The February issue of Crane Data's new publication, Bond Fund Intelligence, which tracks the bond fund marketplace with a focus on the ultra-short and most conservative segments, interviews Leonard Aplet, Senior Portfolio Manager at `Columbia Management and a portfolio manager on Columbia's institutional CMG Ultra Short-Term Bond Fund, one of the largest and oldest conservative ultra-short bond funds. Aplet is responsible for Columbia's short duration strategies, a major segment of the manager's $20.7 billion in bond fund assets. We reprint the article below. (Watch for our profile of J.P. Morgan's Dave Martucci in the upcoming March issue of BFI. Contact us to subscribe or for a sample issue.)
BFI: How long have you been involved in the space? Aplet: I started at Columbia in 1987 and have managed money market funds and short term bond products ever since. The inception date of the Ultra Short Term Bond Fund is March 8, 2004, and the inception date for the Short Term Bond Fund is October 2, 1992. While each of the funds have named portfolio managers on them, there are research analysts, traders, and other portfolio managers that are all part of the team.... My group is a multi-sector group; we manage funds and separate accounts that typically invest in more than one investment grade sector. Columbia also has other fixed income teams that manage shorter duration assets that specialize in a single sector.
BFI: Why was the Ultra Short Term Bond Fund launched? Aplet: At the time Columbia launched the Ultra Short Term Bond Fund, we saw a gap in the market between money market funds and short duration. Our short duration bond fund has as a benchmark the Barclays 1-3 Government Credit Index, so we wanted something between zero duration and 1.5-1.75 years. It was a space that was filled with the Ultra Short Term Bond Fund. The current benchmark for that fund is the Barclays Short Term Government Corporate Index and it's basically anything that falls below the Barclays 1-3 year Government Credit Index. It's an institutional fund and one of the things we've been looking at in this marketplace is the need for a retail offering in the ultra-short term area.
BFI: What is the investment strategy? Aplet: As you know, money market funds are very restrictive and our money market funds are very plain vanilla. They're prime funds and we don't stray from the safe and stable. But with the Ultra Short Term Bond Fund, the difference is it can invest in securities that are longer, even though the overall duration of the Ultra Short Term Bond Fund is not that much longer than a money market fund. It has a duration of around 0.6 years and the benchmark is 0.55 years. The Fund can be as long as a year so it can be quite a bit longer than money market funds. In terms of the individual securities, we will typically go out as far as three years on an individual security basis. So the Fund can employ strategies like barbells when the yield curve is steeper. That's something that a money market fund cannot do. We also can invest in the full range of investment grade securities, down to triple-B. Typically, a money market fund that buys prime securities only buys A1-P1 securities. So we can go down a little bit lower in credit quality but still stay within the investment grade universe. We can also buy tranches of asset-backed securities that are beyond the 2a-7 limitations. Overall, we can be a little bit longer with individual securities; we can invest in some asset classes that are not 2a7 eligible; and we can go down to the full extent of investment grade credit.
BFI: What is the outlook for supply? Aplet: In general, there are not enough bonds to go around. That's not going to get any better going forward, as the population ages, the preference for bonds grows, and a large percentage of US Treasuries are owned by foreign governments, as well as by the Fed itself. So all of that has taken supply out of the market, not necessarily just at the short end of the curve, but it has taken general supply out of the marketplace. There has been good supply of corporate bonds over the past couple of years, but that supply has been met with even higher demand. So when new securities come to the marketplace, they are generally over-subscribed and you can't purchase as much as you want. That has, I think, contributed to less liquidity in the market today. We want to make sure that the NAV price of the fund doesn't fluctuate very much, that we have securities that maintain their investment grade credit rating, and that we provide the necessary liquidity so clients can withdraw their funds when they need them.
BFI: What are the key challenges? Aplet: The recent rally has affected the longer end of the yield curve more than the shorter end, so it hasn't really impacted our yields as much. The very short-term yields have actually gone up a little bit over the past several months, but yields are still low. That's something that is hard to accept for some investors so they go out searching for yield -- sometimes in the right places, but sometimes in the wrong places. Or it could be the right place today, but the wrong place as the market changes. One of the challenges that we see is that besides the fact that yields are low, investors' preferences for yield is growing, so investors are maybe taking more risk today than they would have been comfortable taking a few years ago. We think that has caused more demand for products that are lower quality, especially in the ultra-short term space. Despite that thirst for yield, however, we have stuck with our strategy to provide the investment grade products that our clients signed up for and I think that's going to keep us in good stead as we go through this cycle.
BFI: How are regulations impacting this space? Aplet: Money market reform regulations are going to have a major impact. We also have money market funds, so we're in the process of making decisions on institutional vs. retail; prime vs. government, etc. So far I don't think these changes have caused a tremendous amount of fund flows. You have seen a few mutual fund complexes announce changes to their funds, but in general, people haven't really made those announcements. We're trying to assess what clients find most important -- Is it the floating NAV? Is it the potential for a fee or gate? There's still some time before investors make decisions, so we are evaluating our lineup as we constantly do. Our product development team is looking at the different options to make sure we are giving clients a full range of offerings. We're not yet at the point of offering anything new, but it's something we're definitely considering.
BFI: Has the space been attracting assets? Aplet: The ultra-short term bond space saw most of the asset gains about one to two years ago as investors sought out yield and safety of principle. Much of the money in ultra-short funds came from money market funds or cash-type investments. It's not that big a leap in terms of risk, but I think a lot of that movement has already occurred. So that movement into ultra short funds probably peaked a year ago. However the flows may pick up again if investors decide to move more funds from either lower yielding money funds or longer duration bond funds.
BFI: What is your outlook for rates? Aplet: Our economists see the Fed potentially acting in the second half of the year. The Fed has allowed the unemployment rate to fall below the level that they originally were looking for to raise rates, but they did that because they knew the participation rate was low and the underemployment rate was still pretty high. Now that the adjusted unemployment rate is coming in at about the level in which they previously said they would start raising interest rates, I think they are a little bit more anxious to act. Our view is it's a second half 2015 phenomenon, but instead of June, it might be closer to the end of 2015 before the Fed acts.
BFI: And rising rates might not be a bad thing, right? Aplet: I think people lose track of the fact that rising interest rates are not the worst thing in the world for ultra-short term and short duration products. It's going to drive better returns, especially if you look at returns on a total return basis. The NAV can fall somewhat, but in the case of our products, they are short enough that they won't fall very much, yet the increase in yield is going to more than make up for that. So, our investors are going to be better off if interest rates rise, even if it may not seem like it at the time. When the Fed does start raising rates, the good thing is that ultra-short and short duration funds are probably going to be as much or more rate responsive than money market funds, because there's so much subsidy in the expense ratio for many of the money market funds, more than the longer duration funds. Some of that interest rate increase needs to be absorbed by a reduction in that subsidy. So if rates go up 25 basis points, will the net yield on money market funds go up 25 basis points? I doubt that will happen.
