Below, we reprint our latest BFI profile, "PIMCO's Schneider & Leach: Minding the Short-Term Gap".... This month, Bond Fund Intelligence interviews PIMCO Managing Director and Head of the Short-Term Portfolio Management Jerome Schneider and Vice President and Product Manager Brian Leach. We interviewed Schneider in the inaugural January 2015 issue of BFI (see "Short Now Big at PIMCO: Talking w/Schneider & Reisz"), but wanted to check back with him to review the short-term bond and ETF space. Our latest discussion follows.(Contact us if you'd like to see our latest Bond Fund Intelligence.)
BFI: Tell us about your history and philosophy. Leach: Cash management has been a key tenet of what we do here at PIMCO, really since we founded the firm in 1971. In terms of offering dedicated strategies, we have a nearly 30-year history, both with our short term strategy as well as our low duration strategy. It's really in our DNA.... Because we're an active fixed-income manager, we're looking to meet client needs and generate strong risk-adjusted returns across portfolios. If you look at the way we've built out our structure, the idea is to take what we're doing in the front-end, in the cash management space, and really use it to generate alpha across client portfolios. That's really been a focus of the firm since inception.
Schneider: I came to PIMCO in 2008 to work alongside Paul McCulley and bring my 20+ years of investment experience to the PIMCO short-term franchise. Since taking the helm of the desk in 2010, the team and I have continued to evolve our capital preservation and liquidity-mind strategies, including overseeing the launch of other key short-term products, like MINT, our short term enhanced cash ETF, and also our Short Asset Investment Fund. All together, we manage about $170 billion in cash equivalent assets for clients, across a variety of mutual funds, ETFs and separate account strategies.
When you think about PIMCO, one of the things you think about is our core competencies. What we ultimately are trying to do is manage liquidity for clients, provide capital preservation, and generate some income on top of that. The convergence of changing regulatory frameworks, monetary policies that we've never seen before, along with differing supply/demand mechanics ... are really changing the landscape of management of liquidity management as we know it. So [historical] solutions are being tested in a variety of ways.
PIMCO has recognized the fact that liquidity management, capital preservation, and income is an iterative process, and more importantly, an evolutionary process. The key thing is when we think about it, we understand and we offer money market funds. But we also recognize that our clients have different aspirations for what to do with their cash, as well as different time horizons.... Those translate into differing approaches depending upon client needs.
So over the years, we've built out our franchise to include things like our Short-Term fund [and] Low Duration fund. Subsequent to that, we've looked to fill in the gap shorter on the curve between money market and low duration strategies.... Since the financial crisis, PIMCO has been at the forefront ... in the construction of new strategies.... It's important to understand because of those core competencies, which are really born out of macroeconomics, doing fundamental credit research, and understanding the plumbing of the system. Those three things have allowed us to be a leader in the short term landscape. Those were acknowledged over the past year when our Short Term fund portfolio management team won the 2015 Morningstar bond fund of the year award, and Lipper awards for 3- and 10-year performance.
It's important to understand that our philosophical approach has always been different from traditional money market managers. When we realized the market was changing as we approached ... money market reform, we knew that there was going to be another gap to fill, somewhere between PIMCO's Short Term Fund and the money market strategy. That's when we filled that gap, working with the product management team to create a strategy focused on providing income, having multiple degrees of freedom to control liquidity, and at the same time, have a very low volatility footprint. That's where the notion of our Short Asset Investment Fund (SAIF) came from. That was launched 4 years ago and is now over $1 billion dollars in size.
Clients are mostly institutional, ranging from healthcare, pension plans, middle market institution, and corporate cash clients. It's accessible through a variety of means.... People flock to SAIF because they [recognize] that they still have a tremendous amount of liquidity, given the short term nature of its assets. Yet they don't necessarily need to [stick to] the 2a-7 requirement. Rule 2a-7 reform is exciting because it is the perfect time for investors to pause and determine the best approach to manage their liquidity. Ultimately that is where SAIF came from as a potential solution for reform. The goal is to take small and incremental steps beyond regulated space.
We realize that there is no panacea. If you're a corporate treasurer, a CFO, a retail investor, there is simply no 'one size fits all' solution. So that's why we have these different solutions, recognizing that most of our clients ... are going to use these solutions in a tiered approach. They may be incorporating a little money market fund, but taking an incremental step out and using SAIF or MINT or LDUR, etc.
BFI: Do investors use multiple bond funds? Schneider: This is a philosophical discussion. No longer can clients have one default strategy for how they manage liquidity and earn a positive return.... There is a big difference by nominal returns and real inflation adjusted returns. The discussions we are having right now are not just about simply preserving capital in a nominal sense ... now what we are focused on [is a discussion of] purchasing power preservation. This is important and hasn't really been evident in money market realm for 40 years as these strategies tended to generate positive real returns pre-2008.
Leach: `Now with the combination of money market reform, as well as this purchasing power preservation consideration, the default has changed.... So we're thinking about adapting to this immediate consideration of money market reform but also thinking of forward-looking solution that allows you achieve purchasing power preservation. The way to achieve this is by looking at a mix of strategies ... some usage of money market funds as well as usage of [short-term bond fund] strategies.
BFI: What are the main sectors and securities you buy? Schneider: I think that there is a tactical assessment under way.... No longer can you be comfortable in a world, and this is highlighted by 2008, outsourcing your credit homework and due diligence. For 3 decades now, PIMCO has had a huge, dedicated, independent credit analysis team ... to determine prospect of capital being returned and most importantly the valuation metric.... The second thing is structure.... We want portfolio positioning to be reflective current market condition.... We recognize that interest rate exposure is probably not a great bet right now.
BFI: What about the future? Schneider: The future is now. We've been talking about this for years.... We've been planting the seeds and have been excited for money market reforms for years. The reality is that [investors] are finally starting to react.... They are finally pulling the trigger.... A lot of it frankly is in separately managed accounts and specific solutions and so they recognize that our approaches are different, they might need a little bit of hand holding and ultimately that is where we do a lot of business.
Leach: Jerome and team, as well as the product team, are busier than ever on this front. We are increasingly having conversations and it is materializing in flows. You're seeing it already in the move from prime to government. But our expectation is that [it] continues over the fall. The combination of reform, but also the recognition that rates aren't likely going higher in a meaningful way over the near or long-term is causing many investors to move. So we anticipate a pickup in conversations over the coming year, but also more of a focus on this part of the portfolio allocation on a permanent basis as well.
Schneider: People are very scared of volatility but yet they want income. So ultimately they want to de-risk out of other asset classes.... Short-term bond funds have a unique advantage. They are no longer an afterthought, simply being a step out of money market fund. They are actually a core part of fixed income strategies. The reason they like them is the fact that they are 1, 2% and more compared to long duration bond funds.... So with the risk-reward tradeoff, this is really an attractive class. [It's] a huge growing opportunity.
