. Investors need
to understand that there are material risks in ultra-short bond funds, including that ultra-short
bond funds invest in securities that may experience losses due to credit downgrades or defaults,
and that the NAV of ultra-short bond funds floats and has a greater risk to principal than money
market funds. Credit risk may be less of a factor for ultra-short bond funds that principally invest
in government securities.
CONSIDER ULTRA-SHORT BOND STRATEGIES FOR YOUR CLIENTS’ PORTFOLIOS
PAGE 2
AIDING PORTFOLIO DIVERSIFICATION AND RISK
Ultra-short bond strategies may provide important diversification benefits to well-rounded
portfolios. Because they typically offer relative price stability compared with stocks, commodities
and longer-term bonds, ultra-short bonds may help temper overall portfolio risk while enhancing
return potential.
Exhibit 2 outlines the best, worst and average one-year returns for various asset classes during the
past 10 years. Although stocks and commodities have offered the strongest returns, they also have
demonstrated the largest single-year losses. In contrast, ultra-short bonds have delivered more
consistent single-year returns and an average annualized total return of 2.11%.
Exhibit 2: Asset Class Returns — Ten years ended 12/31/2012
S&P GSCI Total Return
Barclays US Aggregate Credit - Corporate - High Yield (1983)
Russell 2000 - Total Return
57.54
8.21
Barclays Municipal Bond
5.18
-0.81
Barclays US Treasury - Bills (3-6 M)
0.11
Lipper Ultra-Short Obligations Funds
-20%
13.79
Ultra-short bonds seek
to provide relative safety
and low volatility versus
stocks, commodities and
longer-term bonds.
5.59
1.94
5.40
2.11
-1.64
-40%
Best One-Year Return
Annualized Total Return
Worst One-Year Return
14.85
5.10
-3.61
Barclays US Aggregate
20.06
5.58
-9.76
-60%
53.62
7.10
-43.32
Barclays US Treasury Bellwethers (10 Y)
-80%
64.41
9.72
-50.22
S&P 500 - Total Return
64.95
10.62
-31.23
-42.38
MSCI EAFE - Net Return
75.98
2.75
-60.08
0%
20%
40%
60%
80%
100%
120%
Source: FactSet, Lipper, as of 2/14/2013
Although past performance is not indicative of future results, ultra-short bonds avoided significant
losses in any of the one-year periods, including the challenging years of the financial crisis and
Great Recession. As Exhibit 3 shows, in rolling one-year periods, ultra-short bonds’ worst 12-month
period was -1.64%, while their intermediate-term brethren’s worst 12-month period was -6.58%.
There have been six negative return periods for ultra-short bonds while intermediate investment
grade bonds have had 23.
Ultra-short bonds may
offer strong defensive
characteristics and relatively
attractive long-term returns.
This asset class may help
reduce overall downside risk
in a diversified portfolio.
Exhibit 3: Lipper Ultra-Short Obligations and Intermediate Investment Grade Bonds Categories
Rolling One-Year Returns — For the periods ended 12/31/12
20 Intermediate Investment Grade Debt Funds
20 Ultra-Short Obligations Funds
15
15
10
10
5
5
0
0
-5
-5
-10
12/31/92
12/31/96
12/31/00
12/31/04
12/31/08
12/31/12
-10
12/31/92
12/31/96
12/31/00
12/31/04
12/31/08
12/31/12
Source: Lipper, as of 1/14/2013
20%
15%
10%
5%
Ultra-Short Obligations Funds
Intermediate Investment Grade Debt Funds
CONSIDER ULTRA-SHORT BOND STRATEGIES FOR YOUR CLIENTS’ PORTFOLIOS
PAGE 3
In addition to helping reduce overall portfolio risk, ultra-short bonds may help manage duration risk
in a fixed income allocation. Interest rates have tumbled to record lows in recent years, as illustrated
in Exhibit 4. This has prompted many bond investors to extend their fixed income investments into
longer-term and lower-quality securities in an attempt to capture higher yields.
