In the April issue of our Bond Fund Intelligence newsletter, we profile OppenheimerFunds' Senior Portfolio Managers Chris Proctor and Adam Wilde. They manage the Oppenheimer Ultra-Short Duration Bond Fund, which is celebrating its 5th anniversary this month. Proctor and Wilde discuss the conservative nature of the portfolio and why they think it is well-positioned in a "slow and stable" rising rate environment. They also believe the funds' 5-year track record of stable returns will serve it well. Says Proctor, "Funds that can deliver reasonable income and low volatility, I think, will be the winners in the space." The following is a reprint of the BFI article.
BFI: How long has OppenheimerFunds been running short-term bond funds? Proctor: We entered the picture with the launch of our Ultra-Short Duration Fund in 2011, which came about as a result of the money market fund rule changes. This product is managed here in Denver by our Cash Strategies team. One of the other products our team manages is the Institutional Money Market Fund, which is celebrating its 10th anniversary this year. We have a team of eight people and our average tenure in the industry is 18 years. From a firm standpoint, OppenheimerFunds has been running taxable short-term bond funds for about 30 years -- our Limited Term Bond Fund series launched in the mid-'80s and is run by the Investment Grade team out of New York.
BFI: How long have you been managing bond funds? Proctor: I joined OppenheimerFunds in 2008 and I was named Portfolio Manager in 2010. Overall, I've been in the fixed income and money markets space for 26 years. Wilde: I started with the firm in 2001 in our transfer agency department and after a year there, I [moved to] our fund accounting department. In 2005, I joined the Fixed Income team as a research analyst, and I was named Portfolio Manager in 2013.
BFI: Tell us more about the launch of Ultra-Short? Wilde: The thought behind Ultra-Short was ultimately to give clients choices and options to address near-term cash needs in a changing and evolving environment. One of those clients was our own internal corporate treasury, which we worked with to establish some of the guidelines that surround our Ultra-Short fund. As we mentioned, it launched in 2011 after the 2010 money market fund reforms. The changing regulatory environment was really the [driver] of the fund launch. We saw an opportunity in the area just outside of money market funds in terms of supply and the potential for some yield pick-up. From a yield standpoint, we were hitting that gap just outside of money market funds. In terms of our offerings, it fit nicely between our money funds and our Limited Term products. Further, we wanted to build a stable track record with a variable NAV fund.
BFI: What are the biggest challenges? Proctor: The biggest challenge in this low-for-longer rate environment we've been in, and will likely stay in, is tempering yield expectations. Reaching for yield in this type of product, where you are trying to maintain relatively low volatility has historically been a bad idea. Staying focused on your investment strategy and taking what the market gives you is really smart. Everybody wants more yield, but with more yield comes more risk.
BFI: Who do you see as competitors? Proctor: Our focus in launching the fund was client driven as well as market driven. Then we started thinking: What does the peer group look like? It has a lot of different flavors -- it's a broad peer group. You've got funds that focus on credit that might have below investment grade credit, you've got funds that are all government and mortgages, and you've got funds that might do foreign currency.... But what got this group a stigma the last time around was the extension risk, so we decided to focus on the 1 year and under, and limit the volatility of principal.
Also, we cannot buy any junk. Our average credit quality is single-A, and that's where we try to maintain it. I think the peer group is segmenting. And we have seen the peer group double in size since we launched the fund in 2011. A lot of the new entrants are more of the conservative variety, a group that we think we are part of. We're fast approaching our 5-year anniversary on April 25,, and we have a stable history of low volatility in terms of the NAV on the fund. We're hoping that's attractive to investors in this environment.
BFI: What is your investment strategy? Wilde: It evolved out of the money market fund strategy. So it is more weighted to the short side of the curve, with a maximum duration of 0.75 years. The ultimate goal is to provide liquidity with low volatility. In terms of credit quality, the biggest advantage we think for the Ultra-Short fund is the ability to buy Tier-2 corporate names. Keep in mind, with the downgrades, many of these were names we bought in previous years when they were Tier 1, so they are companies we are familiar with and names we have followed for a long time. The average rating on the portfolio is single A. We can go out a little further on the curve, taking advantage of that "dead space" -- where money funds can't invest and short duration funds don't normally bother with. Another advantage of an Ultra-Short fund that you don't get in a money fund is: we have the ability to hedge some of the risk with futures. This has helped to reduce some of that volatility that we've seen with rates. Currently, we're running the duration of the fund right around 0.38.
BFI: Tell us more about what you buy. Wilde: We do purchase asset-backed securities in the portfolio, and while we have the ability to buy commercial mortgage-backed and mortgage-backed securities, it's something we have not done in the past. The positions we hold in ABS are autos and equipment, and we run that right around 13-15% of the portfolio. We don't have nearly as much in financials as ... the money funds [do]. Opening up into that Tier-2 space ... alleviates the need for a higher concentration in financials. We can't have any more than 2% in any Tier-2 name when it has a triple-B plus rating or lower by S&P. With an A-rating, we can go up to 5%. But we run the Fund with the same internal limit system we do with the money funds, so we are applying this same concept a little further out the curve. The universe of names that we're comfortable with is probably double what the money fund approved list is.
BFI: Have you seen yields go up since the Fed hike? Proctor: Yes <b:>`_. Just like money funds, these types of funds can capture the higher yield before the Fed actually raises -- that's what we saw here with this fund before they raised rates in December. This fund is short enough it was able to go and capture higher yields as the markets started to price in the Fed move. We're not targeting a yield level. But we certainly would be rooting for a Fed increase, as yields would increase similarly to how money fund yields would increase.
BFI: Who are the investors in the fund? Proctor: We currently only have Y and I shares, so those are institutional-type investors. But we do have a couple of other interesting types of clients. The first would be investment portfolios, or other investment plans. They are not using the fund as a volatility reducer. [But] they are looking for low volatility investments, and it's a bonus if it pays a 1% yield versus the alternatives. Also, corporate treasury uses it as part of a cash segmentation strategy, and we're starting to get interest from bigger advisors.
BFI: What is your outlook for the Fed? Wilde: Call is S-squared -- slow and stable rate hikes, hopefully. That's with our fingers crossed. Proctor: This slow grind upward started with the Fed's taper tantrum back in the 4th quarter of 2013. I think the Fed is very happy with that, and that's the trajectory they would love to have. These kinds of funds do well in that kind of environment. We're hoping the Fed delivers on one more hike this year. What we've seen is extreme volatility because of people placing bets on the Fed -- they're on, they're off.... So funds that can deliver with reasonable income and low volatility, I think, will be the winners in the space. We spend a lot of effort looking at the volatility of the securities we're buying and how that impacts the NAV.
BFI: What is the future of Ultra-Shorts? Wilde: With money fund reforms, low yields and bank regulations creating a mismatch in supply and demand, we think Ultra-Short funds have a place going forward. It's going to become more apparent as we approach that October money fund reform deadline that liquidity does have a cost. In order to offset some of that cost, investors of all sorts ... will be more cognizant of their asset allocations within cash. Proctor: The future is bright. This is a relatively small sector but its growing and its continuing to grow. The category has almost doubled and I think that growth rate trajectory should continue. (Contact us if you'd like to see the latest Bond Fund Intelligence or our BFI XLS performance spreadsheet "complement".)
