The October issue of our flagship Money Fund Intelligence newsletter features an interview with the cash management team at Morgan Stanley Investment Management -- Managing Director Fred McMullen, Managing Director & Senior Portfolio Manager Jonas Kolk, and Executive Director of Product Management Scott Wachs. Morgan Stanley, which has been managing money funds since 1975, is the 7th largest global institutional MMF manager with over $120 billion in assets. McMullen, Kolk, and Wachs talk about Morgan Stanley's industry leading growth over the past 5 years and about new product development. Here is a reprint of that interview.
MFI: What is your biggest priority right now? McMullen: There are several priorities -- one is working with our clients to help them strategize around the impending rate and regulatory changes. Two is our focus on new product development. We're fortunate that we have a large retail fund money fund lineup as well as a large institutional fund lineup. Some in the marketplace have to create new retail funds to deal with the bifurcation the SEC created between institutional and retail investors. We don't have to worry about that, so we're more freed up to focus on new product development.
We've already announced some changes to our product lineup in response to the regulations, and we've shared our views on several aspects of the regulations and the competitive landscape. A few months ago, we provided clients our perspectives on the announcements that several of our competitors had made to date. We'll soon post a more comprehensive update on our progress to date and on some of our key product development issues. Three, we are very focused on growing our European liquidity business.
MFI: What kind of growth have you seen? McMullen: Most of the growth has been on the institutional side. If you look at our global institutional flows from the beginning of 2010 through the end of July of this year, we're up almost $72 billion. The next largest competitor is [up] $34 billion and there are only 5 or 6 other fund families that have positive flows in the global institutional category over that time period. Some of the fund families have pretty significant outflows, so we've been very fortunate to grow the franchise in what's been a tough market.
Morgan Stanley's commitment to and focus on liquidity management has been the major driver. We thought that with the strength of the Morgan Stanley franchise and the disciplined approach we had to managing the funds, if we just put the right distribution model in place, we would be able to be successful over what we thought were going to be some challenging years. We have focused on adding people to the Team who have extensive direct relevant experience. For example, we brought Scott [Wachs] in ... to head up the product effort. He's got 25-plus years in the liquidity space and he's done a tremendous amount of work for us on the existing product lineup and product development.
MFI: What is the biggest challenge in managing cash today? Kolk: Clearly, the biggest challenge today is the interest rate environment and balancing risk and return. In spite of what the Fed didn't do on Sept. 17, we're still at an inflection point. At some point, it's likely that rates will rise. So that brings into the thought process an evaluation of whether or not we're being properly compensated to extend out the curve. We clearly feel that we haven't been, so generally we have been short duration, shorter than the peer groups. So balancing risk and return in this rate environment is what makes our job especially challenging at this point in time. On top of that is the uncertainty surrounding the timing and the impact of 2a-7 reform in terms of potential AUM movement. We've already seen $200 billion or so in prime funds that are intending to shift to government funds.
MFI: What are you buying? Or not? Kolk: Again, we don't think that we're being compensated to extend duration with the uncertainty of the Fed's liftoff decision. In terms of credit, we're conservative with respect to the areas and locations that we'll invest. We have a clear eye on headline risk -- a perfect example of that is China. We do not invest in Chinese banks, as an example, and I think that strategy has been a smart one, certainly with the volatility that we saw coming out of that part of the world in August.
In terms of [the Fed's] Reverse Repo Program, from the standpoint of how we manage our portfolios and how short and liquid we are in most of our strategies, it's a great investment tool to have, as we look for short dated investment options. We've had a consistent, disciplined investment strategy -- defensive fund positioning, high liquidity -- against the backdrop of a rising rate environment and uncertainty in terms of regulatory reform and AUM movement. That's a strategy that has resonated well with clients, and we expect that as uncertainty persists going forward it will become even more important.
MFI: What are you hearing from clients? Wachs: There is a confluence of events that are going on right now. It's not just money market fund reform, but it's also banking reform and Basel III. How does that play into the treatment that banks will have for deposits? What does that mean for the availability of deposits for clients going forward? Clients are becoming increasingly concerned about that. We already alluded to the interest rate policy and the low interest rate environment -- How long does that continue? We work with a lot of multinational clients and certainly the negative interest rate environment in Europe is a concern for these clients.
MFI: Can you tell us about new products or other new reform-related initiatives? Wachs: There are still a lot of things we're working on relative to money market fund reform. I think back to last summer when the reforms were announced; we quickly kicked into gear. We put into place a very large money market reform project SWAT team with about a dozen work streams. Since then we've been working rigorously through those work streams to prepare ourselves and our clients for the implementation dates. The big one is next October, where the rubber really meets the road.
There [will be] new products that we'll be announcing shortly. There are also some changes to the characteristics of existing products. For example, our institutional lineup has two Prime funds today -- Prime Portfolio and Money Market Portfolio. We are working to determine and will announce how those funds will trade going forward with respect to how many NAV strikes they will have. I'm not aware of any manager that has publicly committed to an NAV strike schedule going forward. We have heard from our clients as to how they would like a prime money fund to look. We'll be aligning our two prime funds in a way that makes sense for our clients. Also, we were one of the first to be out there with most of the information required by the new disclosure rules -- whether its market NAV or weekly assets. We've been displaying it on our website for years now. The new regulations require 6 months' worth of history, [so] we will have that information.
MFI: Where do you expect assets to flow, post-reform? McMullen: You've got to be engaged with clients continuously. But now that the industry is going through a big transition, you need to be in front of clients more than ever. While we are starting to see some regulatory related AUM movements, the client symposiums we are holding tell us that clients are hesitant to make any changes until they see a trend emerge. But you could have a scenario where a significant amount of money moves from prime funds to government and treasury funds. When the regulations first came out, clients were looking for that direct substitute for prime funds that would offer the same utility. Clients are recognizing that there isn't a direct substitute, so an increasing number of conversations are focused on, "What alternatives do I have?" or "How do I bi-furcate my cash going forward?"
Wachs: Certainly there is no perfect substitute for prime funds once the new regulatory regime is implemented. But more importantly, there isn't a clear consensus on what the best option is -- different clients in different segments in different industries with different cash flow requirements are going to want different solutions. We try to engage in conversations with clients about all the possible solutions. We want to provide a compelling set of options for the money that's going to be in motion. The best way we can do that is to have continual dialogue with our clients as their thinking evolves.
MFI: Tell us about your outlook? McMullen: A lot is obviously contingent on how clients respond to the regulatory changes and the rate environment. It's not very clear exactly when and where prime fund assets will move. So I think the outlook for next year is fairly uncertain. But we're well positioned regardless. We can't control flows. But we do have a lot of control over our new business development, and we've got a really robust pipeline. There are a lot of opportunities -- whether it's funds or separate accounts or some of the new products that we have in front of us. If you look at the last couple of years, the industry's been flat to down, and we've been up. Our goal is to continue to take market share no matter what the environment.
Wachs: We are at a sweet spot in terms of our size -- we like to call ourselves right-sized. That means we have the scale to meet our clients need without sacrificing the easy and direct access we provide to our portfolio managers, credit analysts, and product experts. We can talk to them about how we're managing their money, about their concerns in the market. That access, along with the defensive way we manage our portfolio, is the core of our value proposition.