Exhibit 4: Federal Funds Rate and 10-Year Treasury Yields Over the Last 52 Years
25%
Interest rates have tumbled
to record lows, prompting
many bond investors to
extend their fixed income
investments into longerterm and lower-quality
securities in search of
higher yields.
Ultra-short bonds may be
used specifically to manage
duration risk in a fixed
income allocation.
When interest rates
eventually head upward,
ultra-short bonds may offer
greater price protection
than their longer-term
counterparts due to
their lower interest rate
sensitivity.
20%
Federal Funds Rate
10-Year Treasury Yield
15%
10%
5%
0%
12/29/61 12/31/64 12/29/67 12/31/70 12/31/73 12/31/76 12/31/79 12/31/82 12/31/85 12/30/88 12/31/91 12/30/94 12/31/97 12/29/00 12/31/03 12/29/06 12/31/09 12/31/12
Source: FactSet, as of 1/11/2013
Yet, the multi-year downward trend in interest rates leaves little room for additional declines,
suggesting the next major move in rates will be an upward one, triggering greater duration risk.
Given the sluggishness of the U.S. economy, combined with the Federal Reserve’s (the Fed’s)
commitment to keeping interest rates low until inflation increases and the unemployment rate
improves, the timing and magnitude of any rate increases remain unclear. But, when interest
rates head upward, ultra-short bonds may offer greater price protection than their longer-term
counterparts due to their lower interest rate sensitivity.
While longer duration bonds have an important role to play in an investor’s overall portfolio,
ultra-short bonds may offer an attractive risk/return profile in periods of rising rates.
EVALUATING ULTRA-SHORT BOND STRATEGIES While ultra-short bonds offer a way to earn yield, it is important to remember that, unlike money
market funds and CDs, the principal value will fluctuate—meaning investors may realize gains
or losses.
A fund manager’s
professional insights on
duration management,
yield curve positioning,
sector rotation and security
selection may help optimize
risk/return potential.
This is why many investors access ultra-short bonds through mutual funds. Actively managed
ultra-short bond funds may help limit the risk of principal loss and boost return potential by
pursuing a disciplined investment management process that includes duration management, yield
curve positioning, sector rotation and security selection. Different funds can vary widely in terms of
their risk/return profiles, and investors may want to evaluate several crucial areas to determine
if a particular investment manager meets their needs:
1) How volatile is the strategy?
Many investors focus on yield when researching ultra-short bond funds, but total return,
particularly measured on a risk-adjusted basis, may be a better indicator of a manager’s ability
to deliver consistent performance. Examining competitive returns and NAV stability in up and
down markets and across full economic cycles may help reveal if a high yield is symptomatic of
a high-volatility strategy.
CONSIDER ULTRA-SHORT BOND STRATEGIES FOR YOUR CLIENTS’ PORTFOLIOS
PAGE 4
2) Does the fund use derivatives?
Many ultra-short bond funds employ derivative strategies, but a key differentiator is whether the
manager uses these instruments to hedge against interest rate exposure or to increase leverage
in an effort to amplify returns. The former can help reduce portfolio volatility, while the latter can
increase volatility significantly. Investors may wish to examine the fund’s holdings to make sure
the maturities are in line with the fund’s overall maturity profile, because using derivatives to scale
back duration of what is really an intermediate portfolio may add a great deal of volatility in certain
market climates.
3) How strong is the portfolio’s credit quality?
By design, ultra-short bond funds may help protect against interest rate risk, but there remain
other important considerations like credit risk. This was a key factor in the lagging performance of
some ultra-short bond funds during the financial crisis of 2008-2009. Interest rates came down,
which was generally beneficial to ultra-short bond funds, but credit spreads (the difference in
yield between non-Treasury and Treasury securities of the same maturity) widened, which was
detrimental to funds invested in lower-quality, higher-risk assets. Be aware of strategies that
strive for yield by including large allocations to lower-rated securities, because they may expose
shareholders to a higher degree of credit risk. Instead, investors may want to consider funds that
invest in U.S. government-backed securities and high-quality credit and asset-backed securities.
