Below, we reprint the second half of our article, "Goldman's Olivo: Money in Motion; Short Opportunities," which originally appeared in the May issue of our new Bond Fund Intelligence publication. (We interviewed Goldman Sachs Asset Management's John Olivo. See yesterday's "News" for Part I.) BFI: Can you tell us more about the short duration portfolios? Olivo: In finding product for our portfolios, we have noticed that most issuers have had a preference to issue longer duration bonds over the last few years -- that's simply a reflection of how low rate have gotten. But you still do see a meaningful amount of issuance in the 3- and the 5-year sectors, so that is generally the area where most short duration funds will invest, specifically in the credit markets. (Note: We also wanted to remind those planning on attending Crane's Money Fund Symposium June 24-26 in Minneapolis to make hotel reservations by today if you haven't already; our discounted room rate expires today!)
When you move out to the 3- and 5-year part of the curve, one of the benefits you receive is much broader issuer diversification. You see the industrials issue a meaningful amount of supply in that particular part of the yield curve. Unlike a money market fund, where the credit allocation is primarily made up of banks and asset backed commercial paper, you get a much broader set of issuers in the 3- and 5-year space. There is a meaningful amount of industrials in the high quality "BBB" space. That said GSAM also manages strategies that focus more on "A" and above. We are still able to get a broad list of diversified issuers, but it's slightly more challenging.
BFI: What about strategies in separate accounts? Olivo: In the short duration separate account space, the defining characteristic for clients is the ability to customize their investment strategy. Many investors need to tailor their strategy specifically to the type of risk they want to own. A large part of our clientele consists of large multinational corporations whose cash is held "offshore." Given the current tax rules, the money is considered trapped -- it's subject to a large tax penalty if it were brought back onshore. With the high price of liquidity, many multinationals do not need overnight liquidity with their offshore cash. That said, they do not want the volatility associated with a longer duration strategy. Thus, many invest in a one to three year duration strategy, which equates to an overall duration of approximately 2 years. This affords managers greater flexibility in the credit and securitized sectors as well as the ability to create a diversified multi-sector portfolio.
BFI: How is the regulatory environment impacting your strategy? Olivo: We have yet to see a meaningful impact to our strategy due to money market reform. We do feel fairly confident that regulation will put money in motion and create opportunity in our space.
BFI: What is your outlook for rates? Olivo: It's difficult to draw a lot of conclusions from prior Fed tightening cycles because most expect this one to be quite different. Our call is for the Fed to begin raising rates in September, starting a tightening cycle where you could see 25 basis point hikes every other meeting. We believe the ultimate place the base rate reaches is likely to be data driven. Clearly inflation will be the biggest risk toward the Fed maintaining tightening or pushing out the start of the tightening cycle.
In terms of how short term investors are going to react, it's challenging to forecast that. You have a number of external factors weighing on the fixed income market -- there's the strength of the dollar, the price of oil, geopolitical events, or just the relative attractiveness of the US Treasury curve vs. other interest rate curves globally. It's difficult to forecast how the curve is going to react if the Fed begins raising rates with some of these external factors at play. In terms of asset volatility, we think that the short duration strategies should continue to be attractive given their ability to price in future Fed interest rate hikes relatively quickly. We're optimistic about these portfolios continuing to do well in a rising rate environment.
BFI: What do you think about the future of ultra short bond funds? Olivo: The changes that we're seeing on the front end are forcing liquidity investors to rethink their strategy. GSAM believes short duration strategies will continue to be a big part of an investor’s cash management solution. (See our latest BFI for the full interview.)
Finally, we again wanted to remind those planning on attending our Crane's Money Fund Symposium next month (June 24-26) at the Minneapolis Hilton to please make your hotel reservations today and register soon! Our discounted hotel rate expires today and we expect the hotel to be sold out shortly. (Visit here to make Hotel reservations and here for the conference agenda.) See you next month in Minneapolis!
