Below is the second half of our interview with Jerome Schneider, Managing Director and Lead Portfolio Manager for Short Term Strategies at PIMCO. (We ran part I of our article, "PIMCO's Jerome Schneider Looks at 2a-7 and Beyond" on Friday; it originally appeared in the August issue of our Money Fund Intelligence newsletter.) In part II, Schneider talks about portfolio strategies, the transformational period that MMFs are about to go through, new products, and the outlook for money market funds.
Q: Are you wary of Commercial Paper? Schneider: I wouldn't necessarily say that. What people often misunderstand about PIMCO is they think that we're overly conservative by steering clear of CP entirely. Rather, what we strive to avoid are situations where we don't find value. It's not that we think there are unforeseen default risks everywhere in Commercial Paper-land, rather, the hurdle is high and we don't always find good value. It's not that we don't think it's a good asset class -- obviously it's money good in many regards -- it's more about the value proposition to our clients.
Together with our team of over 60 credit research analysts who routinely review the entire capital structure of issuers, we find many opportunities that other managers may overlook. We want to find the best value from the perspective of liquidity, price stability, and risk-adjusted returns. That's the framework that we operate in and, as such, we typically steer clear of traditional financial commercial paper that other 2a-7 funds might find attractive. Instead we find value in short-term instruments which may offer better returns with similar risk.
Q: Your MMFs are now 100% Repo. Why? Schneider: For PIMCO, Repo is an invaluable asset. It offers both attractive yield and excellent liquidity, given that we typically are looking for very short dated offerings. Our clients like the liquidity, they like the profile. Sure, there are other things we could do to help increase the yield, but we've got to do what offers a good liquidity and risk profile. We have run longer average maturities. But I'm being a little more defensive ahead of the Fed hikes than most by being beholden to the short term repo, whose yields have been attractive of late.
Q: How have fee waivers impacted you? Schneider: Fee waivers are something that all investors have to be cognizant of. As we evolve to higher rates those fee waivers might come into play the opposite way.... Managers might choose to manage their fees based on a net yield. That goes hand in hand with a larger discussion of money market fund yields. Net yields will remain low for a long time and there are two components to that. First, is supply and demand. You have a huge amount of demand for assets with limited supply, and that will keep yields low. Second, managers may take the opportunity to recapture some of the fees that they've been waiving for the past few years. Net yields are something that investors' need to [watch].
Q: What concerns are you hearing? Schneider: I just spent a week on the road visiting with clients from universities, health care systems, pension funds, state plans, retail investors -- we run the entire gamut. [We're] having a discussion with clients about how this is a transformational period, how they need to think about managing liquidity in a much different paradigm than before. Money market funds as they existed, a $1.00 par NAV without gates and fees, won't exist anymore beyond 2016. Investors have to become educated that there are more options for them.... Money market funds are one element of that. However, liquidity investors need to have other short-term options in their quiver as well, and we see many current and prospective clients moving actively in this direction.
Q: Will you be making any changes? Schneider: It's more of a 'stay tuned'-type of situation. PIMCO is obviously cognizant of the deadlines and we'll be compliant at that point. We're using this time right now to work with existing and new clients about matching their interest with existing product offerings and what the team at PIMCO might be developing. What we're thinking about is simply expansion of access to many existing strategies that we have had for years -- the floating NAV, step outside of the money market space. PIMCO has been doing it very successfully in all different types of markets and we're finding that clients want these alternatives in different formats -- funds, ETFs, separate accounts.
Our discussions are on how to build upon those building blocks of capital preservation, income, and liquidity management. Depending on which of those variables clients weigh more or less, we'll emphasize those in that portfolio. What PIMCO's doing is creating a suite of products so investors can go down the shopping aisle of front end offerings and pick from the shelf what they find most attractive.
Q: What is your outlook for money funds? Schneider: Money market funds will be utilized as one viable tool for managing immediate cash needs -- there's very little doubt about that. What we're going to have to think about though is the simple constraints that we're seeing evolve -- supply constraints, overwhelming demand, regulatory changes and the new structure where you could potentially have floating NAV or gates and fees. We think investors will move assets from Prime to Government funds, as many others do.
But we think the secondary shift will see investors moving assets from money market funds to other short term strategies. It's not going to happen overnight, it's going to happen over quarters. These conversations have been fairly slow in developing. We've had many clients, call it 20% or 30%, who have asked about these types of strategies <b:>`_. But there's a tremendous number of people who are either getting educated or remain undecided about how to approach this new regime. So the shift is underway, but not in any way, shape, or form complete. We are in a transitory period where the structures are being redefined and should be reevaluated.
