Last Wednesday, we excerpted the first half of Money Fund Intelligence's latest fund manager "profile," "State Street Global's Meier & Smith on MMFs." MFI interviewed `SSgA's Steve Meier and Barry Smith and discussed the Boston-based manager's history with cash, recent challenges in the short-term markets including concerns about Europe, and the regulatory outlook for money funds. We reprint the second half of the piece below.... Our last excerpt asked about French banks at the end.
Meier told MFI, "Some French banks have exposure to Greek debt. We have been very conservative in terms of our assessment by assuming that at some point Greek debt may be restructured and there may be a 50% reduction in the principal value of holdings. But even if this were to occur, it would be a relatively small percentage of core capital for those institutions, only one to two quarters of earnings. You need to be selective, but we are still very constructive on several French banks. European bank obligations are a very significant component of the market. We're four years into this global financial crisis, and those banks have done a fairly good job in terms of diversifying their sources of funding, extending their liabilities, and reducing their reliance on wholesale funding. All of that makes us more comfortable.
But the other consideration is headline risk. We want to buy high credit quality securities for these portfolios that have safe yield. But you also buy these institutions on a relatively short basis to mitigate the risk of a concern if there is a deterioration of credit quality or liquidation down the road. We aim to be transparent with our clients by providing context around why we are comfortable with specific banks, and we strive to mitigate risks associated with liquidity drains at these institutions by keeping maturity relatively short.
Q: Are you guys getting customer calls? Smith: We are getting calls from clients, and I think that is a good thing. One of the most important lessons investors have hopefully learned from the financial crisis is that cash as an asset class requires the same up-front due diligence and ongoing monitoring as any other asset class. The calls we are getting are from clients who are seeing something going on in the marketplace, making a connection to holdings in their own portfolio, and then making a reasonable inquiry of their asset manager. What we have not been seeing in recent weeks is the kind of panic response to news that you would have seen at the height of the financial crisis.
Q: How are low yields impacting the business? Is State Street committed to cash? Smith: State Street is absolutely committed to this business. We are one of the largest managers of cash assets globally and we are well-diversified. While registered 2a-7 funds are a critical component of our cash business, it is just one piece.... We run everything from securities lending cash collateral accounts, to pool funds, to separate accounts. As we look forward, one thing that won't change is our clients' need to invest cash assets. I am confident that State Street has the breadth of resources and investment expertise to be able to respond to any changes that may come about and will continue to help our clients meet those needs. As far as the fee waivers, I would say that they are an impediment to our revenue stream, but the business is not unprofitable. There may be an individual fund, particularly the Treasury funds, etc., but when you look at the business as a whole it is still a healthy and commercial business.
Q: Are you guys seeing more demand for yield or separate accounts? Smith: There is a lot of concern about the low rate environment and that has a lot of people asking what they can do to increase their returns. In most cases, we are hearing, 'The low rates on money funds are killing me. What can you do to get me a higher rate of return'? These conversations generally focus on a separate account as an alternative. But I am concerned that this is being asked without consideration for the risk/reward payoff in doing that. These discussions need to be about risk and return, not just higher yields. However, while I hear a tremendous amount of conversation on this topic, I do not see a significant number of clients across the industry funding new separate accounts. It is unclear at this point whether that will change when the rate environment changes.
Q: What about the future? Smith: It's difficult to say what is going to happen. There are a variety of ideas out there, some of which we like more than others. The one thing I hope for is that any changes that do come about actually make the product stronger and better and don't just represent change for change sake. The financial crisis was the proverbial 100-year flood for our industry. I think any additional proposed changes should be benchmarked against that crisis and be required to demonstrate that it meaningfully adds resilience to that environment.
Meier: The SEC did go a long way with 2a-7 reform, most significantly by imposing an overnight and 7-day liquidity requirement and placing a limit on the weighted average life of a portfolio. This does a lot to reduce the spread duration risk of the funds. But I don't think you can eliminate all the risks associated with managing money, be it an equity fund, bond fund or cash portfolio. Smith: I think one of the biggest challenges is that both my and Steve's jobs have become a lot more interesting. Our goal at SSgA is to help make cash management boring again.
