State Street Global Advisors released a new white paper called, "Meeting the Challenges: Six Strategies for the New World of Cash," wherein they introduce 6 new funds -- 3 money market funds and 3 ultra short-term bond funds/enhanced cash funds –- and discuss how they meet the challenges of the changing landscape of cash investing. We first reported on the new offerings back in July in the story, "State Street Files New 60 Day MMF, Current Yield, Ultra Short Bond," based on the initial SEC filings. This new white paper elaborates on the launches and comments on SSgA's larger strategy as it readies for the implementation of money fund reform. The 3 new money funds are: State Street 60 Day Money Market, State Street Institutional Liquid Assets, and State Street Cash Reserves. The 3 new "non 2a-7" or bond funds include: State Street Ultra Short Term Bond, State Street Current Yield, and State Street Conservative Income. We also recap some of the other recent ultra short term bond fund launches below.
The SSgA paper says, "The environment for cash investors changed dramatically after the Global Financial Crisis (GFC), when the federal government stepped in with new regulations to keep future liquidity dislocations at bay.... New 2a-7 rules were enacted to increase the liquidity of money market funds and improve the credit quality of underlying securities in those funds.... As before, any funds operating outside the 2a-7 requirements may not be considered "money market funds."
It continues, "It's hard to overstate the repercussions these various changes will have on the cash markets. The new banking rules will, among other things, heighten demand for short-term government debt and reduce issuance of short-term corporate debt. For their part, managers of prime money market funds have already lowered their risk tolerance and moved into shorter-maturity, higher-quality bonds, both government and corporate. The potential for supply-demand imbalances and lessened liquidity in certain areas of the market is obvious."
State Street writes, "As regulations come into effect in 2016, the floating NAV rule in particular is likely to lead institutional investors to shift assets out of prime and tax-exempt funds. Much of those assets are likely to flow into government money funds. Those flows, along with new banking regulations, will cause a leap in demand for short-term government securities, weighing down yields on these investments and funds that hold them."
They add, "But fortunately, today's challenges also present opportunities, particularly for those able to move beyond the traditional stable NAV marker for a portion of their cash needs. To provide a solution to the investment limitations now vexing some cash investors, the State Street Global Advisors cash team scribbled up its whiteboard with fund ideas. We're now bringing these six new funds to market, each designed to answer a different combination of challenges created by the post-GFC amendments, while maintaining a sharp focus on its investment strategy." (For more on SSgA's post–reform plans, see also our News story, "SSgA Says State Street ILR Will Float, Defends Gates, Fees or see SSgA's letter to shareholders.)
The white paper goes into some detail about each of the new funds. We start with the 3 money funds -- all of which fall within the parameters of 2a-7. First is the 60-Day Money Market Fund. "While this fund is a prime fund under Rule 2a-7 with a variable NAV, it will take advantage of an SEC position allowing assets maturing in 60 days or fewer to be priced at amortized cost, so long as the amortized cost value is approximately the same as the fair value of the security without the use of amortized cost. Holding securities maturing in 60 or fewer days will ensure this fund maintains high levels of liquidity. Meanwhile, the use of amortized cost accounting should provide a potentially steadier NAV than floating NAV funds valuing their portfolios using market pricing. This is a credit fund able to purchase commercial paper, certificates of deposit and time deposits. As prime funds potentially become less attractive, due to the complexity of a floating NAV, yield spreads between government securities and CP, CDs and time deposits could increase. That dynamic could present an opportunity for this fund to pick up yield while maintaining a high level of liquidity."
Second is the Cash Reserves Fund. "This fund will invest in commercial paper and other securities consistent with prime funds. These securities are likely to offer considerably higher yield than government issues, helping generate more yield than government-only funds. The fund will serve retail investors. As such, it will seek to maintain a stable $1.00 NAV while investing in prime securities. Retail prime funds are allowed to seek to maintain a constant NAV in the new regulatory environment because regulators observed that during the financial crisis retail investors did not redeem out of prime funds to the extent institutional investors did. Like institutional prime funds, this fund will nevertheless be required to adhere to new 2a-7 rules requiring the use of gates and liquidity fees."
