Below, we excerpt the second half of our article, "Short Now Big at PIMCO: Talking w/Schneider & Reisz," which appeared in the inaugural issue of Crane Data's new Bond Fund Intelligence publication. (See our Jan. 27 News, which features Part I of the interview here or see the January issue of BFI.) BFI: Is the ultra-short space getting more crowded? Schneider: The space is becoming more crowded because there's more interest from the investor side. The reality is, managing a 2a-7 fund and managing in the short-term space are two entirely different propositions. The reason is because you have to be thinking about liquidity, not just simply from a duration or interest rate perspective, but also in terms of market risk and market orientation.

That requires managers to focus on what bonds are liquid in times of defense when clients need it. Building an infrastructure that caters to that is paramount. We've been doing it for 40 years. It's been tried and tested through the 2008 financial crisis and more recently, the European crisis. For us, the number one focal point is looking at the funding element and the financing element. This is sort of the barometer of the overall health of the front end market.... You want to be opportunistic and sell rich bonds when you can and buy cheap bonds when you can. That's the beauty of active management as opposed to buying an asset and holding it to maturity.

BFI: What is your strategy in the short-term space? Schneider: At PIMCO, we focus on 4 things -- liquidity, capital preservation, credit risk, and macroeconomic conditions. What differentiates us is our broad and deep team of portfolio managers and analysts and our top-down macroeconomic process that drives portfolio construction that other managers may not have. For example, our resources are extensive. We have over 60 credit analysts worldwide who focus on individual credits from the bottom up -- a robust platform that strives to add value and protect the portfolio. In addition, our macroeconomic process is a critical component of our portfolio management.

Reisz: Another important consideration in constructing these portfolios is our emphasis on the key objectives of principal preservation and liquidity. These are cash alternative portfolios where investors aren't looking for a surprise -- that is what we always keep in mind, so our strategy is to make sure that these portfolios are well diversified and that they maintain a high level of liquidity.

BFI: How are regulations impacting you? Schneider: Overall, supply has decreased for a variety of reasons. What we focus on at PIMCO is relative value opportunities. Those have really been attractive to us for a variety of reasons. We've used our credit sources, our structured products resources, and a variety of different avenues to look beyond the constraints of a typical money market instrument. We've been active in using our resources to do reverse inquiries with corporate issuers, looking at buying low volatility assets, around the world, through avenues that typically haven't had their stones turned over in many years. We were pioneers in this and we will continue to look for ways to actively pursue better risk adjusted investments.

Reisz: That's why active management is important; it helps us navigate supply changes or rising rates. It also provides the flexibility to invest in various sectors, in fixed vs. floating rate by utilizing a broad and diverse toolkit.

BFI: Do you see assets flowing in from money funds or longer-term bond funds? Schneider: This is an evolutionary process. We don't expect everyone to go stage left all at once. This has been a bespoke, individual dilemma for institutional and retail investors. We've seen interest evolve over the past three years and it's going to continue to evolve, precipitated by changes in the regulatory environment over the next year or two. Investors need to be cognizant of that and consider new avenues.

Reisz: Money markets will still play an important role within a liquidity strategy, but investors will probably start to focus on how to tier that liquidity. How much should I allocate to money markets? How much should I allocate to short duration strategies that might earn a little more than money markets? That's why we've developed a broad range of strategies, to make sure we're covering the different investor profiles and needs.

BFI: What is your outlook for this space? Schneider: Even in an environment where interest rates may increase, ultra short strategies have the potential to perform well on a risk adjusted basis. Supply constraints are going to continue to limit the ability to generate attractive yield in money market funds. Investors want not only yield, they also want to be more nuanced in how they choose strategies to manage their liquidity, and that is where short term strategies may be beneficial. Our focus is on the middle of 2015 for the initial rate hike, but we believe the Fed is going to be deliberate in how it continues to tighten. We may not see a hike at every meeting or even at every other meeting -- it will be as the data permits.

Note: Crane Data recently launched Bond Fund Intelligence to track the bond fund marketplace with a focus on the ultra-short segment -- see our Dec. 23 News "Crane Data Launches Bond Fund Intelligence, Focus on Ultra-Shorts". Contact us if you'd like to see the January or our pending February issue, which will feature an interview with Columbia's ultra-short bond fund team.

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