Why An Increase In Interest Rates Yield For Cash Management Accounts May Not Always A Good Thing For Investors

In a recent update to the changes in interest rates projected by cash management accounts in Singapore, we observed that almost all the major cash management accounts offered by financial institutions and robo advisors in Singapore have recently increased.

This comes as no surprise. Thanks to the U.S. Federal Reserve increasing its benchmark interest rates, interest rates in the financial industry have also increased. This, in turn, means borrowing has become more expensive while lending rates are more attractive. As a result, money market funds and short-term duration bond funds that cash management accounts invest in are now offering higher rates.

We would think that interest rates going up is good for investors. After all, higher returns are surely better than lower returns, right?

Not necessarily. Let us explain.

Interest Rates Projected By Cash Management Accounts Are Not The Same As Interest Rates Offered By Bank Deposits

Whether it’s cash management accounts or bank deposits, the main reason why many of us park our money in these accounts is usually the same – to earn higher interests on our excess savings that we don’t intend to use in the near term.

However, unlike high-interest savings accounts, where the banks are obliged to give you the interest rate they advertise and protect your savings, this isn’t the same for cash management accounts.

For cash management accounts, it’s the money market funds and the short-term duration bond funds with which the cash management accounts invest their money that gives us the returns we get. The advertised interest rates that the cash management accounts state is merely a projection, not the actual returns we get. Like any investment, the actual returns we get can increase or decline in value, depending on market conditions.

What this implies is that the projected return being advertised is a function of how the cash management account is constructed.

Using Endowus Cash Smart as an example. Even within Endowus itself, we can see that the company offers three different cash management account portfolios designed to cater to the risk tolerance and cash management needs of individual investors.

Endowus Secure currently gives a projected return of between 1.5% to 1.6%, while the higher risk portfolios, Enhanced and Ultra, give us a projected return of between 2.3% to 2.6% and 2.9% to 3.3% respectively. However, we can’t say that Ultra is better than Secure. The different risk levels affect the returns and what is better for individual investors will depend on their preference.

There are overlaps between the three portfolios when we look at how each is constructed.

The LionGlobal SGD Enhanced Liquidity is an underlying fund that is part of all three portfolios. Thus, its performance will affect all three portfolios, though to varying degrees, since all three portfolios are constructed differently.

Source

Ironically, the fund – LionGlobal SGD Enhanced Liquidity – is also an underlying fund in many other cash management accounts currently. These include the FSMOne Auto-Sweep Account, Stashaway Simple and the Syfe Cash+.

Just remember, it’s the fund and other similar funds that are invested that gives us our return, and not the robo advisors.

Changing The Construct Of The Cash Management Accounts Can Change Projected Returns

Besides the underlying funds giving higher returns, changing how the cash management accounts are being constructed can also change the projected returns.

As Endowus Cash Smart already shows, different portfolios can give different returns. A company can increase its cash management account returns by changing the underlying funds within its portfolio.

To my knowledge, at least two robo advisors – Syfe and Stashaway, changed the construct of their cash management accounts earlier this year. Syfe removed one of its underlying funds – Lion Global Short Duration Bond Fund, which previously comprised 35% of the portfolio to 0%.

Stashaway also recently reallocated its portfolio for Stashaway Simple.

The reason, as explained by Stashaway in this article, is simple.

“As you may have seen with our recent updates to Simple’s projected rate, the current rate hike environment has benefited both the underlying funds, LionGlobal SGD Enhanced Liquidity I Acc (LGI ELF) and LionGlobal SGD Money Market Fund Class A (LGI MMF). However, LGI ELF has a higher yield than LGI MMF. So by having more exposure to ELF, you get a better yield for Simple.”

The company, to its credit, also explained what this means for its portfolio.

“LGI ELF’s higher yield comes with a longer duration (meaning it’s more sensitive to interest rate changes) and higher credit risk than LGI MMF as LGI ELF has more exposure to corporate bonds. So, does this mean you need to worry about higher risks? The short answer is: no. We did our due diligence on LGI ELF and based our decision on the following”

By changing the portfolio allocation, projected returns are now higher. But this isn’t necessarily a free lunch for investors. For better or worse, we are getting a (slightly) different product.

Coincidentally (or perhaps not), Stashaway Simple and Syfe Cash+ now offer the same underlying funds and weightage in their portfolio. Both currently have a projected return of  1.5%.

Projected Returns May Also Increase If The Underlying Value Of The Funds Have Gone Down

Last, but certainly not least, we need to remember that similar to traditional equities and fixed income, money market and short-term duration funds can fluctuate and decline in value, especially when market interest rates unexpectedly spike.

As shared by Endowus in their performance review, both the Cash Smart Enhanced and Cash Smart Ultra saw a return of -0.81% and -1.69 respectively in 1Q2022. This means the underlying funds within these portfolios must have seen a decline in value during that period.

As explained by Endowus.

“The Endowus Cash Smart Enhanced Portfolio ended the second quarter flat, while the Endowus Cash Smart Ultra Portfolio registered a negative return of -1.0%. The Cash Smart Enhanced and Cash Smart Ultra Portfolios’ allocations to bonds and other short-dated fixed income instruments have subjected these portfolios to mark-to-market adjustments of fixed income markets. They have also been impacted by the unprecedented speed at which interest rates have moved up, which triggered a repricing of bonds.

Despite the allocation to the shorter-duration and amortised performance of the LionGlobal Enhanced Liquidity Fund, which anchors most of our Cash Smart solutions, the Cash Smart Enhanced and Cash Smart Ultra Portfolios’ remaining allocations were negatively impacted by rising interest rates and elevated inflation. Moreover, the exposures to the Asian credit market hurt performance as that market continues to be challenged.”

With all things being equal, this decline also means that the projected yield moving forward will increase. For new investors, coming in at a lower price means having a higher projected yield.

For existing investors, this is not so attractive because they would already have lost some value in their cash management accounts. So even though the projected yield is now higher and the funds should eventually recover in the mid-term as long as there is no default, these investors would have already gone through a period of low/negative return.

For investors who are intending to invest in cash management accounts, we strongly suggest that you do not only look at just the projected yield a portfolio is offering, but also the past track record. Remember, higher returns aren’t necessarily better and higher projected returns may come with higher risks. 

Read Also: Complete Guide To Cash Management Accounts In Singapore

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