USFR - ICSH: Useful As Cash Replacement But Mind The Risks

2023-09-05 07:43:21 ET

Summary

• The BlackRock Ultra Short-Term Bond ETF is marketed as a cash replacement tool, offering higher yields than money market funds.
• ICSH outperforms 'cash' in most scenarios but can underperform during rising interest rate environments and is exposed to credit risk.
• I prefer the safety of treasury bills for cash allocation due to zero credit risk and little duration risk.

A reader recently suggested I review the BlackRock Ultra Short-Term Bond ETF (ICSH), given my recent articles on treasury bill ETFs. The ICSH ETF has been compared to 'cash' by many analysts here on Seeking Alpha and he wanted to know the difference.

The ICSH ETF seeks to outperform money market funds by investing in slightly higher duration securities with modest amounts of credit risk. In most scenarios, the ICSH does outperform 'cash'. However, there are risks that investors should be aware of.

ICSH's higher duration means that during rising interest rate environments, it can underperform treasury bills. Furthermore, its modest assumption of credit risk means that during panics, investors may suffer inconvenient MTM losses. In extreme cases like 2008, there may even be some permanent capital losses.

As long as investors understand these risks, I believe ICSH can be useful as a cash replacement tool.

Fund Overview

The BlackRock Ultra Short-Term Bond ETF is an active ETF managed by BlackRock's Cash Management Team that seeks to provide income from a portfolio of short-term U.S.-dollar denominated investment grade fixed and floating-rate debt securities.

The ICSH ETF is marketed as a tool to diversify traditional bonds to reduce interest rate risk while preserving capital (Figure 1).

The ICSH ETF has over $6 billion in assets and charges an ultra-low 0.08% expense ratio.

Portfolio Holdings

Figure 2 shows the portfolio overview of the ICSH ETF. The ICSH ETF holds 212 investments with a 30 day SEC yield of 5.47%. The portfolio has an effective duration of 0.43 years and an average yield to maturity of 5.68%.

Despite its ticker 'ICSH' implying the fund is holding cash , the ICSH ETF is not actually a money market fund. Figure 3 shows the sector allocation of the ICSH ETF as of June 30, 2023. It holds a variety of ultra-short term debt instruments like Commercial Paper (37.2%), Certificate of Deposit (18.1%) or bonds with short durations.

These 'near-cash' investments have a variety of credit risk associated with them, unlike true cash instruments like treasury bills and bonds that have zero credit risk. Figure 4 shows the credit quality allocation of the ICSH portfolio. 8.4% of the fund is invested in investments rated AAA or above, 33.3% is rated-AA, 40.6% is rated-A, and 17.9% is rated BBB.

Finally, Figure 5 shows the maturity profile of the ETF. The fund is primarily invested in securities that mature within 1 year (77.6%), or 1-2 years (15.4%).

Distribution & Yield

The ICSH ETF pays a trailing 12-month distribution yield of 4.06% and has a 30-Day SEC yield of 5.5% as of August 31, 2023.

Its most recent monthly distribution of $0.2162 / share annualizes to 5.17%.

Returns

Figure 7 shows the historical returns of the ICSH ETF. It has delivered modest 1/3/5Yr average annual total returns of 4.5%/1.6%/2.0% respectively to August 31, 2023.

Importantly, while ICSH's returns have been low, it has not lost money since inception, consistent with its capital preservation mandate. However, the fund is not totally devoid of risks.

ICSH Has More Duration Risk Than Money Market Funds...

First, looking at Figures 2 and 5, we can see the ICSH ETF does hold some investments with longer than 1 year maturity, leading to the ICSH portfolio having an effective duration of 0.43 years.

In contrast, money market funds like the Fidelity Money Market Fund ( SPRXX ) mostly holds investments that mature within a year (SPRXX has 77.5% of the portfolio maturing within 1-7 days) with weighted average maturity of 18 days (Figure 8).

So in effect, investors are trading off a slightly higher duration for a higher distribution yield when investing in 'near cash' investments like ICSH. In most years, the difference in duration is negligible, and ICSH outperforms. However, in rising interest rate environments like 2022, the higher duration does become a drag, causing ICSH to underperform. In 2022, ICSH returned 0.95% compared to SPRXX's 1.49% (Figure 9).

...And Higher Credit Risk

Another risk to consider is that ICSH's portfolio contains credit risk, as we mentioned above. In times of market stress, like during the COVID-19 pandemic, credit spreads can be dislocated and the ICSH ETF can suffer MTM losses (Figure 10).

In extreme events like the Great Financial Crisis in 2008, some of these high quality corporate bonds and commercial paper may even default (prior to 2008, AIG, Lehman, and Bear Stearns were all highly rated corporate entities but went bankrupt in 2008).

For investors who need access to cash during volatile times, this could be problematic and lead to haircuts on supposedly safe 'cash'.

I Prefer Treasury Bills For Cash

Personally, I prefer the safety of treasury bills for my cash allocation. Treasury bills have zero credit risk and little duration risk if held to maturity. Furthermore, with treasury bills now yielding over 5%, the duration and credit risk associated with 'near cash' investments like ICSH may be hard to justify.

I currently hold the iShares 0-3 Month Treasury Bond ETF (SGOV) and the WisdomTree Floating Rate Treasury Fund ETF (USFR) as my 'cash' holdings. SGOV has a 30-Day SEC yield of 5.29% and is paying an annualized 5.15% on its latest monthly distribution, while USFR has a 30-DAY SEC yield of 5.35% and is paying an annualized 5.35% on its most recent distribution.

Conclusion

The BlackRock Ultra Short-Term Bond ETF is an active ETF marketed as a cash replacement tool for investment portfolios, offering higher yields than money market funds and capital preservation. While ICSH does perform like 'cash' during most scenarios, investors should be mindful that it is not truly devoid of risks.

For example, during rising interest rate environments, ICSH's small, but not zero, duration causes it to underperform treasury bill returns. Furthermore, the ICSH is exposed to credit risk that money market funds do not. Although bankruptcy risk is remote, it could cause MTM losses during times of market stress.

I think the ICSH is useful as a cash replacement too, as long as investors understand the trade-offs being made in order to achieve its superior yield. I rate ICSH a hold .

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