Below, we reprint from the November issue of our Bond Fund Intelligence newsletter, which features an interview with Invesco Managing Director & Head of Government, Short Duration, and EMEA Portfolio Management Laurie Brignac; and Senior Client Portfolio Manager Robert Corner . Brignac and Marques Mercier manage the Invesco Conservative Income Fund, which launched in July 2014. As Brignac tells us, "In looking at that larger ultra-short category and listening to our clients, we wanted to create a product and strategy that provides them with additional yield and at the same time has enough of a footprint in the money market space." (To request the full latest issue of BFI, e-mail us at info@cranedata.com.)
BFI: How long have you been in the "conservative" ultra-short bond space? Brignac: I've spent most of my 26-year career in the money markets and front end of the curve. I did spend some time in the bond fund space and ran what was then called the Intermediate Government Fund, which is now Invesco US Government Fund. But the majority of time has been spent managing ultrashort and money funds over the years. Corner: I've been with Invesco for two years now, but I cut my teeth in the global liquidity space in a prior position, managing short-term bond funds, ultrashort bond funds, and separately managed accounts in liquidity, low duration, and other fixed income mandates.
BFI: What was the genesis of the Conservative Income Fund? Brignac: Conservative Income was launched in July of last year. The idea behind the launch was that there was definitely an opportunity in the product lineup -- given our extremely strong money market reputation.... Clients are becoming more educated in terms of how they are managing their cash. They're not just looking at money market funds -- they're starting to tier and bucket their cash -- looking at immediate needs and longer term needs for cash. In light of what's coming down the pike with money fund reform, clients are looking for other options. Their view seems to be, 'If my NAV is going to float, why don't I try to get a better return?' We do think that the Conservative Income Fund fills a gap in that space.... We feel that this product and strategy really does sit between short term bond funds and money market funds. Going forward, if more clients want something that’s even shorter and more conservative than this fund, it's something that we can definitely manage. We have separate account strategies ... managed that way.
BFI: What is the strategy of the fund? Brignac: The Ultra-Short category is comprised of many different types of funds. What we wanted to do is just take a step outside of money markets. When we were structuring this strategy, we wanted principal preservation, a higher income return, and then liquidity -- that's our investment objective. In order to maintain a more stable NAV, part of our strategy is to hold at least 50% of the assets in money market eligible securities, or securities less than one year, as they act as an anchor on the fund's NAV.
BFI: How has it been received? Brignac: You have to start garnering a track record in order to get the assets and that is the phase we are in now. But we do have a lot of clients that are looking at the strategy and we spend time educating investors about the strategy and what it means for them, whether it's in a separate account or a commingled product like the Conservative Income Fund.
BFI: What do you see as the biggest challenges for the strategy? Brignac: For this particular strategy it goes back to educating clients. This is meant to be a complimentary liquidity product -- it is not meant to be your only cash vehicle or even your primary cash vehicle. It's going to have a duration of less than a year and most times it will be much shorter than that. You have to understand what you are buying. If a client wants absolute stability of principle then they should be in a money market fund. But when clients are looking for an option for their longer term cash, then these types of funds are an important component in a broader liquidity strategy. At a time when hopefully the Fed is raising interest rates, given the short nature of the portfolio and how we have it structured, we think that even with an increase in interest rates it should perform relatively well in the ultra-short space.
BFI: What are the portfolio guidelines? Brignac: The portfolio looks to achieve its investment objective by investing in short duration, investment grade money market and fixed income securities. The fund will maintain an average portfolio quality of 'single-A' or better with a portfolio duration of less than a year. More recently, we've been more conservative in our interest rate risk allocation and are maintaining a duration under half a year. As I mentioned earlier, the portfolio will hold at least 50% of its assets in securities which mature in less than one year. As of right now, with the Fed in play, that percentage of money market securities is a little higher -- we're actually over 65%. The portfolio can purchase asset-backed securities and we currently hold approximately 20% in that asset class. Asset backed securities provide additional yield to the portfolio and, at the same time, it's an asset class that provides stability in terms of valuations, even in a rising interest rate environment.
And as you would expect, we will hold at least 25% in financials. If you look at the issuance in the front end of the curve, 80% of it is financials, so we are going to have a concentration there. But outside of that everything else will have the standard industry limits. Also, we're taking advantage of short A-2, P-2, or second tier commercial paper. We're combining that with nontraditional repo and it is providing a higher yielding anchor on the front end of the curve.... That’s really where you're going to get most of your pricing variations -- in the longer dated securities. So it's kind of a modified barbell if you will. But it's all investment grade. With our history and credit leadership, and given the fact that a lot of the clients we're talking to are money market clients, we don't want to veer too much away from how they know us.
BFI: Can you tell us about yields & fees? Corner: The gross yield is in the low 80s [bps]. There are a couple of things that we're seeing lately. We saw spreads gap out a little bit through the end of September, but we've seen some improvement in October. That has benefitted the portfolio, and yields have come down a little bit. The net fee of the fund is 28 basis points. The stated fee is 65 bps; we're voluntarily waiving 37 bps. But that is just the nature of the product and not because of the environment that we're in right now.
BFI: Are regulations impacting the space? Brignac: It's sort of a 'Catch-22.' Obviously, we know with [the FSB's] TLAC ["total loss absorption capacity" mandate] there's a lot of issuance that's going to be coming that will need to be absorbed in the market. But we find that a lot of traditional issuers are also cash rich. In talking to treasurers, we know they've got money they need to put to work. Because banks don't want to hold a lot of client cash on their balance sheets, they are encouraging them to look to other products. There's only so much money you can put in your money market fund, so they have to either find a strategy like Conservative Income in the Ultra-Short space, or they have to do it themselves with individual securities. Corner: What's nice about the Ultra-Short space is it's almost a natural home for LCR-friendly investments that banks are trying to create ... beyond the money market realm. So as the Ultra-Short space grows, it's probably a friendly space for bank issuers.
BFI: What is your outlook for rates? Brignac: We are expecting the Fed to raise rates and obviously, December is in now in play following October's employment report. Initially, after the September meeting, we thought a rate hike would be on hold for the rest of the year, but they've definitely put December back on the table.... But we do see them raising rates, if not at the December meeting, definitely in the first quarter of next year. For Conservative Income, we have been shortening and increasing the amount of money markets securities ... to hedge against higher rates. But at the same time there are areas where we can continue to extend -- selectively and strategically. I think the portfolio is very well positioned for an increase in rates.
Corner: For us, it is not necessarily a matter of when the Fed starts to raise rates, it's monitoring the expected pace and the terminal rate of the Fed funds. We expect the path is going to be slower than in the past Fed regimes -- at least the number of tightenings and the amount that they tighten could be less than in the past. The slower pace actually bodes well for fixed income investments and will minimize potential pain in the market in general. The duration in this fund is right at about 0.33 of a year. We've been running it very conservatively from a rate risk perspective.
BFI: What is the future for Ultra-Shorts? Brignac: It's going to become a more important asset class as we move forward because so many investors are holding quite a bit of cash and they need to find other options. But they need to understand the Ultra-Short space, and understand the differences between a low volatility Ultra-Short fund and a high volatility Ultra-Short fund. It's critical that clients recognize the different risks in funds within this broad category. Corner: We think it's important that investors, especially in the Institutional space, see the value in bucketing their cash. We also call it 'liquidity layering,' or bucketing your cash by liquidity needs and layering it that way. The industry in general has seen a lot of growth in the Ultra-Short bond fund space -- it's up to about $60 billion in assets. It's becoming a much more meaningful part of the investment mix.