4) How well does the manager mitigate call risk, extension risk and prepayment risk?
Some additional items that an investor needs to consider when selecting ultra-short bond funds
are how call risk and extension risk are managed. Call risk is the risk that the issuer of the bond
will redeem the issue prior to maturity and the bondholder will receive payment at par and have
to reinvest in a less favorable interest rate environment. Extension risk in mortgage-backed
securities is similar to prepayment risk, but acts in an opposite manner. Prepayment risk is when
the mortgages underlying the mortgage-backed securities are paid off ahead of schedule (for
example, by people refinancing in periods of falling interest rates) and the proceeds have to be
invested in a less favorable interest rate environment. Extension risk occurs when less prepayments
than expected occur due to rising interest rates (e.g., when the mortgage holders do not refinance
because their current mortgage is at a lower interest rate than what is currently available), and the
securities’ expected maturity will lengthen in duration due to the deceleration of payments.
Investors may wish to consider a manager who has assumptions and models in place to manage
call risk, prepayment risk and extension risk.
Actively managed mutual
funds offer an easy way
to add ultra-short bond
exposure to a portfolio.
Investors may wish to more
closely scrutinize strategies
with outsized yields or other
risk flags that may be overly
volatile in difficult markets.
5) How experienced is the manager of the strategy?
The mutual fund industry has seen the launch of many new ultra-short bond funds recently, some
managed by firms with no previous experience in the investment style. While no one knows what is
in store for the financial markets, examining a manager’s tenure in the investment style may provide
important insight into how the fund is managed and how it navigated the markets during the credit
crisis of 2008 - 2009.
CONCLUSION
Investors with intermediate liquidity needs looking for the potential for additional yield — and who
are willing to take on some additional risk in comparison to deposit accounts and money market
funds — may wish to consider ultra-short bonds. Ultra-short bonds’ low volatility may help diversify
portfolio risk, while their low sensitivity to interest rate changes may help investors prepare their
fixed income portfolios for an eventual rising-rate environment.
CONSIDER ULTRA-SHORT BOND STRATEGIES FOR YOUR CLIENTS’ PORTFOLIOS
PAGE 5
About RidgeWor th Investments
RidgeWorth serves as a money management holding company with six style-specific institutional
investment management boutiques, each with a well-defined, proven approach and all with
unwavering commitments to exceptional performance. Through our multiple, style-specific boutiques,
we offer a wide range of equity and fixed income investment disciplines. RidgeWorth Investments, an
investment adviser registered with the SEC since 1985, is headquartered in Atlanta, Georgia.
Investment Considerations
Bonds offer a relatively stable level of income, although bond prices will fluctuate providing the
potential for principal gain or loss. Intermediate-term, higher-quality bonds generally offer less risk
than longer-term bonds and a lower rate of return. Generally, a Fund’s fixed income securities will
decrease in value if interest rates rise and vice versa.
This information and general market-related projections are based on information available at the
time, are subject to change without notice, are for informational purposes only, are not intended
as individual or specific advice, may not represent the opinions of the entire firm, and may not be
relied upon for individual investing purposes. Information provided is general and educational in
nature, provided as general guidance on the subject covered, and is not intended to be authoritative.
All information contained herein is believed to be correct, but accuracy cannot be guaranteed. This
information may coincide or conflict with activities of the portfolio managers. It is not intended to
be, and should not be construed as investment, legal, estate planning, or tax advice. RidgeWorth
Investments does not provide legal, estate planning or tax advice. Investors are advised to consult
with their investment processional about their specific financial needs and goals before making any
investment decisions. Past performance is not indicative of future results.
CONSIDER ULTRA-SHORT BOND STRATEGIES FOR YOUR CLIENTS’ PORTFOLIOS
PAGE 6
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Investment Terms
Net Asset Value (NAV) is a mutual fund’s price per share value.
The per-share dollar amount of the fund is calculated by dividing
the total value of all the securities in its portfolio, less any
liabilities, by the number of fund shares outstanding.
