At Crane's 6th annual Money Fund Symposium in Boston, an expert panel explored trends in the money funds alternatives space during a session called "Enhanced Cash, SMAs, and Ultra Short Options," moderated by Alex Roever, MD, J.P. Morgan Securities. The panelists were David Fishman, MD, co-head of liquidity, Goldman Sachs Asset Management, Jonathan Carlson, MD, Bank of America Global Capital Management, and Peter Yi, director, short duration fixed income, Northern Trust. "What's confusing about this space is there's so much different nomenclature," said Roever, kicking off the session. There are short duration bonds funds, enhanced cash, some 3 or 4 different categories within this space between traditional money funds and the core bond fund.
"When you are talking to a client, how do you explain which strategy you are trying to sell them?" asked Roever. "Typically, you tell them whatever they are looking for is the exact sweet spot on the curve for them," quipped Carlson. "But there is a wide gamut so salespeople have to know who they are talking to, how much cash they have, how much risk they want to take with their cash, where the cash in domiciled -- all of those things go into the risk appetite. Depending on how opportunistic they want to be with a sleeve, or multiple sleeves, or even all of their cash, will define what space they're in. The more risk tolerant they are, the more that risk tolerance will find its way into the guidelines and the portfolios will get longer, go lower in quality, and make greater use of the securitized asset classes, those kinds of things. When we talk to clients, we talk to them about these sleeves and we work to supply a solution."
Yi said this enhanced cash space/short duration space started to gain traction after the financial crisis of 2008. "The first wave of general interest came from money market investors that ultimately got sick of the zero [yield] interest rate environment. But 5 years later, when the markets have healed and the economy has healed, they are asking the question, 'Why am I still getting 0?' So with this global search for yield, they are looking for new alternatives. When you offer them a more holistic cash management solution like segmenting your cash, allocating a certain percentage into your operational cash needs, a little bit to your reserve, then having your strategic bucket, it makes a little more sense for them."
So what are clients looking for in this space? Said Carlson, "Every client that comes to us says the same three things in the same order: One, it is our cash don't lose it; two, I want to make sure it liquid so I have it when I need it, not when you tell me I can have it; and three, give me some added yield in compensation for the risk that I'll let you take."
Fishman talked about portfolio construction. "When we look at a typical short duration benchmark, you are going to include Treasuries, government agencies, and high grade corporates -- those are the three basics in almost every short duration portfolios that we manage. What we've seen is, when rates were higher, sometimes that was enough. But as rates have been driven lower, people have started to add tools to their tool belt -- they've added asset-backed, then mortgage-backed paper, and as spreads have been tighter in each one, we've seen corporates expand out to high yield, usually triple-B. We don't see too many corporates going down into double-B, but you get into high yield, EM, bank loans, CLOs. What happens is, we keep adding categories as yields go lower."
He adds, "In the search for yield, people will start to explore other asset classes. There are asset classes that a short duration would have never have looked at before that they are now looking at -- high yield paper for one. Very short-time to maturity high yield paper was taboo in these types of products historically; now we have conversations with clients almost every day about adding that."
Yi says his firm spends a lot of time focusing on the new issue market. "Right now the dynamics in the new issue market are so robust, there are deals every week. It's really a healthy market and we view that to be a sign of really good dynamics for the fixed income space." He adds, "Most of the activity now is definitely in the new issue market. If you have the access to it, that's where you get most of your supply."
On the prospect of negative returns in a rising rate environment, Carlson said, "I think it's important to define what performance is. Total return is what we all live and die by, but it's not necessarily what our clients look at and its not necessarily, in our case, even what are clients are sometimes even remotely interested in." He continues, "Some clients don't even look at the page that shows the total return -- they want to know what is the book yield on their portfolio, what's the income that they are making. It matters internally, you want your composites to look good, you want to market yourself, but to a lot of clients, total return doesn't really mean all that much."
Also, the panelists spoke about the lack of an adequate benchmark in this space. "You can't find a great benchmark in this space," said Carlson. "There is not one that matches a mandate, so we have found, at least in the SMA space, the best benchmarks are other managers for that same client."
Finally, the panelists were asked if money market reform pushes money into the enhanced cash area. Said Fishman, "Reform is going to put money in motion, and money in motion has to land somewhere. The nice part is, there are a lot of landing spots for it. It's going to cause people to examine things they haven't thought about before. The world was very orderly before. We're going to go into a period of disorderliness when money fund reform gets announced. The first thing to do is take a deep breath and exhale -- there's nothing we need to do ... yet. But now is the time to start getting educated on what those options are. And yes, money is going to end up in this space by pure action of reform."
Added Carlson, "The Fed took rates to zero in the 4th quarter of 2008, and the size of the money fund industry is [still] $2.6 trillion. So there's got to be something that money funds offer that is over and above the zero rates.... Maybe I'm being way too simplistic, but dollar in, dollar out NAV has got to be a big one of those things. If that goes away, I think money almost automatically has to migrate into this space."
