Why Institutions Pair Short-Term Fixed Income with Unfunded Exposure

Summary

The document asks why institutional portfolios might hold a sizable allocation to short-term fixed-income instruments, such as repo, while also maintaining a similarly sized unfunded position in another asset class. It distinguishes this allocation from cash kept to meet routine near-term outflows and questions whether the combination is economically efficient.

The central issue is the comparison between carry earned on the liquid assets and carry paid on the unfunded exposure. The author suggests that reducing the short-term allocation and funding the other position could be more efficient, potentially avoiding a spread between the two carry rates. The document offers no answer or supporting analysis, so it does not establish when the arrangement makes sense. It leaves open considerations such as liquidity needs, collateral, financing terms, and portfolio constraints.

Key ideas

• The document questions why institutions hold short-term fixed income alongside unfunded exposure in another asset class.
• It asks whether the liquidity allocation earns enough carry to offset the cost of the unfunded position.
• It proposes replacing excess short-term holdings with a funded position as a possible efficiency improvement.
• The document presents the question without resolving it or evaluating other institutional constraints.

Tags

# Does it make sense to have an allocation to short term fixed income and a leveraged or unfunded position?


# Does it make sense to have an allocation to short term fixed income and a leveraged or unfunded position?












This may sound like a basic question but I have seen many large institutional investors have this as part of their asset allocation and am wondering why they do this?

Does it make sense to have a large allocation to short term funds (such as repo and other short term fixed income instruments); and simultaneously have a similar notional amount in an unfunded position in another asset class.

When I say a large allocation, I mean on the order of 5% or more, and certainly more than an allocation that one would view as a checking account to meet any short term cash outflows.

Wouldn't the carry cost of having an unfunded position exceed any carry one might earn on having this excess liquidity position? Wouldn't it be more efficient just to reduce the allocation to the short term instruments and take a funded position instead? They would at least be able to recapture the bid ask spread between the short term instrument and the carry of the unfunded position (assuming they are funding with the same reference rate like repo). Wouldn't the excess liquidity allocation just be dead money since unfunded position requires carry?

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.