Public Funds Investment Institute

First Quarter Investment Returns:  Cash Led the Way Again

April 2, 2024

• Local government investment pools and money funds once again produced market-leading returns in the 2024 first quarter. The beat by cash-type investments followed the strong showing for cash-type investments in 2023.

• Returns of longer-duration portfolios were dragged down by a modest rise in interest rates.

• The yield curve also worked against longer-duration portfolios. The curve has now been inverted for more than 21 months, meaning that investing out more than six months or so costs yield—defying the long-held expectation that investors should receive a premium for committing to term investments.

The details.

Yields of prime LGIPs government LGIPs as tracked by the PFII indices in the first quarter of this year averaged 5.45% and 5.25%. The annualized yields (as shown in the above chart) of 5.62% for prime funds and 5.42% for government funds were notably higher than the annualized return of 4.90% for the model portfolios which are invested in Treasury and corporate bond securities.

The LGIP yields were lower by five and nine basis points respectively than yields in the last quarter of 2023. The small declines were matched by declines in money fund yields reported to the Securities and Exchange Commission.

The modest move lower in LGIP and money fund yields resulted from a decline in long-tenor Treasury bill rates of four to five basis points and in commercial paper and negotiable certificate of deposit rates by six to nine basis points. This, even though the overnight rate—represented by the Secured Overnight Funding Rate—was virtually unchanged through the quarter, has gradually brought LGIP rates lower.

Longer duration portfolio returns were depressed by the (modest) move higher in yields on securities with maturities of one year or more. The 1-3 year model portfolio had an annualized return of 4.90% while the somewhat longer duration 1-5 year portfolio returned 4.27% in the quarter.

Portfolios that held securities maturing longer than a few months were challenged by two factors. First, the inverted yield curve meant longer-maturity investments sacrificed some initial yield in order to lock in rates for a term. Second, market rates early in the quarter reflected an (apparently unrealistic) expectation that the Federal Reserve would soon lower rates. Thus, yields on two-year Treasuries opened the year at around 4.25. Stronger than expected economic growth and a slowdown in the rate of disinflation soon led investors to adjust their outlook for Fed policy, and rates on two-year Treasuries rose by nearly 40 basis points to end the quarter.

The model portfolios consist of allocations to cash, Treasuries, and high-grade corporate securities. They can also hold Federal agency securities. Corporate credit had standout performance in the quarter, driven by underlying strength in the economy and absence of market-disrupting events. (In some respects the results mimicked that of equities.)

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Investment grade corporates accounted for 30% of the holdings of the 1–3 year portfolio (see accompanying chart). They returned 9.45% and contributed 46% to the portfolio return. Treasuries accounted for 60% of the holdings but returned only about 2.25% on an annualized basis. They contributed less than 30% to the quarter’s returns. The balance came from cash invested in a government money fund.

A portfolio whose investments were limited to government and Federal agency securities would have under-performed the LGIP/money fund strategy by about 3% on an annualized basis.

What’s next?

Cash was the winning strategy in 2022 and 2023 as interest rates rose to levels not seen in a generation. It also paced public sector investment returns in the first quarter of this year, but perhaps the market dynamic is about to change. Markets began the year dominated by expectations that the Fed would begin easing monetary policy as early as March and would proceed quickly to lower rates by as much as 200 basis points. Reality—and a strong economy—gradually gained investor attention and as the quarter ended bond investors had lost much of their bullish optimism.

One might consider the difference in yields between cash investments and investments for a term—say the two-year Treasury rate—to be the cost for insurance on the rate that will be available over the future term.

If the Fed begins to loosen monetary conditions later this year, the 5% plus yields now available on LGIP investments will quickly disappear and the 4.50% plus rate offered by two-year Treasuries also will be history as investors buy these securities in anticipation of future Fed actions.

At that point cash will no longer reign.

Note on method: The accompanying charts show annualized yields for comparative purposes; this includes the effect of compounding and assumes that first quarter results would carry forward for the year. Returns are presented in this fashion rather than on a periodic basis or as simple annual yields in the case of LGIPs to provide a consistent basis for comparison.

Greetings, fellow colleagues in the public funds investment community! I'm Marty Margolis, a seasoned expert with a deep understanding of the intricacies of managing public sector investments. Having led the growth of PFM Asset Management and managing assets exceeding $150 billion, I am excited to connect with you through the Public Funds Investment Institute. If you haven't already — subscribe below to join our community, explore our thought leadership, and gain valuable insights. I encourage you to connect with me on LinkedIn or reach out via email to share your thoughts, feedback, and ideas. Let's collaborate and make a positive impact together.

Best regards,
Marty Margolis

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