The fixed income space has been hit by central banks tightening rates and an Asian credit selldown. Given these recent headwinds, how should clients think about their existing positions in the Endowus Cash Smart portfolios? We address the most pressing questions posed recently by our clients.

Q: I have been invested in Cash Smart Ultra since September, and my returns are still negative. You indicated a 3 months investment horizon for Ultra so when will it turn positive?

A: We have received this question from more clients as the returns in their Cash Smart Ultra portfolio have remained negative for longer than they had anticipated. Some clients have focused on the 3-month horizon as a benchmark to see whether the portfolio will recover. However, our suggestion of more than 3 months or 3~6 months in previous publications for Cash Smart Ultra was shared to highlight the risk that the portfolio can generate negative returns based on previous historical precedents. 

A prime example was during March 2020, when the covid-induced shock hit the fixed income market and all returns turned negative. We calculated how much the total drop was for all three Cash Smart portfolios during this period and displayed this data to give an indication of the magnitude of the loss that is possible in a worst case type of scenario. The length was given as a guidance to suggest that it could take several months, and longer than people may commonly expect for the portfolio to return to the previous high and the March 2020 data served as a guidance.

In March 2020, we saw a -2.6% move in one month. It then took about 2.4 months for Ultra to recover to its previous peak, thus giving a total length of 3.4 months for Ultra to be back at its pre-Covid drawdown level. However, we know that March 2020 was more of a sharp, short shock to the system. The correction that began in September 2021 is turning out to be, so far, a shallower fall of around -1.3%, but the length of the downward trend was almost twice as long, and the recovery is looking like it will take much longer too.

The recent fall in markets has been driven by a convergence of several macro factors. The 2020 March drawdown was a result of the covid-19 induced liquidity shock in the fixed income market. The recent fall was caused by central banks around the world adopting tighter monetary policies coupled with a very specific country and sector shock in the form of the regulatory crackdown in the Chinese property sector. This led to a pronounced and concentrated effect in the China and Asian credit market, in particular the high yield market. In March 2020, the -13.53% fall in Asia high yield index was largely in line with the -11.3% fall for the broadly diversified Flagship 100% fixed income portfolio. This is in stark contrast to the -16.74% fall in the Asian high yield index compared to the -2.17% in the same period for the Flagship 100% fixed income portfolio.

As investors ourselves we can fully relate with clients in this period of uncertainty, volatility and negative returns, and hope to be able to address some of these concerns. At the same time, the nature of investing is such that it will be difficult to anticipate how different segments of the fixed income space will perform, especially when things such as the direction of the US Fed and Chinese government policy-making are very fluid.

Looking forward, we must closely watch where the Chinese government’s policy is headed and their actions with regards to interest rates, liquidity and direct capital injections. In particular, the outlook for the real estate sector is an important barometer (including mortgage loans restrictions and rates). Policy does seem to be turning and implementation has been incrementally positive. However, the overall market sentiment remains fragile and uncertain with a heightened level of volatility seen across credit and high yield markets. Tougher housing policy is what started this downturn and so if we see policy translate to better liquidity to developers and property price falls are limited, then there is a chance that market sentiment could recover barring any systemic threat to stability.

Q: Why are we comparing Cash Smart solutions to Fixed Income? Isn’t this more like deposits or money market funds?

A: Endowus Cash Smart was not designed to be a deposit or a capital guaranteed product. It is an investment product made up of institutional bank deposits, money market funds and short duration fixed income funds, all of which carry with it inherent risk. 

When we talk about fixed income, it is a very broad term that encompasses different forms of borrowing, usually with an interest rate component. Therefore, apart from the various bonds that we are familiar with or securitised products, even bank loans and bank deposits can be considered fixed income too. 

Cash Smart Secure was built with two funds. one invests primarily in institutional bank deposits, making it the lowest risk of all cash smart funds. The other is a money market enhanced yield fund with some allocation to short duration bonds to enhance the yield. The price of the latter is based on the amortised cost basis which assumes that most holdings are held to maturity thereby limiting daily fluctuation in pricing. 

Cash Smart Enhanced was also built with two funds - one that overlaps with Secure is the money market enhanced yield fund but with an ultra short duration bond fund to generate slightly higher yield by taking marginally higher  interest rate or credit risk. 

Cash Smart Ultra was built with the same enhanced yield fund as an anchor but a series of different short duration bond funds with differing duration, maturity and exposure to credit across diverse geographies, with a low correlation that was designed to dampen the volatility of the overall portfolio. 

All the underlying funds are fixed income - whether it is the institutional bank deposits or money market funds or short duration bond funds. What we are doing is managing the duration or maturity schedule of the funds to ensure that the portfolio has a suitable level of risk including volatility versus the expected re

Q: Why are my Cash Smart returns negative, but the updated projected yield from Endowus remains consistently high or even rising?

A: Endowus Cash Smart solutions calculates projected yields based on yield numbers published by the fund management companies as a guide for investors. However, these solutions are inherently investments and therefore are exposed to volatility and periods of negative returns in varying degrees as the portion of longer duration and higher yielding fixed income increases in Enhanced and Ultra with corresponding exposure to interest rate and credit risk. 

Yields of a fixed income portfolio can go up for two reasons. The first is when the price of the bond falls in which case you get the same coupons based on a lower price which increases the percentage yield number. The second is if the maturing bonds return investors’ money and the market yields have risen and so investors are able to deploy cash at a higher interest rate leading to  higher yield. 

Generally we can say that yields and returns have an inverse relationship in the short term, which means that yields will typically go up when returns go down. Therefore, a rising rate environment generally corresponds immediately to falling bond prices. However, the nature of a bond means that once the bond reaches maturity, its price would recover back to the par level and the previous price losses would be recouped. Investors can then take the returned principal and interest and invest in newly-issued bonds that pay a higher interest. The rule of thumb is that if an investor's investment horizon is longer than the duration of a bond portfolio, rising interest rate in fact improves the return prospect for the investor despite immediate mark-to-market losses due to falling bond prices.     ‍

If you have further enquiries or feedback on the Endowus Cash Smart Portfolios, please reach out to us at support@endowus.com. You can also refer to the latest update on Endowus Cash Smart here. We hope that these answers have given greater clarity on how to use Endowus Cash Smart for your financial goals.