Investors are pulling back from both stocks and long-term bonds, and they are putting more money into ultra-short bond funds. The shift is driven by concern that a decade-long equity run is nearing a peak, combined with the failure of long-term bonds to act as a reliable cushion.
According to a report by CNBC, the S&P 500 has delivered double-digit gains for most of the past decade, with the rally driven heavily by the so-called "Mag 7" technology stocks and the AI boom. That run has left many investors uneasy. "Investors have enjoyed one of the strongest equity markets in history, and they're starting to get worried about downside risk," said Christopher Coolidge, chief investment officer at Brookwood Investment Group in Phoenix.
The traditional alternative, long-term bonds, has not been a safe harbor. The iShares 20+ Year Treasury Bond ETF has posted an average annual return of negative 6.7% over the past five years. The iShares 7-10 Year Treasury Bond ETF has posted an average annual decline of 1%. At the same time, average bank deposit yields remain well under 1%, leaving investors with few obvious places to park defensive cash.
Brookwood Investment Group has responded by raising the cash-like portion of its model portfolios. The firm generally holds about 5% in cash equivalents, up from about 2% in June. "We've become more defensive as equity markets continue to hit all-time highs," Coolidge said. That defensive allocation is built from a basket of ultra-short ETFs that blends treasury exposure, floating rate securities, funds with active credit management, and option-enhanced income strategies. Depending on a client's comfort level, allocations to the basket can range from a small slice to 100% of a portfolio.
Cyrus Amini, chief investment officer at Hyphen Wealth Management in Lafayette, California, uses a similar approach, combining short-duration bond funds with money market funds. "I don't see the need to take duration risk in this market," he said.
The appeal of ultra-short funds comes down to two factors: yield and stability. Longer-dated bonds have grown more volatile as inflation concerns, geopolitical uncertainty, and the possibility of Federal Reserve rate hikes before year-end have all weighed on the market. Though CNBC noted that recent inflation data, combined with unexpectedly soft jobs figures, have lowered the market's expectation that rate hikes are imminent, the uncertainty has not gone away.
Ultra-short bond funds, by contrast, carry far less exposure to rate swings. Their durations are measured in months rather than years, which limits the damage if rates move up. They are not designed to match the return of stocks in a bull market, but that is not their purpose. For investors who want to reduce equity exposure without accepting near-zero bank rates or the volatility of long-duration treasuries, they represent a middle path.
The movement is still measured. Most advisors are not pulling clients entirely out of equities. Brookwood, for example, has moved from 2% to 5% in cash-like instruments, not 50%. But the direction is clear, and the tools being used are more sophisticated than simply moving money into a savings account or a standard money market fund. The basket approach, mixing different types of short-term fixed income, is designed to capture yield from multiple sources while keeping risk low.