Weighted Average Maturity is the length of time until the
average security in a fund will mature, be redeemed by its issuer,
or paid down over time, which is the case with most securitized
assets.
Yield Curve is a curve that shows the relationship between yields
and maturity dates for a set of similar bonds, usually Treasuries,
at any given point in time.
Credit Spreads are the difference between the yields of sector
types and/or maturity ranges.
Fed Funds Rate is the interest rate at which depository
institutions actively trade balances held at the Federal Reserve,
called federal funds, with each other, usually overnight, on an
uncollateralized basis.
Credit Ratings Standard & Poor’s rates securities from AAA
(highest quality) to C (lowest quality) with BBB and above being
called investment grade securities. BB and below are considered
below investment grade securities.
Lipper Ultra-Short Obligations, Lipper Money Market Funds
and the Lipper Intermediate Investment Grade categories are
equally weighted averages of the mutual funds within their
respective investment objectives, adjusted for the reinvestment
of capital gains distributions and income dividends.
Standard & Poor’s 500 Index is an unmanaged index of 500
selected common large capitalization stocks (most of which are
listed on the New York Stock Exchange) that is often used as a
measure of the U.S. stock market.
Russell 2000 Index is an index measuring the performance
approximately 2,000 small-cap companies in the Russell 3000
Index, which is made up of 3,000 of the biggest U.S. stocks. The
Russell 2000 serves as a benchmark for small-cap stocks in the
United States.
Morgan Stanley Capital International Europe, Australasia
and Far East (“MSCI EAFE”) Index is an unmanaged marketcapitalization-weighted equity index comprising 20 of the 48
countries in the MSCI universe and representing the developed
world outside of North America. Each MSCI country index
is created separately then aggregated, without change, into
regional MSCI indices. EAFE performance data is calculated in
U.S. dollars and in local currency.
Barclays U.S. Aggregate Bond Index is a widely recognized
index of securities that are SEC-registered, taxable, and dollar
denominated. The Index covers the U.S. investment grade fixed
rate bond market, with index components for government and
corporate securities, mortgage pass-through securities and
asset-backed securities.
Barclays Municipal Bond Index is a widely recognized index
of investment grade tax-exempt bonds. The eight subsets of
the Index are market weighted. The Index includes general
obligations, revenue bonds, insured bonds, and pre-refunded
bonds.
Barclays Capital 3-6 Month Treasury Bill Index is the 3-6
Months component of the Barclays Capital U.S. Treasury Bill
index which includes U.S. Treasury bills with a remaining
maturity from 1 up to (but not including) 12 months. It excludes
zero coupon strips.
Barclays 10-Year U.S. Treasury Bellwethers Index is a universe
of Treasury bonds, and used as a benchmark against the market
for long-term maturity fixed income securities. The index
assumes reinvestment of all distributions and interest payments.
Barclays U.S. Corporate High Yield Bond Index is an unmanaged
market-value-weighted index that covers the universe of fixed
rate, non-investment grade debt.
S&P Goldman Sachs Commodities Index serves as a benchmark
for investment in the commodity markets and as a measure
of commodity performance over time. The index currently
comprises 24 commodities from all commodity sectors - energy
products, industrial metals, agricultural products, livestock
products and precious metals. The SPGSCI is expressed in
a dollar price based on the underlying contracts and their
respective weights.
CONSIDER ULTRA-SHORT BOND STRATEGIES FOR YOUR CLIENTS’ PORTFOLIOS
PAGE 7
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This and other important information about the RidgeWorth Funds can be found in the fund’s prospectus. To obtain a prospectus, please
call 1-888-784-3863 or visit www.ridgeworth.com. Please read the prospectus carefully before investing.
©2013 RidgeWorth Investments. RidgeWorth Investments is the trade name for RidgeWorth Capital
Management, Inc., an investment advisor registered with the SEC and the adviser to the RidgeWorth Funds.
RidgeWorth Funds are distributed by RidgeWorth Distributors LLC, which is not affiliated with the adviser.
Collective Strength Individual Insight is a federally registered service mark of RidgeWorth Investments.
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