In an hour-long webinar on June 19 called "A Look Under the Hood of Money Market Funds," Vanguard money market portfolio manager David Glocke and Vanguard senior investment strategist Sarah Hammer discussed interest rates, regulatory issues, the European Central Bank, and portfolio management strategy. Vanguard is the 5th largest money market manager in the U.S. with $171.8 billion in money fund assets as of May 31, 2014. The Vanguard Prime MMF is second largest money fund in the U.S. with $101.8 billion in assets. When you include the $27.9 billion in the Vanguard Prime Institutional Fund, the Vanguard Prime Portfolio is the largest money market portfolio in the U.S. with $129.7 billion in total assets. It surpassed the Fidelity Cash Reserves Portfolio as the largest in November 2012.
The Vanguard produced webinar featured Glocke, who manages the Vanguard Prime Money Market Fund, taking questions submitted by viewers on a range of topics. Here are some excerpts. When asked how long the zero interest rate policy will be in effect, he said: "We've been 6 years into the recovery but economic conditions are starting to respond finally. Chair Yellen yesterday responded to some of the changes that took place just in the last two months since the last FOMC meeting. Ultimately the Federal Reserve is looking down the road and they are starting to see better signs. We're seeing it in the estimations of where the federal funds rate may end up moving over the course of the next one and two years, so we feel a lot better about market conditions and at some point the Fed will raise interest rates, which is something money market investors I'm sure would be appreciative of."
On the subject of SEC regulatory changes, Glocke said: "Ever since the financial crisis and the Reserve [Primary Fund "breaking the buck"] event, the SEC has been active in trying to find ways to enhance money market product, make it more attractive to investors, and provide the confidence to them that the money market is an appropriate investment option. In 2010 they came out with a first set of new rules for money market funds." Those changes included enhancements to liquidity, know your client rules, reducing the average maturity in a fund, and putting limits on ther amount of lower quality debt in a portfolio, he explained. These changes were made with the intentions of doing more, he added. A year ago, the SEC issued a 698-page report that included new ideas they are considering.
"Since that time we have been patiently waiting for the SEC to conclude their study of that information and release the new sets of rules, but we haven't heard anything yet. The Wall Street Journal recently reported that there's still some dissension amongst the SEC Commissioners on which way they want to go with this. They speculated [that] it might not be until the end of the summer that the new rules may or may not come out. So I don't think it's best to speculate on what may or may not happen over the course of the next few months."
Glocke was also asked about the European Central Bank's recent move to lower the deposit rate. "The ECB recently took their deposit rate from zero, which they set in 2012 in response to the financial crisis that was taking place in Europe, to -0.10%. That has happened before. We've seen Sweden and Norway take their deposit rates into negative territory. It's unusual but not unheard of. What we're seeing is the ECB trying to respond to the marketplace, trying to encourage banks to lend more in essence, by setting a negative rate. It may be more symbolic than anything else as far as its actual benefit to the overall marketplace, so we're not expecting a major change to come out of it."
A Vanguard investor asked, "What scenario would lead to a MMF loss? Glocke answered, "A challenging question. We think back at 2008 period when Lehman event took place and the Reserve Fund broke the buck -- and that became a major concern across the board for all of us. But what we do on a day to day basis is all designed to try and manage the portfolio in a way to reduce the risk of such an event ever taking place. And it's done in multiple channels. For instance, at the first level, we would have 20 senior credit analysts working in our fixed-income group, and they make the decision about which securties, which issuers, are eligible for investment.... [T]hen we take it to next level where we are concerned about big issues in the marketplace, broad issues that can affect our investment strategy, and there we have meetings with other parts of the FI group within Vanguard."
He continues, "Finally at the desk level where we manage the actual cash, we'll take that approved list of issuers and we'll structure our investments, focusing on high quality assets, particularly. There's a ratings spectrum that's out there in the marketplace and we'll take the highest level quality assets. We'll focus on those and we'll be willing to invest for a longer period of time in those securities.... [T]hen as we go down the spectrum of credit quality we'll reduce those expsoures -- then we'll also manage the overall amount that we're buying of a particular name. So the higher quality names like U.S. Treasuries and Agencies, we have an unlimited number of those that we can buy. Yet other securities, we'll put hard limits on how much we are willing to invest."
Glocke comments, "Then we'll try to structure it across the maturity spectrum, so we spread those maturities out. The primary reason behind that is if there is a liquidity event in the market -- it may not be a credit issue but a liquidity event -- that may reduce the demand for a particular security, its price can be impacted. So by having the maturity structured across the portfolio, we're able to step into the market and allow securities to mature rather than put stress on the market and sell into it. And gradually over time we can get out of a position we may feel we are uncomfortable with.... It just allows us to react earlier rather than later."
Finally, he adds, "We did that back at the time when there was concern about bank problems in Europe. In 2010, we started to get the sense that ... there were problems starting to emerge. So we awere able to gradually reduce our exposures over time by just allowing the positions to mature in the fund. [We] didn't have to put any stress on the market and it was about a year, year-and-a-half later that things became unwound ... by then we were already out of the positions that would have been a concern."
