Liquidity investing: keeping your options open in an uncertain world

Alastair Sewell

Liquidity Investment Strategist, Aviva Investors

Recent market turmoil following President Trump’s radical—and ongoing—changes to trade policy have underlined the value of cash as a store of value. At the same time, however, many investors are grappling with the implications of falling interest rates.

Optimising cash in this complex environment is an important priority.

In Asia, for instance, we have already seen many central banks across the region begin to follow the US Federal Reserve’s lead in cutting policy rates. In just the last few weeks, Australia and India have joined those that had already started to shift to an easing cycle.

But even though geopolitics and trade uncertainty mean the year ahead is unlikely to be plain sailing, we believe the conditions for liquidity investment look broadly favourable. It is our view that liquidity funds – a type of investment that ranges from regulated money market funds (MMFs) through to more flexible products that seek higher yields but still with lower risk and lower volatility – should remain a compelling option, even as policy rates fall.

Firstly, the global economic picture is increasingly varied, with recession risk back on the agenda. Maintaining healthy levels of liquidity in a varied and volatile economic environment makes sense. And second, while central bank rates – and hence liquidity fund yields – may not match the highs of 2024, we would still expect levels of cash income to be healthy in 2025 and certainly well above the lows of the 2010s.

In this environment, investors—insurers or return-seeking family offices, for instance—looking to access higher overall yields than those that can be achieved through bank deposits or classic short-term MMFs may consider “step-out” strategies for part of their cash.

These strategies can include so-called “standard” money market funds, or ultra-short bond funds, both of which aim to offer a potential yield pick-up over MMFs. They still invest in the same high-quality issuers as MMFs, but can have exposure to longer-dated securities or a greater diversity of sectors. And for investors seeking the possibility of still higher yields, there are yet more funds that invest in securities with maturities of several years.

Economic uncertainty

An increasingly mixed economic picture combined with renewed concerns over recession loom large over investors. With risk assets under pressure in many markets and volatility high many investors may see an increased value in holding larger liquidity allocations. Not only does liquidity offer a potential store of value in turbulent times, it could also provide the opportunity for tactical optionality to re-enter markets when timing presents opportunity.

However, with rates falling, complementing core liquidity tools such as MMFs with other liquidity options can potentially help maintain an overall higher yield.

Reliable income

Most major central banks are in a rate-cutting mode, although the timing and pace of cuts remains subject to considerable variation. This will put negative pressure on money market instrument yields. The key challenge for liquidity fund portfolio managers will be in predicting the timing and magnitude of future rate changes and hence the relative value of securities with different maturities.

In other words, it’s all going to be about the shape of the short-term yield curve. In 2024 pricing moved materially as market participants adjusted their expectations for future rate movements, and this trend continued into 2025.

Looking at 2025, market participants have adjusted their expectations. Take the US for example: in mid-November 2024 market participants were expecting three cuts in 2025. By early January 2025, market pricing suggested fewer than two cuts in 2025, but this had moved back towards three cuts by mid-March. The volatility investors are facing is evident!

And there is also no indication of rates falling back to the ultra-low levels of the 2010s. This means that liquidity funds are likely to continue providing a good level of income. Indeed, with inflation falling, and below central bank base rates, the yields on liquidity funds should be positive in real terms for the foreseeable future.

Stepping out

There are options for those investors seeking to generate higher yields in an overall declining rate environment. Where investors can segment their cash into buckets, they may be able to allocate some into higher yielding near-cash vehicles.

This is where so-called “step-out” vehicles come in. Choosing these can be challenging because it usually means leaving the conformity of liquidity funds, which invest in short-term assets, and instead using ultra-short bond funds, which typically have a weighted average maturity of less than one year.

But for those investors unwilling to step outside the regulated liquidity fund world, so-called “standard” MMFs can be an option. These operate with longer weighted average maturities than “short-term” MMFs, and can therefore generate potentially higher yields, especially as rates fall.

Short-term bond funds come in many shapes and sizes. Many will have material allocations to short-dated corporate bonds, potentially rated in the “BBB” category. While these securities seek to provide attractive yields, credit spreads are currently tight. A widening of credit spreads could be negative for the performance of funds with material allocations to these securities.

But there are assets with more stable profiles available which have the potential to deliver incrementally higher yields. These will typically be higher credit quality – perhaps rated ‘A’ or better – and they will be instruments that are less sensitive to credit spread or interest rate volatility. Covered bonds, which are usually rated ‘AAA’, are a good example.

Keeping options open

In a falling rate environment, it can be tempting to assume that there is less scope for returns from liquidity funds. But we think they will continue to be worthwhile for investors looking for a yield uplift on their cash holdings. And it’s also worth remembering that while inflation remains a risk, central banks will be constrained in their ability to cut rates.

Finally, there is also the strategic value of keeping cash in an uncertain world. No one knows today how the tariff situation will play out in the long term, but a volatile world is one in which opportunities arise.

At times like this the “option value” of cash is high. For investors looking to maximise their return potential in the meantime, liquidity funds may offer an array of possibilities.