How To Find The Best Money Market ETF

By ETFDatabase | September 21, 2012 AAA

ETFs continue to gain popularity as these innovative financial instruments allow for easy access to virtually any asset class without having to sacrifice cost-efficiency ortransparency, making them ideal tools for long-term investors andactivetraders alike. While the bulk of exchange-traded products have appeal as longer-term investments that can potentially appreciate by a significant amount, not all funds are created with lucrative capital gains in mind. Enter money market ETFs; this breed of funds has caught the attention of countless investors who are looking to preserve capital and, luckily, there are a number of options to choose from .

Price Drivers

  • Interest Rates: This is perhaps the single most important price driver that affects the money market ETFs asset class. The prevailing benchmark interest rate set by the Federal Reserve impacts the yield generated by these funds; in a low-rate environment, money market ETFs can offer a source of low-risk current income. On the other hand, this asset class has a tendency to loose its luster when investors can tap into more lucrativedistributionselsewhere like the investment grade bond market .
  • U.S. Debt Credit Rating: Because these ETFs focus on domestic debt securities, the credit rating on U.S.governmentdebt can impact the appeal of this asset class. In times of economic uncertainty, money market ETFs will hold capital preservation appeal given their focus on debt, which bears virtually no default risk. Likewise, a credit rating downgrade could have a negative impact on investors' confidence, although it would likely raise the yieldsassociatedwith this asset class as well.

Where They Fit

Money market ETFs can serve as viable core holdings in a long-term portfolio for those looking to tame overall volatility. As such, these ETFs might attract cautious investors who are looking to preserve capital over the long-haul, while more risk-averse investors with a bullish economic outlook willlikelyfind this asset classunappealing. Money market ETFs can also be used as defensive tools in times of economic uncertainty when investors are looking to put their money to work while evading stock market volatility .

Factors To Consider

  • Expenses: Because the expected yields on money market ETFs aregenerallyultra-low, a minor difference in the expense ratio among seemingly identical products can have asignificantimpact on bottom line returns. The Money Market ETFs ETFdb Category features products that charge anywhere from 0.13% to 0.35% in annual expenses, with the average price tag coming in at 0.23%.
  • Duration: This is the measure of a bond's sensitivity to changes in the prevailinginterestrate. Money market ETFs with a shorter duration will generate a lower yield because they are less sensitive to changes from the Federal Reserve, and thus carry lessinterestrate risk than comparable securities with a longer duration .

The Contenders

  • iShares Barclays Short Treasury Bond Fund (SHV): This ETF is designed to measure the performance of public obligations of the U.S. Treasury that have a remaining maturity between one and 12 months.
  • PIMCO Enhanced Short Maturity Strategy Fund (MINT): This fund invests in short duration investment grade securities, covering bothgovernmentdebt as well as mortgage-related securities.
  • SPDR Barclays Capital 1-3 Month T-Bill ETF (BIL): This fund tracks the performance ofpublicly issued zero-coupon U.S. Treasury Bills that have a remaining maturity between one and three months.
  • PowerShares VRDO Tax-Free Weekly Portfolio (PVI): This offering tracks the performance ofvariable rate demand obligations (VRDOs) which are best characterized as long-term, floating-rate bonds with characteristics of short-term money market securities.
  • Guggenheim Enhanced Short Duration Bond ETF (GSY): This actively-managed ETF holds ultra-short-term debt securities, making its portfolio very resilient tointerestrate changes.
  • SPDR S&P VRDO Municipal Bond Fund (VRD): This ETF is similar to PVI as it provides exposure to VRDOs which are comparable to short-termmoneymarket funds.

People's Choice

The most popular option in the money market space is the iShares Barclays Short Treasury Bond Fund (SHV). This ETF has accumulated nearly $2.7 billion in assets under management since launching on January 5, 2007 and boasts an average daily trading volume of around 300,000 shares .

Expense Considerations

Cost-consciousinvestors ought to consider the SPDR Barclays 1-3 Month T-Bill ETF (BIL) as it boasts the cheapest expense ratio among competitors, charging a mere 0.13% in annual expenses. Investors should also note that there are currently no money market ETFs available for commission-free trading .

Best Performers

From a performance perspective, BIL stands out as it boasts the highest trailing five-year return; this ETF has gained 3.06% over this time period, while the next closest competitor, SHV, is up 2.79% .

Unique Options

Investors considering PVI and VRD should note that interest earned from VRDOs is generally exempt from federal income taxes; furthermore, this interest is often exempt from state and local income taxes for residents of the issuing state.

Follow me on Twitter@SBojinov

Disclosure: No positions at time of writing.

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