The January issue of our flagship Money Fund Intelligence newsletter features a profile of the liquidity management team at RBC Global Asset Management in the U.S., including Brandon Swensen, Senior Portfolio Manager and Co-Head of U.S. Fixed Income; John Donohue, Head of Liquidity Management; and, Matthew Appelstein, Head of U.S. Sales and Distribution. They discuss RBC's decision to no longer offer the RBC Prime Money Market Fund, the firm's growth in the U.S., and the opportunities that exist in the new liquidity management landscape. Below, we reprint the Q&A from our January issue. (Note: Thanks too for all those attending our Money Fund University in Boston, which concludes at noon on Friday. We hope you had a great show, and safe travels home!)
MFI: How long have you been running money funds? Swensen: In 1991, RBC GAM in the U.S. launched money market funds as sweep vehicles for the brokerage and wealth management business. Since that time money funds have been a significant part of our asset management offerings. We consider this a core capability and a focus of our U.S. asset management lineup, one we expect to grow going forward. We feel like we have differentiated ourselves in this business in a few ways, the most notable being that during the financial crisis our funds did not need any capital. We are one of the few fund families that can say we never invested in a SIV and we have never experienced a default in our money market portfolios. It's a track record we're very proud of.
MFI: What is your biggest priority? Appelstein: A strategic priority for the bank is to grow the U.S. asset management business. The good news is in the last four years, RBC's U.S. business, revenue-wise, has more than doubled. We just added 8,000 square feet of space in Boston and have plans to add more square footage in Minneapolis. We are investing in the U.S. business with people, resources, and products right now to grow this business. Obviously, a big component of that is the liquidity business, where we've also been adding resources. We have a 31-member Sales and Distribution team to which we continue to add resources. Swensen: To Matthew's point, the growth of our liquidity business is a natural extension of RBC's growth in the U.S. overall. The money market fund and liquidity business has always been about two things: Rule number one: preserve principal, and rule number two: never forget rule number one.
MFI: Tell us about your recent changes. Why are you getting out of prime? Donohue: The decision was driven by conversations with our clients -- they just don't feel the need to be involved in a variable rate NAV product. What we've seen is that the majority of our clients are considering a move to our government money market fund, while also evaluating our ultrashort products. In addition, clients continue to explore customized separate account strategies for their core cash positions. We have approximately $30 billion of short duration assets, which enables us to be large enough in the market, but remain flexible. We believe clients will scrutinize their cash investing practices more than ever before.
Swensen: While we're not predicting the demise of prime funds, we are in the camp that believes they have been fundamentally changed and are less desirable in terms of delivering the liquidity solution our clients are looking for. Prime funds now exhibit liquidity characteristics that aren't quite the same as what a liquidity investment should look like. We think government funds are still a pure play liquidity product, but prime funds have this baggage associated with it. Fundamentally, we feel that clients that are looking for yield should be in something other than a prime fund, and that's where our separately managed accounts will come in to fill that void. The government funds are there to provide that pure play liquidity with no strings attached.
MFI: What is your biggest challenge? Swensen: Yield is obviously a challenge. It's been very painful for our clients. The challenge is not just about us trying to manage a portfolio that delivers a yield that is 'X', it's about meeting our client's goals, and unfortunately the market just hasn't been there. So, we were over-the-moon thrilled about the Fed deciding to hike rates. It's been so long overdue in our view. For them to breathe a little bit of oxygen into the front end of the yield curve has just been fantastic for our clients.
Our fees in this business are very low and they're not expected to rise anytime soon. So our clients really experience this first rate increase in their portfolio. It has been coming through for two months as the market started to price in a very high probability of the rate increase occurring. Then, there's the challenge of the regulatory environment. We think the [recent] round of reforms has fundamentally altered the liquidity landscape. That's unfortunate on the one hand, but on the other hand, it's a once in a lifetime opportunity for investors and for asset managers to position themselves for the new reality in liquidity.
MFI: Have you seen yields rise already? Swensen: Yes. The historical relationship has held up very well when you look at the Prime to 'Govie' spread. Historically, the spread is plus or minus 10 basis points and that's right where we sit today. About a month ago our institutional government fund finally broke through the expense ratio and started providing more than a basis point of yield. And we're not raising fees or raising expenses to recapture past waivers in our money market funds, so clients are experiencing the full benefit of that increase. It remains to be seen how things progress in 2016 as market dynamics change. We are hoping for more Fed increases, albeit at probably a slower pace than we've experienced in past recoveries. That's going to be of great benefit for money market funds and liquidity investors.
MFI: What are you buying? Swensen: Probably the biggest thing for money market funds from the Fed release in December was the essentially unlimited cap on the reverse repo program (RRP) -- and when I say essentially unlimited, it's actually limited at $2 trillion. When you look at the size of the overall money market space, they've got it covered -- the whole thing can get put to the Fed if need be.... We think this will be a benefit to the market in the short term. The longer term question is: How long does the Fed want to be such a big factor in money markets? Also, how does the Fed then pull away from the repo market if they become such a large share of it for money market funds? It will be interesting to follow.
MFI: Tell us about the demand for Government securities. Swensen: Some concerns that have been raised -- even at your conference here in June [our 2015 Money Fund Symposium was held in Minneapolis], about supply for government funds and how are they going to manage the big inflow -- are alleviated by the Fed's RRP. Being a significant but not gigantic player in the money fund space, we can be more selective. We are able to participate in auctions at a different degree as well as be able to access some other parts of the market that the bigger funds avoid. Outside of just discount notes and Treasury bills, we are able to invest in some of those other sectors where there is potentially value. We've always been big buyers of agency floaters and they continue to make a difference in our strategies. Their performance was really driven by our positioning in floaters and some other subsectors of the market that bigger funds aren't as active in.
MFI: Are customers more averse to floating NAVs, or gates & fees? Donohue: Over the last four years, I've probably visited about 300 institutions, and almost every one of them, with the exception of five, said they're not dealing with a variable rate NAV. The ones that felt comfortable with the variable NAV said their biggest hurdle with the CFO and senior treasury leadership are the gates and fees.
MFI: Tell us about your other offerings. Swensen: We have Ultra Short and Short Duration bond funds that we launched in anticipation of money market reform in December 2013. In our view, they are a strong component of what liquidity investors should be thinking about going forward in terms of buckets of liquidity. Government funds should be used for your pure play liquidity and, beyond that, a short duration solution other than a prime fund should be used to earn some income. We feel that those funds are natural extensions of our prime fund capabilities -- very high quality funds managed in a way that is about preserving principal, but also capturing additional income that is available when you free yourself up from the money fund space. By no means are they money market fund surrogates, because they have variable NAVs. But in our view, the extra income you pick up by moving out just a little bit on the duration curve is a nice value proposition for risk-averse investors.
MFI: What is your outlook for 2016? Swensen: The rate environment certainly gives reason to be optimistic. Earning something other than a basis point in your cash is a welcome development. The future of money funds is going to be very interesting because nobody knows exactly what it's going to look like in October. We see the general trend of fund families converting Prime funds to Government funds, and investors being concerned about variable NAVs and fees and gates. But when do they actually start to move money? That hasn't really occurred yet in significant size, other than these fund closures and conversions that have occurred already. We believe 2016 is an unprecedented opportunity for investors to rethink their liquidity strategies. So, as much as we may be disappointed about prime fund reform, we're even more optimistic about the opportunity.... It's going to be an extremely exciting year and we're looking forward to it.
