This month, our Money Fund Intelligence newsletter speaks with Linda Klingman, Vice President & Head of Taxable Money Market Strategies for Charles Schwab Investment Management. She reflects on Schwab's more than 25 years in the money fund business, and she comments on recent changes and challenges. Our interview follows. This interview is reprinted from the June issue of our flagship MFI newsletter; contact us at info@cranedata.com to request the full issue. (Note: We'd like to welcome attendees to Atlanta and to our 9th annual Money Fund Symposium, which takes place today through Friday at the Atlanta Hyatt Regency. Over 530 money fund professionals and cash investors will gather to discuss all things money market over the next several days. Watch for coverage of this event in coming days and in the next issue of MFI.)
MFI: Tell us about Schwab's history? Klingman: Charles Schwab Investment Management, or CSIM, has been offering money market funds since January of 1990, and we've been managing them in-house since 1991. In the past 26 years, we've grown to manage over $160 billion in assets, in AUM, and we're now the number 8-ranked money fund manager by assets. I personally, joined CSIM in December of 1990. At that time, we had two funds, the Schwab Money Market Fund and the Schwab Government Money Fund, which were sub-advised by Kemper.... It's my understanding that at a board meeting in May of 1990, Charles Schwab, or as we fondly refer to him as 'Chuck,' said to our then treasurer, 'We're managing our own corporate cash. Let's put a portfolio management team together and bring our money funds in-house.' That's when I joined CSIM to initiate that effort. A fun fact: I am the first CSIM employee."
MFI: What is your biggest priority? Klingman: Our biggest priority is always maintaining the stability of our fund NAVs and insuring liquidity for our shareholders. And this doesn't change regardless of market conditions, regulatory changes, or lineup changes. Last year, we did have several changes to our product lineup to respond to money fund reform. Two notable changes were both designed to ensure that we continue to provide compelling money market funds to a wide array of investor types. The first change was the creation of our Schwab Retirement Government Money Market Fund. This fund was designed specifically for retirement plans seeking government money fund exposure. The second change that we had was the launch of our Schwab Variable Share Price Money Fund. That fund was designed to provide investors that were deemed institutional by the new SEC rule, with prime money fund exposure with a variable NAV. Since then our product line has remained constant.
MFI: What are your big challenges? Klingman: One key challenge facing all money fund managers right now is positioning for uncertainty around the next Fed rate move. The Fed has proven that they can surprise the industry. So, we're determining how to position the funds in an environment where we believe the Fed wants to raise rates but inflation is mixed. Additionally global and political forces could keep the Fed on hold. That makes for a pretty interesting time in the market. Another challenging aspect that we face today, and in the years since the financial crisis, is a reduction in the supply of money fund eligible securities. Regulations which require money funds to maintain significant liquidity within 7 days, but also require issuers to rely less on wholesale funding has created a mismatch between issuers and investor needs. Additionally, several regions that money funds used to actively invest in before the crisis, such as Spain and Italy, are no longer eligible regions in which 2a-7 funds invest, further leading to reduced available supply.
MFI: Has everything been calm on the credit front lately? Klingman: The regulatory mandates put into place following the financial crisis have strengthened balance sheets and credit profiles. CSIM has a robust credit review process performed by a large team of very experienced credit analysts who review and approve all the credits in which we invest.
MFI: Tell us about your portfolio composition? Klingman: We continue to invest in the breadth of money market securities, such as certificates of deposits, commercial paper, both on a fixed and the variable rate basis, and also repurchase agreements. Something that we've invested in more recently in our taxable money funds is variable rate demand municipal securities. The relative value of these securities has provided a unique opportunity to add yield and liquidity to the portfolios. In years past, this wasn't something that we actively invested in but the dynamics in the current market has provided much more of an opportunity. CSIM has a significant municipal money fund presence with skilled portfolio managers and credit analysts that we closely partner with when investing in these securities.
MFI: Are money market issuers hanging in there? Klingman: We have definitely seen a reduction in money market supply as issuers term debt out the curve in response to regulatory requirements, but luckily they haven't abandoned the short end altogether. It's a tough environment for issuers and money funds alike as money funds are required to maintain significant liquidity within seven days, but it is costly for some issuers to issue and maintain maturities so short.
MFI: How's the new variable NAV fund? Klingman: We're pleased with the success of Schwab Variable Share Money Fund. In the 15 months since it launched, it's grown to over $800 million AUM. It's proven to be an important option for investors deemed institutional by the SEC, who can't access a constant NAV Prime fund.
MFI: Can you comment further on last year's MMF reforms? Klingman: We were in a unique position, in that the majority of our investor base is retail investors. While we did have some migration from our prime funds to our government funds, I don't think it was to the same degree as some of the other managers in the industry experienced. We were also able to work with our partners within Schwab to schedule when the shift in assets would take place, so that we on the portfolio manager side could plan our liquidity accordingly. Things went very smoothly. It was amazing to see an entire industry be transformed last year and how well it went. I think it's really a testament to all the hard work and planning by fund shops across the industry. Reform was a major undertaking requiring a lot of preparation to ensure a successful implementation. We took a very focused and coordinated effort across all of CSIM, as well as with our board to ensure they were informed and educated of the changes being implemented and their responsibilities.
MFI: Do you run ultra-short or offshore funds? Klingman: We don't manage any ultra-short bond funds or enhanced cash strategies and we don't have any separately managed accounts. We do manage an offshore money market fund. We manage the fund in line with our US money funds following the rules of 2a-7. It currently has about $2.2 billion in assets. On that front, we have European Money fund reform up next. So we're currently preparing for the changes that will bring. We'll be going through the same effort, partnering across Schwab to make sure that we address all aspects and we'll be educating our board on the changes reform will bring.
MFI: Can you comment on rising rates and moves in LIBOR? Klingman: The Fed has indicated another couple of rate increases are possible in 2017. I think the Fed would like to raise rates, and they'll be on track to do so as long as the economy and market permits. In regards to Libor, the significant steepening experienced last year was primarily driven by money fund reform. Money fund managers reduced weighted average maturities to extremely low levels as they increased liquidity in anticipation of a large migration of assets from prime to government. As assets shifted, demand declined substantially for securities in which prime funds invest, causing longer Libor rates to rise. Libor has subsequently flattened as prime investors are once again investing in the market.
MFI: What is your outlook for the coming year? Klingman: Money funds are still a very important asset class for CSIM. Our outlook for the current year and the future in money market funds is encouraging. Rates are rising gradually and money funds have found their footing. So, it's back to business. As we reflect on the past and look to the future, we recognize things will always change, but with change always comes an opportunity to rise to the occasion.
