The June issue of our flagship Money Fund Intelligence newsletter features an interview with Peter Yi, Head of Short Duration Fixed Income at Northern Trust Asset Management. Yi discussed a range of topics, including how his firm is responding to money market reforms, the growing interest in ultrashort bond funds, the biggest challenges, the top priorities, and other topics in the money markets. The first half of our article follows. (Note: Yi will also moderated the "Dealer Panel: Supply Update and Outlook" at Day 2 of Crane's Money Fund Symposium, which started yesterday and which runs through Friday in Minneapolis.)
MFI: How long have you managed cash? Yi: We've been managing money market funds since the 1970s, when we created our first cash sweep vehicle in our trust department. We've been doing this for a long time and have demonstrated a commitment to the money market business. We view cash management to be a flagship capability and a product that caters incredibly well to our institutional asset servicing business and our wealth management franchise. Right now we're managing about $235 billion in assets across various money market funds and short duration products and strategies. Of that $235 billion, about $85 billion is in money market funds. The remainder is in STIFs, "sec lending" reinvestment vehicles, ultra short fixed income strategies and separately managed accounts. What resonates most with investors across all these strategies is our conservative investment philosophy that emphasizes credit research and risk management.
MFI: What is your top priority right now? Yi: Both internally and externally, I'm spending an enormous amount of time focusing on money market reform. Without a doubt, our number one priority is to focus on our investors and find the right solutions for them as the reforms take effect. We have the benefit of a reasonably long compliance period for the new structural changes for certain types of money market funds. Our message to investors is that we believe that this is enough time for everyone to thoughtfully assess their options and not react in a disruptive, knee-jerk manner. It's very valuable to engage with our money market investors, observe reactions to these changes, and think about what we can do to address their liquidity needs in this changing industry. It's also especially important to ensure that our investors have a voice in our product evolution.
Aside from the regulatory debates, I'm spending a lot of strategic focus on our ultrashort fixed income product offerings. Investors have been drawn to our ultrashort strategies as some money market investors are seeking more yield, while core fixed income investors are positioning for higher interest rates. Our view is the ultrashort space will continue to be popular and gain traction. With the money market landscape changing, we're ensuring that Northern Trust is nimble enough to quickly adapt to investor needs.
MFI: What is the biggest challenge managing cash today? Yi: In today's environment, we remain sensitive to the pricing of risk in the money market space, especially with historically low interest rates. We're concerned that we're not getting paid enough, through the interest rate, for taking credit risk. Demand for high quality instruments continues to outpace supply. We operate in an environment where high quality issuers can increase their offering by one basis point and that is met with billions of dollars of interest from portfolio managers. We think that's an unhealthy dynamic. So we continue to debate the question -- are we getting paid for this risk? In these situations, relative value assessments become critical within our portfolio positioning.
The biggest challenge we see in the intermediate to longer term is the supply dynamics of the money market sector. Money market PMs are focused on high quality issuers with short maturities. We are now facing an environment inundated with regulatory constraints for issuers and investors.... This dynamic will make it much more difficult to source high quality instruments that traditionally were available to money market funds. The sensitivity to regulatory metrics like capital and leverage ratios will continue to strain issuance. Issuers globally are being driven to be less reliant on the short term wholesale funding markets and are certainly motivated to seek longer term liabilities, so this will continue to be a big challenge for the industry.
MFI: Are you preparing portfolios now for October 2016? Yi: As of right now there aren't a whole lot of changes, but as we get closer to September and October, which is approximately one year from the structural implementation compliances dates, we'll start to see some changes in how Portfolio Managers are repositioning their portfolios to adjust to new market liquidity dynamics and investment demand considerations.
MFI: Are you expecting large flows? Yi: Our investors want to know more about the new rules and are concerned about how some of these changes will impact their traditional use of money market funds. They're concerned with situations where they can't access their cash when they need it. They're concerned with the operational complexities of a floating NAV structure. The new complexities at the very least give them reason to pause and reflect on how they use money funds, and they are willing to see what other liquidity solutions emerge. In terms of flows, we believe that some investors are simply not comfortable with a VNAV structure or any imposition of a redemption gate or liquidity fee.
However, since government money market funds are exempted from these structural changes, there's still going to be a money market product that will preserve the CNAV structure. We think it's reasonable to believe that some investors will simply move to a government fund if they're in a prime or tax-exempt strategy today. But over time, we do think credit spreads will widen because government securities will continue to have incredible demand from these initial investor shifts. When that happens, we expect a new market equilibrium will develop, with a more meaningful difference between yields in credit funds and government funds. Some investors that initially shifted to government funds will move back to prime funds <b:>_. (Look for Part 2 of our interview with Peter Yi in the coming days, or see our latest issue of `Money Fund Intelligence.)
