In the June issue of our flagship Money Fund Intelligence newsletter, we profile Joe Lynagh, Fixed Income Portfolio Manager and Head of the Cash Management team at T. Rowe Price, in charge of all the firm's money market and ultra short funds. Lynagh discusses the changes that T. Rowe Price has made to its money fund lineup as the firm prepares for reforms, based on the mandate of "do no harm to existing shareholders." T. Rowe Price plans to offer a range of options, including a Prime Institutional fund. Lynagh also talks about why retail investors will stay with Prime funds, why Ultra-Short Bond funds will grow in popularity, and why differentiation will return to the market. A reprint of the Q&A that appeared in MFI follows. (Note: Thanks to those who attended Crane's Money Fund Symposium this week in Philadelphia! Safe travels home and watch for coverage of the conference next week and in the July issue of MFI.)
MFI: How long have you been running money funds? Lynagh: T Rowe Price's history with money funds goes way back. Our first money fund -- Prime Reserve Fund -- was launched in January of 1976.... Our first tax exempt money fund was launched in 1981 and our California and New York tax exempt money funds followed in 1986. We launched our Summit series of funds in 1993, starting with Summit Cash Reserves Fund and Summit Municipal Money Fund. Three years after that we launched our Maryland tax exempt money fund. So ... it's been a steady progression building out our product line-up. As our mutual fund business grew, we launched two internal money funds -- the `Reserve Investment Fund and our Government Reserve Fund. These funds serve as cash sweeps for our other mutual funds, primarily our stock and bond funds. They are internal money funds, but they have the lion's share of the money fund assets. In all, we manage about $45 billion in money fund assets, but the majority of that, call it $25 billion, is internal money fund assets. The balance, about $20 billion is in our publicly offered funds.
I joined T. Rowe Price in 1990 and moved to the tax exempt money market trading desk in 1994. I moved up from that position, ultimately to become a portfolio manager in charge of all the tax exempt money funds. In 2009, I succeeded Jim McDonald, who retired, to become portfolio manager of our taxable funds, heading up the management of all money market funds and cash.
MFI: What is your biggest priority? Lynagh: Getting prepared for the SEC money market reforms has been an all-consuming project for T. Rowe Price. The rule release in July 2014 set in motion probably the biggest multi-departmental, multi-function project I've ever been a part of.... This rule change touches upon just about every functional area across the company, so for our weekly conference call, it seems like a cast of thousands are signing on. The breadth of impact ... of these changes is huge.
MFI: Tell us about fund lineup changes. Lynagh: We started out with the basic premise of 'let's do no harm' to existing shareholders. Said another way, let's make sure we have a home for all of our shareholders. Then we did an assessment of our shareholder base. What are they investing in today and what would be the potential implications for those shareholders of the rule changes? With our internal money funds, virtually all the shareholders would be considered "institutions." The prospect of gates and fees, in effect a liquidity lockup, is simply untenable to those investors. So our internal Reserve Investment Fund will migrate from a prime to a government strategy. Our Government Reserve fund is in fact a Treasury fund; it will be renamed Treasury Reserve fund. So all of our internal money will move to a no fees, no gates ... platform.
In terms of our client-facing money funds, T. Rowe Price has always been primarily a retail-focused shop. While we have institutional accounts in our money funds, we never created a separate institutional fund, until now. If you look at our lineup going forward, we made the decision with all of our municipal money market funds that we will only offer a retail share class. Quite honestly, the amount of institutional assets they held was so small, we didn't feel that it was productive to launch an Institutional tax-exempt product.
With our two prime strategies -- Summit Cash Reserves and Prime Reserve -- we looked at the constituents of those funds. Taking into account our original mandate to 'do no harm' and to make sure that there is a home for all shareholder assets, we realized that we need to offer a Retail Prime strategy, we need to offer a Government strategy for those shareholders that are uncomfortable with gates and fees, and we needed a prime strategy for institutional shareholders. We already had a treasury money fund, so we checked off that box. We decided to convert the Prime Reserve fund into a Government strategy, re-named the Government Reserve Fund. We decided that our Summit Cash Reserves Fund would remain Prime and become our flagship Prime retail offering.
