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3 Funds That Could Be Cash Alternatives

These highly rated ultrashort bond funds can diversify a cash strategy--and add incremental yield, too.

Susan Dziubinski: Hi, I'm Susan Dziubinski for Funds in the ultrashort bond category are generally high quality. You have some sector flexibility. Although they maintain durations of one year or less, they aren't replacements for FDIC-insured bank money market funds or certificates of deposit. That being said, here are three Morningstar Medalists in the ultrashort bond category that investors can use to diversify their cash holdings.

Alaina Bompiedi: As its name implies, Fidelity Conservative Income Bond is indeed conservative, but it is not risk free. The fund invests below the one-year mark on the yield curve in a mix of commercial paper, floating rate, and short-term debt. That's pretty similar to other funds in the ultrashort bond category, but compared to money market funds, this one has a wider investment range. It can invest in taxable municipals, corporates, as well as foreign bonds. But the team that manages this fund allocates across those risks prudently. They limit the fund's investment in midgrade BBB bonds to 5%, and the fund is not allowed to hold below investment-grade bonds. With that, the fund's performance has been relatively placid in its category. Its five-year trailing return is about average, but we think that's a good sign that the fund is fulfilling its mission of providing incremental return and capital preservation.

Eric Jacobson: Bronze rated BBH Limited Duration looks for undervalued bonds that have enough income to compensate for the liquidity and credit risks and that have an extra margin of safety. That's not a novel idea, but its process, both quantitative and qualitative, is meant to keep the fund invested in proven robust structures or time and battle tested guarantors. The fund is run by Andrew Hofer and Neil Hohmann, and in the case of asset back securities underpinned by loans or leases, for example, they stick with markets that have endured multiple credit cycles. Each asset pool is tested against levels of trouble, including at least a 250% hike in their base case loss projections. Hofer, Hohmann, and their analysts use a structure they describe as being built on four important elements of durability, transparency, appropriate structuring, and good management. Part of that involves looking to understand every element of an issuer's business model, underwriting, and servicing capabilities. They like to steer clear of those without a long record of underlying rigor and consistency, whether they're buying an issuer's debt or securities that they've packaged from other assets or loans. When it comes to the latter, the team sticks with those issuers holding an economic interest in the long-term health of their deals. They will work only with those issuers they view as having easily understandable and very transparent balance sheets. Financial firms dominate issuance in the short end of the market, though, and Hofer argues that management's attitude toward risk across market cycles is ultimately an investors first and last line of defense. Just relying on the look of a company's balance sheet in that space can get you into trouble, since, as Hofer has said, their financials can look entirely different short order when they're not managed well. Among other factors, the depth, rigor, and success of its methods have helped support its Bronze Morningstar Analyst Rating.

Miriam Sjoblom: One of my favorite ultrashort bond funds is PIMCO Enhanced Short Maturity ETF, which gets a Gold analyst rating. One of the reasons we like it, it's got a very experienced team. Jerome Schneider's been running it for nearly a decade and he's supported by PIMCO's vast resources across pretty much every bond sector globally. While Jerome has the expertise to invest pretty much anywhere, he actually plays it extremely safe here. The fund's duration is kept under one year, which means it has very little interest-rate risk. Also, he avoids some more volatile sectors such as currencies and high yield bonds, so he's really focused on downside protection. The fund charges a 35 basis-point expense ratio, and while that's not especially cheap relative to ETFs, actually when you look at it versus the active open end fund universe, it's actually a pretty good deal. Adding it all up, this one's tough to beat.

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