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3 Things to Look for in Ultrashort-Bond Picks

Investors should assess quality, fees, and risks associated with these funds, which can enhance, but not replace, cash accounts.

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Emory Zink: Beginning in October 2016, the SEC's greater legislation on money markets takes effect. When combined with a low-yielding environment, some investors are looking for alternatives to manage their cash.

Cue the ultrashort-bond category. Open-end funds in the category have doubled in number over the last decade. Many ultrashort-bond funds blend the higher quality and more-liquid bias of money market funds with a sector flexibility that is more similar to short-term bond funds--investing across geographies and in corporate debt and municipals. The average duration of the ultrashort category is a half year.

So, what should investors consider when looking at the options in this category? Three things: 

1) Quality. There is a temptation to load up on lower-quality paper when liquidity dries up; in a credit crisis, ultrashort bonds can be hit hard.

2) Fees. Yields are inherently lower at the short end of the curve, and low fees are critical for long-term outperformance.

3) Appropriateness. Most retail investors should recognize that this isn't a replacement for an FDIC-insured bank money market fund or bank CD. There are greater risks with these funds.

Two of our picks in the category include Bronze-rated Fidelity Conservative Income (FCNVX)--a high-quality, lower-volatility fund with broad sector flexibility--and Silver-rated PIMCO Short-Term Institutional (PTSHX)--a fund that manages duration actively and is run by our 2016 Fixed-Income Fund Manager of the year, Jerome Schneider. 

Again, this category is not a replacement for a savings account or bank money market fund; but for an investor looking to enhance or diversify a cash strategy, it provides an option.

Emory Zink does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.