Third is the Institutional Liquid Assets Fund. "While this fund does follow 2a-7 rules on liquidity and credit quality of underlying securities, it is not subject to additional restrictions from the major rating agencies. Funds not rated could have yield advantages while not posing significant additional risk. For example, this fund would allow the purchase of A2/P2-rated securities while the ratings agencies allow no A2/P2 rated securities. This fund may be ideal for investors who use ratings agencies as one input in their evaluation of money market funds but not as the determining factor. The fund will still purchase securities that meet top-tier ratings criteria, but will not have additional constraints that impede proper relative value evaluation."
Next, we look at the new funds that fall outside of 2a-7 in either the ultra-term bond fund or what's often called the "enhanced cash" space. One is the Current Yield Fund. "This fund purchases investment grade commercial paper with maturities no longer than 90 days. Rating requirements for this fund are less strict than those dictated by 2a-7 rules, allowing the fund to choose from an entire universe of investment grade securities. This fund can purchase A2/P2 securities, as well as A/3, P/3 and F/3 securities that mature in less than 30 days. A Moody's report found default rates of only 0.03 percent for A1/P1 commercial paper over a 40-year period, and only 0.04 percent for A2/P2 securities. Even when a CP issuer experiences a credit event, the risk of default in the short term is very low. This fund seeks to enable investors to benefit from securities issued by quality firms lower on the credit curve, while mitigating default risk by limiting the maturity range."
Another new offering is the Conservative Income Fund. "With this strategy, the fund can extend WAM and WAL limits beyond what is dictated by Rule 2a-7. The fund therefore is designed to provide additional current yield, while maintaining sharp focus on preservation of principal and liquidity to meet shareholder activity. This fund's WAM can stretch to 90 days; its WAL can go out to 250 days; and the per-asset maturity limit can be up to 760 days. By investing in longer-maturity securities, the fund may present an attractive yield for investors looking to invest "rainy day cash" that can be put aside for nine to 12 months. The fund has the flexibility to invest up to 20 percent of AUM in A2/P2 securities, limited to A2/P2 securities maturing in less than one year. This way, the fund can benefit from quality, higher-yielding names further down the credit curve. The fund has the flexibility to purchase up to 10 percent of AUM in illiquid assets. This allows the fund to enter a greater proportion of repo agreements, one of the higher-yielding fully-collateralized investments for cash investors."
The last addition is the Ultra Short term Bond Fund. "This bond fund carries a duration of one year, allowing the fund to purchase fixed rate assets further out the yield curve to potentially generate a higher current yield. Additionally, the fund will include floating rate assets to hedge against a future upward move in interest rates. Fund managers will purchase a wide range of investment grade credits to capitalize on relative value analysis that reveals names that typically provide higher yield without a significant increase in default risk. The stipulations include an average credit quality of single A for the overall fund, and no more than 30 percent of AUM in BBB and BBB+ rated names. The fund has the ability to purchase ABS investments (such as credit cards and automobile trusts) up to three years WAL for a broader choice of high quality assets. All ABS securities purchased will be rated AAA. The fund also has a greater AUM allowance for illiquid securities (up to 20 percent), offering a greater opportunity for term repo agreements. Investors in this fund seek to reduce interest rate risk while not giving up too-much yield. The ultra-short-term bond strategy is for investors willing to venture well outside of traditional cash guidelines and have at least a 12- to 24-month time horizon."
State Street joins a growing list of companies that have come out with or filed to launch "ultra, ultra-short" term bond funds (or "Conservative Ultra Short" as our new Bond Fund Intelligence, which tracks this space, terms them) since the SEC reforms were announced. Most recently, Morgan Stanley filed to launch Morgan Stanley Institutional Ultra Short Income Fund. Deutsche Wealth & Asset Management plans to introduce two new bond funds, Deutsche Limited Maturity Quality Income and Deutsche Ultra Short Investment Grade. In April, Western Asset Management announced that it was coming out with the Western Ultra Short Obligations Fund and Western Asset Short Term Yield Fund. In February, Vanguard came out with the Vanguard Ultra Short Term Bond Fund, and last July, Invesco launched its Invesco Conservative Income Fund. BlackRock, Fidelity, Putnam and a number of others also have offerings immediately adjacent to the money fund space. (See our latest Bond Fund Intelligence for more.)
