The August issue of our flagship Money Fund Intelligence newsletter features an interview with Jerome Schneider, Managing Director and Lead Portfolio Manager for Short Term Strategies at PIMCO. Schneider oversees not only money market funds, but all short duration strategies. In that role, Schneider and his team have positioned PIMCO to compete in an evolving marketplace, "focusing on actively managed strategies which offer liquidity management, capital preservation, and income." As he tells us, investors are now dealing with a "different set of cards" that will change the game going forward. Schneider discusses those changes and PIMCO's strategy of creating opportunities in 2a-7 and beyond. The first half of our article follows.
Q: How long has PIMCO managed cash? Schneider: PIMCO has been involved in managing cash for more than 40 years. Our evolution emanated from the growth of the initial 2a-7 fund and the launch of our low duration strategies in the late 1970s. While we aren't the biggest money market fund manager out there, it's always been at the forefront of our thoughts as one avenue to protect our clients' capital. Through all of the different stress points in the market, our goal has always been to provide liquidity, income, and capital preservation in nominal and in some cases, inflation-adjusted terms. We seek to constantly adapt to the changing market conditions with our strategies in order to sidestep pockets of illiquidity and to take advantage of market dislocations. Ultimately we need to be cognizant of evolutionary changes in the marketplace and educate our investors on the impact of these dynamics on liquidity and capital preservation.
Q: What's your background? Schneider: I came to PIMCO in 2008. I worked initially with my predecessor Paul McCulley, who ran the desk for many years. Together, we were the perfect marriage in a lot of ways. We blended monetary policy and the 'wonkish' side of economics, if you will, with the practical side of understanding the plumbing of the front end. When Paul departed in 2010, I took charge of our money market, short term, and low duration strategies, and we've continued to grow our capabilities. More importantly, as we embark upon the first rate hike in many years, we're dealing with a different set of cards that is going to make the game entirely different going forward.
Q: Tell us about PIMCO's money funds. Schneider: Our true regulated 2a-7 money market fund segment is relatively small -- right now it's between $1 and $2 billion. However, we believe there is value in looking beyond the typical confines of money market funds to find attractive risk-reward profiles for our clients. For years we've been using short-term, floating NAV-type strategies that limit duration, provide liquidity, and add value while still preserving client's capital.
Our desk manages over $200 billion of short term assets in these various strategies across the front-end. Some investors value investing across the entire spectrum of front end dollar and non-dollar opportunities, so we've created a suite of strategies that provide an array of liquidity solutions. So while our footprint in traditional 2a-7 space is limited, our capacity in terms of strategies that are very similar to 2a-7 is actually very creative and robust, and is probably often understated by the marketplace.
Q: What changes do you see in the marketplace? Schneider: Obviously, the shift from Prime to Government is going to be more of a strategic shift for many investors who want to maintain that $1 par NAV and avoid fees and gates. We have money funds that are going to remain available and we have the capacity to continue to grow those funds. But over the next 2 years or so, we think we will see an evolution out of the liquidity management paradigm that we've had for the past 40 years into a new one that is continuing to be defined.
It's not completely formed, and in fact it's in the embryonic stages. As things change -- such as regulations, banks, intermediaries, monetary policies, and even monetary tools such as the reverse repo facility -- all of these things are going to impact how we think about capital preservation and liquidity going forward. Investors are going to have to understand these changes and rely on partners who can help them. Most importantly, we suggest that investors should not limit themselves to the historic frameworks that the industry has used for the past forty years to manage liquidity. Liquidity management will evolve and investors will benefit if they are flexible enough to adapt to these changes.
Q: What else can you tell us about the new paradigm? Schneider: When you think about previous Fed hiking cycles, you typically have seen money market fund yields rise. This time is different. With the overwhelming demand outstripping supply, you could potentially see yields on money market funds stay relatively low for a hike of 25, 50, or even 75 basis points. It is important for investors to understand this as they need to think about the opportunity cost of remaining in money market funds yielding near zero and not taking incremental steps slightly outside of those confines. Investors could use a blended approach, which often requires thinking about how to tier liquidity.
We're not saying go entirely out of money market funds. Money market funds can be a key component in the portfolio, but the overall footprint might be reduced in this new paradigm. What investors can do is implement a 2- or 3-tier strategy for cash management. How much cash do you need for same day purposes? How much do you need in immediate cash? How much do you need in longer term cash? If you take this approach, you're able to close that "opportunity cost" gap of earning relatively little yield and earning more income to cushion against the threat of rising rates.
The second point is the opportunity cost isn't just a nominal "expense." There's actually now a higher real cost as you may be battling inflation which could erode your capital. Within our DNA is the whole notion of active management; that requires us to be continually evaluating changes in the marketplace, including inflation's impact. (Note: Watch for Part II of our interview with PIMCO's Schneider in coming days, or see the August issue of MFI.)
