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Buy Side

Wanted: More Yield, Less Risk

Just because money’s on the sidelines doesn’t mean it’s out of the game.

Gary Gildersleeve deals with a lot of clients who aren’t yet ready to jump back into the market, but who also are dissatisfied with meager earnings on their money.

The fixed-income portfolio manager at asset manager Evercore Wealth Management argues that with a little patience, creativity, and selectivity, and a lot of solid fundamental research, investors who want to play it safe can earn more than money market funds with no insomnia-inducing risks.

For all the talk about a rally, people are still scared.

Households at mid-year had $7.76 trillion tied up in deposits and money market funds, according to Federal Reserve data, which is almost $380 billion more than the beginning of 2008.

And though the exodus of cash from money market funds has garnered plenty of press, most of it is just a retreat from the severe flight to safety in the second half of last year.

The $3.33 trillion entrusted to money market funds is still higher than it was at the beginning of 2008, according to the Investment Company Institute.

“Even though we see opportunities in the market, people are holding onto their cash,” Gildersleeve said. “Everybody wants yield but obviously after last year nobody wants to take a lot of risk.”

Money on the sidelines earns very little today.

The Fed’s target for short-term rates is essentially at zero, and that, coupled with investors’ distaste for longer-term investments, has yanked returns on short-term safe havens to the floor.

The average yield on money market funds is 0.04%, according to iMoneyNet, a record low.

One-year Treasury bills yield less than 0.29%, according to Thomson Reuters, and investors can’t earn more than 1% on triple-A rated municipal bonds until they reach out to maturities past three years.

Gildersleeve uses a few techniques to out-earn these safe havens while still sheltering his clients’ money. One is to pick up variable-rate demand notes backed by letters of credit from German Landesbanks that still benefit from a guarantee from state governments in Germany.

VRDNs are bonds whose interest rates reset regularly. Most are supported by letters of credit from a bank. A major provider of these letters of credit have been German Landesbanks, which are banks jointly owned by local private banks and state governments.

The German state governments were forced to pull their guarantees under a new regulatory framework implemented earlier this decade. Some of those guarantees issued at certain times, though, were grandfathered in. Bonds backed by the grandfathered-in guarantees are ultra-safe but carry higher yields because of the association with the besmirched Landesbanks, Gildersleeve said.

One example is the Colorado Housing and Finance Authority’s taxable weekly VRDNs issued in 2001, with backing from Landesbank Hessen. Gildersleeve claims he was able to pick that issue up at a yield of 2.25% despite triple-A ratings from Standard & Poor’s and Moody’s.

He also snapped up the Utah Housing Finance Agency’s weekly VRDNs issued in 2000, yielding 0.95% despite backing from Bayerische Landesbank and triple-A ratings. Compare this to the average weekly VRDN yield of 0.22%, based on a Securities Industry and Financial Markets Association index.

For clients willing to tolerate a six-month maturity, Gildersleeve in early September picked up a National Rural Utilities Cooperative Finance Corp. issue at a yield of 2.25%. The issue is backed by strong collateral with negligible default history, Gildersleeve said.

The bondholder gains the right to sell the bond back to the issuer in March, rendering it effectively short-term.

Gildersleeve also likes buying municipals eligible to be bought back by their issuers soon, saying they often offer superior yields whether they are called or not.

“Most of our clients have felt very good getting the additional yield that we’re talking about with these,” he said.

Evercore Wealth Management manages $1.4 billion.

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