Beyond Money Market Funds: Where to Find Higher Returns Amidst Market Declines

Recent stock market downturns are prompting investors to seek safer investment options, but the question remains whether higher returns are achievable without significantly increasing risk. While money market funds (MMFs) have offered a stable haven, their average annual yield has decreased to approximately 3.3% following a cut in the Bank of Israel's interest rate from 4.5% to 3.25%. In the past year, 33 shekel-denominated MMFs yielded an average of about 3.8%.

In contrast, various managed bond funds, excluding stocks, have shown lower returns. 95 government and corporate bond funds yielded an average of 2.66%, and 98 corporate bond funds yielded around 2.8%. Even government bond funds combining shekel and inflation-linked bonds averaged only 2.58%. This indicates that investors taking on additional interest rate and credit risks in bond funds received lower returns than those in MMFs. Index-tracking government bond funds also underperformed MMFs, with yields around 3.7% for short-to-medium term bonds and 1.5% for longer-term bonds.

Management fees contribute to these discrepancies, with MMFs averaging 0.18% and index-tracking bond funds 0.15%, compared to 0.62%-0.76% for managed bond funds. Additionally, MMFs are typically exempt from purchase, sale, and custody fees, unlike some bond funds which may incur these charges, further reducing net returns.

The expected capital gains from falling interest rates in bond funds did not fully materialize. While the Bank of Israel lowered its rate by 1.25 percentage points, the yield to maturity on two-year government bonds only dropped by about 0.5 percentage points to 3.3%. Five-year bond yields remained stable around 3.7%-3.8%, and ten-year yields even increased to about 4.15%. This is because bond prices reflect future interest rate and inflation expectations, with some rate cuts already priced in, limiting significant capital gains.

Alternative investment options with potentially higher returns include government bonds with maturities matching the investment horizon, offering yields around 3.4% for two-year bonds and 3.9% for five-year bonds before tax. Bond funds with specific maturity dates, such as 2028 or 2029, have shown average yields of 4.67% and 4.65% respectively over the past year, exceeding MMF returns. However, current yields to maturity are more critical than past performance, with some shekel-denominated bonds maturing in 2029 offering yields around 4.76%. These funds may include corporate bonds, introducing credit risk. Investors should also consider credit spread increases and potential defaults.

Other alternatives include index-tracking Tel Bond funds for corporate bonds, offering gross yields to maturity of about 5% for shekel-denominated bonds and 2.6%-2.7% real yield for inflation-linked bonds. Fixed-rate bank deposits are also an option, with some banks offering rates around 3.25% for a one-year term, and others offering up to 6% under specific conditions. While MMFs remain attractive for liquidity, recent market shifts have improved the yield-to-maturity outlook for certain bond investments, presenting better opportunities than in the past year.