Madison Short Term Strategic Income ETF (MSTI)

The Madison Short Term Strategic Income ETF (MSTI) traces its origins to a straightforward investment need: there are times when an investor wants income from bonds but does not want the interest-rate risk that comes with holding longer-dated securities. When long-term rates rise sharply, the price of a 10-year bond falls hard; a fund holding only short-term bonds or floating-rate instruments suffers far less. MSTI was created to serve that demand — investors seeking current income from their fixed-income allocation without excessive exposure to the pressure that rising interest rates can exert on bond prices.

The founding logic

When MSTI was launched, the US bond market offered a wide spectrum of duration and yield. Investors could buy Treasury bonds with maturities from 3 months to 30 years; they could buy corporate bonds of varying credit quality; they could buy mortgage-backed securities backed by pools of home loans. Yet most bond ETFs asked investors to choose between extremes: either hold money-market funds (nearly zero risk, nearly zero yield), or hold intermediate or long-term bond funds (higher yield, but substantial price sensitivity to interest-rate moves).

MSTI stepped into the middle ground. It holds a mix of bonds and income-bearing securities with maturities or duration targets of roughly 1 to 5 years — longer than Treasury bills, short enough to cushion against major rate swings. In a rising-rate environment, short-term bonds hurt less than long-term ones because they mature (or reprice) faster. The fund is designed for investors who have given up on near-zero money-market rates as too meagre but do not want to accept the full duration risk of a barbell or long-term core bond allocation.

Portfolio composition and strategy

MSTI’s holdings mix government debt, corporate bonds, and mortgage-backed securities — the exact blend shifts with market conditions and the fund manager’s outlook. In periods when credit spreads (the extra yield companies pay relative to Treasuries) are wide, the fund might hold more corporate bonds to capture that extra return. When spreads tighten, Treasury duration or floating-rate notes may dominate. The fund is actively managed in the sense that a human portfolio manager or team makes allocation calls, but it operates within strict constraints: all holdings must fall into the “short-term” bucket (maturity or duration within the stated range).

The benefit of this approach is clearer income than a money-market fund, with less price volatility than an intermediate-bond fund. If short-term rates are 5 per cent, MSTI will yield somewhere in that ballpark — not enough to get rich on, but real current income that compounds. The cost is that MSTI will not capture the full upside if rates fall and longer-term bonds soar in price. When the Fed cuts rates and long-duration bonds rally hard, shorter-term bond funds lag.

Interest rates and opportunity costs

MSTI’s value proposition is tied tightly to the level of short-term interest rates in the economy. When the Federal Reserve keeps rates at near-zero (as it did from 2009 to 2021 and again during the 2020 pandemic shock), MSTI cannot offer much yield. A 0.1 per cent or 0.3 per cent annual return hardly justifies the fund. But when short-term rates rise — as they did in 2022 and 2023 — MSTI becomes attractive because money-market funds and short-term bond funds suddenly offer 4 per cent, 5 per cent, or higher. The fund then attracts inflows from investors tired of holding cash at almost no return.

This also means MSTI’s appeal is cyclical. Investors rotate into it when rates are high and out of it when rates are low and the opportunity cost is least painful. That is not a flaw, only a reality of the fund’s design.

Risks and trade-offs

The main risk is credit risk — if MSTI holds corporate bonds and the issuer defaults, the fund loses money. The fund mitigates this by focusing on higher-quality credits and spreading holdings across many issuers, but credit defaults do happen. During a severe recession, the short-term corporate bonds MSTI holds might suffer defaults at elevated rates, dragging down performance.

A second risk is reinvestment risk. Short-term bonds mature frequently, and the fund must reinvest the proceeds. If rates have fallen since the bond was bought, the newly purchased bonds will pay less. In a falling-rate environment, this “reinvestment drag” compounds the lag versus longer-term bond holdings, which locked in higher rates years earlier.

Finally, there is the inflation risk. If inflation rises, the real purchasing power of MSTI’s cash flows erodes. A 5 per cent nominal yield is worth far less if inflation is 6 per cent. Unlike longer-term bonds (which suffer capital loss from rising rates), MSTI doesn’t protect against inflation through price appreciation of the bonds themselves.

How investors use MSTI

MSTI typically appears in portfolios as a parking place for short-term bond or “cash plus” allocation. It appeals to savers who want slightly more yield than a money-market fund and are willing to accept modest volatility in exchange. It also suits investors who have a short time horizon — say, they will need the money in 3 to 5 years — and want to avoid the interest-rate risk of longer bonds. For those saving for a down payment on a house in two years, MSTI is less risky than a stock fund but more rewarding than cash.

The prospectus and fact sheet detail the fund’s duration, average maturity, credit quality distribution, and yield. Anyone considering MSTI should review those documents and understand the fund’s performance in rising and falling-rate environments — what happened during 2021–2023 (rising rates) versus 2019–2020 (falling rates) — to calibrate their expectations.