This month, Money Fund Intelligence speaks with Eric Thole, CEO of U.S. Bancorp Asset Management and President of First American Funds, and Jeff Plotnik, Director of Money Market Fund Management for First American Funds. We look back at the implementation of reforms and changes in 2016, and we discuss the current environment and future of money funds. Our Q&A follows. (This interview is reprinted from the February issue of our flagship Money Fund Intelligence newsletter; e-mail info@cranedata.com to request the full issue.)
MFI: What is your biggest priority? Thole: Our biggest priority today is very similar to what it's been in past years. We continue to diligently work with our shareholders. Money fund reform hit its finish line back in October of last year, but it's certainly the starting line for a new way of thinking about cash management. The operational pieces have been successfully completed. But we continue to see money in motion and our goal is to ensure we have the products to meet our shareholder's needs.
Plotnik: From a management standpoint, we're still adjusting to the new universe. We have more government cash than we once had, so we're really focused on putting that to work. It's harder to add value in that space, so you're always hunting and pecking to find product. We're also adjusting to the new prime environment.... It's early and we're still getting feedback through communications with our shareholders in regards to what’s important and what they want to see.
Thole: We're focused on having as many conversations as possible with various shareholders while making sure they understand the new pieces of money fund reform. We do expect, at least over time, shareholders are going to be excited about the yield differential they may pick up in a prime product and may -- at least for a portion of their money -- look to move back into the prime space.
MFI: What's your biggest challenge? Plotnik: We're approaching our 35th anniversary this year. Historically, pre-2009, as a manager my biggest concern was, 'Where can you get that extra basis point for your shareholders?' That was what we focused on ... and that's changed. In today's world, I find the biggest challenge, at least for me, comes from the regulatory and compliance side. As a portfolio manager, it's my job to deliver the best performance I can for our shareholders. But we're also dealing with additional regulatory restrictions from the SEC, from our own internal guidelines, from the rating agencies, etc., like never before and they all come with a heightened sense of scrutiny.
At the same time, we're thinking about the floating NAV, and the perceptions of gates and fees. So a lot goes into each trade. We have the processes that check, double-check, and triple-check all our activities. Even though these processes are very thorough and dependable, when it comes to compliance, seeking perfection is the only outcome that's acceptable. We as managers are ultimately responsible for the portfolios, and all of the regulatory requirements that have been implemented are additions to the job that require an extra layer of diligence.
Thole: We at First American hit the reform deadlines on time, but it wasn't without its complexity. During reform, we were constantly in touch with the board of directors. We still are today, but as we move into 2017, we're talking with the board about growth and shareholder needs from a cash management perspective. So our focus has returned to more forward-looking business considerations and making sure we have the right products that meet our shareholder's needs.
MFI: What are you buying? Plotnik: We obviously buy the most product in the government space. The bigger challenges are getting our government portfolios invested efficiently with large growth assets as a result of money fund reform. There's a larger reliance on the Fed's reverse repurchase program (RRP) as part of your portfolio, especially in the government and Treasury funds. We are buying the same products we have historically purchased in these funds, but finding enough has become the challenge.
In terms of the prime space, we obviously have smaller portfolios to work with now. When considering the institutional fund, we're more sensitive to NAV volatility and the perception of gates and fees, as opposed to the retail fund which just has the gates and fees considerations. Although our liquidity metrics have been consistent, we find it prudent to try and find value in shorter tenor securities, as we are more focused on potential price volatility. We're also more focused on finding value with securities in the three-to-seven month area with really good credit and a clean structure vs. pre-reform when 13-month tenors were much more common.
Getting invested efficiently back in October when floating NAV was being implemented was easier because issuers were really focused on getting funded ahead of reform. But today, only a few months after reform, I am finding that issuers once again are becoming more selective. I think they have adjusted well to the new environment. Nonetheless, we have been able to get invested with the liquidity and credit structure that we're looking for, so the yield opportunity is still there, providing an attractive yield for prime fund investors.
MFI: Are there pros and cons to size now on the Govt fund side? Plotnik: Yes. One of the cons is prior to reform we were able to get nearly the entire portfolio invested in government-sponsored enterprises (GSE) and dealer repos. Today the supply just isn't there to satisfy the size of the universe. I think everyone is struggling to a certain extent to fill those buckets.... The RRP is often our biggest single repo exposure. The sheer demand for the GSE product has forced a yield spread differential of a basis point or two in many cases. On the pro side, government funds are a simple and easy product for institutional investors. They are a great liquidity tool for our shareholders and their increased size allows us to accommodate investors of almost any size.
MFI: Can you touch on the debt ceiling? Plotnik: We've been through a couple of these debt ceiling fire drills before. Typically, we try to avoid those particular notes and bills surrounding key debt ceiling dates. At this point ... there hasn't been a lot of negative impact attributed directly to the upcoming debt ceiling debate, and we don't see any noticeable market stress at this time. I expect that at some point, as we approach the debt ceiling date, it will hit the headlines and there will be some market reaction. But we're not there yet. We are aware of it and are investing around it as best we can.
MFI: What are customers concerned about? Thole: We're hearing about yields <b:>`_. Shareholders and investment professionals tell us they're excited about potential for increased investment yields. There hasn't been a lot of noise around the floating NAV in prime funds. We continue to educate around fees and gates to make sure the shareholders understand how they work. For the most part, shareholders are focused on the utility of money funds as well as the yield. Many of our shareholders are enjoying the increase they received from the latest rate hike. If the trajectory of the market continues -- and we are forecasting multiple rate hikes this year -- the yield pickup for shareholders will continue. It may take more time before significant assets flow back into the prime space.
MFI: What about fee waivers and costs? Thole: Think about institutional prime and the fact that many institutional prime products are striking multiple NAVs per day. The operational costs have gone up in those particular products in general. If you think about the first two rate hikes, they absolutely were important not only from a shareholders perspective, but also from a business perspective. We're not out of the woods yet. Like many in the industry, we need another rate hike from a fee waiver perspective. The shareholders are going to continue to enjoy the benefit of the rising rate environment. This is important for both us and our shareholders; it continues to put a positive tailwind on money funds in general throughout 2017 and into the future.
MFI: What's your outlook for 2017? Plotnik: We expect higher rates this year, so that's certainly going to be attractive to our shareholders.... I would speculate that if you give it time, more NAV history and 40 or 50 basis points in yield spread, those investors that are allowed to will move back from government to prime funds.... I believe there is a sizeable client segment that can move back when they feel the environment is right [and] I believe 2017 is going to be good year. It's going to be a solid future for the money fund industry, as well as investors and managers on the short end of the curve. Thole: Higher rates translate into higher yields for shareholders, and that's a good thing for the money fund industry.