MFI: Tell us about the new Prime Institutional fund. Lynagh: Recognizing that we need a landing place for those institutional shareholders that want a prime strategy, we will be launching a fund that we are going to call Institutional Cash Reserves. We'll be launching that sometime in September of 2016. As we go through the summer, we've already begun communications with shareholders in all of our money funds, alerting them of these changes.
MFI: What is the biggest challenge? Lynagh: Right now, the biggest challenge is trying to ascertain where the asset flows will go, what the scale of assets is that will either be forced to redeem or will opt to redeem, and how assets will move back and forth among strategies. Cash Reserves is a good example. There's been a lot of work done trying to identify who the shareholders are.... [W]e feel like we've got a good handle on those institutional assets that will need to choose a different offering than Summit Cash Reserves. But there is also the larger unknown about the flows industry-wide that will be set in motion by reform.
In the fourth quarter of 2016, shareholders are going to see where they've landed and that's going to coincide, hopefully, with a Fed rate increase. As rates begin to move higher and returns begin to differentiate among these various products, investors are going to probably take another look around at their options. So I think managers will be faced with this continuing unknown variable of assets in motion for some time to come. You see that uncertainty manifest itself in the shorter WAMs and higher liquidity position that most funds are running these days. We all face a summer where the assets flows are uncertain and that makes you very circumspect about longer-dated investments.
MFI: Are you hearing any customer concerns? Lynagh: The retail money market experience is very different from that of an institutional client. If you go back to 2008, retail funds simply didn't see the asset movement like we saw on the institutional side. It was a non-event. They've never run. Retail money funds will continue to live on because they don't have the run risk. They have such a diverse and broad base of decision makers that the prospect of a run is extremely remote. Institutional assets -- because of their scale -- will simply find another way to access capital markets. The industry is going to reshape itself where I think the prime strategies will be dominated by retail assets, which takes us full circle back to where we started back in the mid-70s.
MFI: How about fee waivers? Lynagh: Our Summit Cash Reserves fund is finally at a point where our gross yield has crossed its expense ratio threshold. Today we're grossing about 50 basis points vs. an all-in expense ratio of 45, so we crested above. Relief for the other funds will come on a market by market, mandate by mandate basis. Our Government and Treasury strategies will need at least one more Fed tightening to get those gross yields up where we are being made whole in terms of our expense ratio. It's really only in the last two months that Tax-Exempt yields have recovered, so they'll need certainly one full rate increase to get whole in terms of the expense ratio. It's important to note that we don't have any "claw-back" provisions.
MFI: Do you see demand for Ultra-Short funds growing? Lynagh: The reforms of 2014 really force investors to re-think cash investing. We launched our Ultra-Short Bond Fund in December 2012, and it was forward thinking in terms of what the landscape was going to look like in the post-reform money fund world. If you look at that landscape today, assets in government funds have now surpassed that in prime strategies.... But the demand for government assets, in my opinion, is also going to create a suppressive effect on government yields, especially in the front end of the yield curve. So money fund investors are going to realize there's a significant gap between the yields they see on their government fund compared to alternatives out there in the rest of the market. They're going to be faced with a choice -- Do I want to go into a prime money fund?
If you're an institutional investor, you're probably going to balk at that, at least with some portion of your assets, because you're concerned about gates and fees. So, you're going to be seeking out non liquidity restrained investment alternatives, and ultra short nicely fits that bill.... Money funds will always have a home, but there may be a yield give-up, which is the cost of liquidity. We believe liquidity 'tiering' is the solution; it will be productive to combine that operational cash -- your government money fund, with a more strategic investment, like ultra short bond. It's our opinion that you're going to see more and more investors begin to strategically reallocate a portion of their cash into alternatives like ultra-short bond funds and perhaps even stretch that into short term bond funds.
