"One of the hottest questions we've been getting recently, other than who is switching to government, is about the space beyond money market funds -- what's developing there, who is launching products, and what are the different options there," said Crane Data President Pete Crane, speaking at our recent Money Fund University in Boston. Crane and BofA Global Capital Management's Jonathan Carlson presented at a session called "Offshore MMFs, SMAs, and Ultra-Short Bonds." Crane discussed the burgeoning "Conservative Ultra-Short Bond Fund" sector, while Carlson focused on Separately Managed Accounts. We briefly excerpt from this session below (look for more in our upcoming February Bond Fund Intelligence), and we also review the U.S. Treasury's latest "Quarterly Refunding Statement," which indicates increasing Treasury Bill issuance in coming months.
At MFU, Crane estimated that the size of the Ultra-Short Bond Fund (USBF) market at about $200 billion, with another $100 billion or so in Short-term Bond ETFs. The SMA market is a bit harder to pinpoint, but he estimates it at about $400 billion, based on a recent report from the Treasury's Office of Financial Research, "Private Fund Data Shed Light on Liquidity Funds," which tracks Managed Account assets. (For a video of Crane's comments on Ultra-Short Bond Funds at MFU, see Crane Data's Facebook page, and for the slides to this session see the MFU Download Center.)
"We dove in about a year ago and started tracking the Ultra Short Bond Fund category," said Crane, referencing the launch of Crane Data's new Bond Fund Intelligence monthly newsletter. (In BFI, Crane Data tracks the performance of $1.663 trillion in bond fund assets, about half the universe, with a focus on the Short- and Ultra-Short sectors <b:>`_.) Crane added, "What you are seeing now in the Ultra-Short space is segmentation. We're creating a new Conservative Ultra Short Bond Fund category, because there's a cluster of new funds coming out -- from Deutsche, Morgan Stanley, SSGA, to name a few. Some of them are like "old" 2a-7 funds, some are beyond that. There are a series of different points where these bond funds are setting up camp. `How investors' react to them depends on where spreads go."
The attraction of Ultra-Short Bond Funds is they only price out to the third decimal place (vs. 4 decimal places for new floating NAV MMFs), so the NAV is not going to move very often. Crane explained, "Of course the further out on the curve you go, the further down the credit spectrum you go, the more volatility you're going to get. But you may have an odd scenario where the conservative Ultra-Short bond fund fluctuate less than a Prime money market fund." He concluded, "The asset managers have to be ready. Wherever their investors want to move they need a bucket, so they are putting out buckets. It is truly a new frontier, and what gains investor acceptance is anyone's guess."
On Separate Accounts, Carlson said they are poised for growth. "If you are accepting of the idea of a Variable NAV, why would you not be accepting of the idea of cutting your fees and determining your own destiny? This is ultimately the biggest plus of the separate account space. You put your money in, you determine your risk tolerance -- all of that gets built right into your separate account." He added, "You are not diluted by anybody else's activity. You own the securities." In addition, he said, "You get your money when you want it, there's no such thing as a gate or a fee." Carlson added that the investment fees are typically lower than money fund management fees, and the minimums range anywhere from $10 million to $500 million, depending on the manager.
The key is educating clients about Separate Accounts, as many don't know they are available or what their benefits are. Of their clients, Carlson said the number one priority is principal preservation. The second priority, he said, is "make sure you have it when I need it, not when you tell me I can have it." The third, and its always number 3, is "give me a rate of return that's commensurate with the risk in the portfolio." Added Carlson, "My first job is to keep the guy that decided to hire me, employed. I don't want to buy a bond that is going to cause him angst."
In other news, the Treasury will increase T-bill issuance in FY 2016, according to a release "Quarterly Refunding Statement of Acting Assistant Secretary for Financial Markets Seth B. Carpenter." It says, "In November 2015, Treasury reiterated intentions to increase Treasury bill issuance. The supply of bills outstanding as a percentage of the total Treasury portfolio is at a multi-decade low while demand for Treasury bills is high and is expected to grow. Given current projected financing needs over the next few years and the existing auction schedule, Treasury will modestly reduce the issuance of coupon securities in order to increase Treasury bill issuance."
Furthermore, in a "Report to the Secretary of the Treasury from the Treasury Borrowing Advisory Committee of the Securities Industry and Financial Markets Association," Chair Dana Emery writes, "Treasury believes it prudent to increase the level of Treasury bills outstanding over the coming quarters. Given demand for high quality liquid collateral by market participants, the Committee agreed that Treasury bill issuance should increase, and that Treasury should continue to study the potential addition of two month Treasury bills. Demand for Treasury bills remains strong."
The TBAC report continues, "The Committee continued its recommendation from the November 2014 meeting that Treasury increase its Treasury bill issuance in order to reduce interest expense, to enhance short-term market function, and to increase Treasury's operational cash balance. Treasury bill demand is expected to increase given demand for high- quality liquid collateral given money market and other regulatory changes. However, if Treasury were to significantly increase in Treasury bill issuance, it would likely need to reduce nominal coupon and TIPS issuance over the coming quarters."
Finally, the "Minutes of the Meeting of the Treasury Borrowing Advisory Committee of the Securities Industry and Financial Markets Association February 2nd," says, "Deputy Assistant Secretary Clark noted that demand for Treasury bills is high and is expected to continue to grow throughout FY2016. DAS Clark commented that, consistent with Treasury's commitment at the November 2015 quarterly refunding to increase bills issuance, Treasury may need to downwardly adjust nominal coupons and TIPS auction sizes."
Finally, the minutes state, "Next, the Committee turned to a presentation on Treasury bill market dynamics.... The presenting member began by noting that money market mutual fund reform and the need for high quality assets will likely result in increased demand for Treasury bills. The presenting member estimated that Treasury could meet this demand by increasing bills issuance by $230 billion in FY2016 and by an additional $65 billion in FY2017.... [T]his increase in bills issuance might justify the introduction of a new bill maturity. However, the presenting member also noted that an increase in bills outstanding of this magnitude was unlikely to result in significantly higher yields for the current suite of bill securities, given the aforementioned demand dynamics.... Members broadly agreed that the case for increasing bills issuance is strong, but acknowledged that the estimates for bill demand vary widely. As such, several noted that a gradual approach to increasing bills and reducing coupon issuance was prudent."
