We're transcribed another session from our recent Money Fund Symposium, which was held last month in Atlanta. Today, we excerpt from the opening day's "Private Money Funds, SMAs and ETFs" session, which featured Alex Roever from J.P. Morgan Securities, Deborah Cunningham of Federated Investors, and Rich Mejzak of BlackRock. Their session discusses the world of "Alt-Cash," options fund providers have launched in the hopes of becoming a possible successor to Prime money funds. Watch for quotes from Symposium's keynote with Invesco's CEO Martin Flanagan in the pending Money Fund Intelligence and watch for more coverage in coming days. (Crane Data subscribers and conference attendees may access the recordings, Powerpoints and final binder via our "Money Fund Symposium 2017 Download Center.)
Roever asks in his intro, "What are some of the new developments in the wake of money market reform? We are going to talk about some of those products today, although, some of them aren't really substitutes for money funds.... They are complementary products in some ways. We are going to talk a little bit about private money funds, ETFs, and SMAs.... I don't have much data on private money funds, but on ETFs, short term funds, and SMAs I have a little more. [See Roever's slides here.] Looking at other asset classes, moving further down the table, the [short-term bond] mutual fund and ETF space is somewhere just north of ... half a trillion dollars. [T]he big space is short term credit, where most of the money is. Sec lending is still running somewhere in the order of about $550-600 billion dollars.... [You have] government investment pools, and separately managed liquidity accounts is a sector we know is at least $250 billion.... But [it's] not a very transparent sector, so it is hard to see flows going in and out."
He continues, "Back to the fund space for a minute, just to talk a little bit about market structure. `On the top we have ultra-short bond fund sizes, and on the bottom here we have short term bond fund sizes, split into open ends [and] ETFs. ETFs get a lot of focus these days, they are sort of the hot product across fixed income and a lot of other sectors. Even though there are some relatively large ones they still are small relative to the open end business. In both cases though, market structure is such that there is a lot of concentration.... I think particularly in the case of the short-term funds, there are a lot of very small competitors."
Roever explains, "We try to differentiate a little more in our work around the fund space trying to figure out investment styles. So ... in the case of both ultra-short and short-term in the SMA and fund space, we find that the investment strategies fall into similar buckets. So we often talk about the strategies being 2a-7 like. So they may be SMAs run like a money market fund, but they are separately managed. They don't have the pool of liquidity, but very similar instruments. Ultra short would be a little bit longer.... Then, within the risk spectrum, we find things break out into government, what we would call a conservative credit portfolio, [and then we] would include down to general investment grade, sort of expanding the triple B. And multi-sector would include more securitized products, and may well have more credit exposure in it.... The big category in the fund space is the credit product in the open end space."
Cunningham comments, "We have been in the ultra-short and short term bond business for quite some time, our core competency as a firm from a longer term fluctuating NAV mutual fund business has always been in that space. So, we have strategies that encompass all of the things.... We have them on the corporate side, on the municipal side; we have the government space, and we span the gambit to ultra-short to sort of short-intermediate.... So, out to the 7 year time frame on the yield curve."
She tell us, "We have recently ... started a private fund that mirrors identically the old 2a-7 prime fund. We've also started a collective fund, so both of those being pretty much identical in product type to the 2a-7 funds.... We definitely are in that separate account space from a liquidity products perspective, as well as short term and ultra-short type separate accounts. [We've] found that business to be one that's grown, although to a large degree not as much as we would have expected. There has been a lot more conversation around it than ... real growth in the assets under management of that category."
Cunningham says, "Where we have seen a lot of growth from an alternative perspective has been offshore, [and] in 2a-7 like products like state and local government pools.... So I think those are businesses which are currently growing pretty substantially, and I think as long as interest rates continue on a path that's level to moderately up on a regular basis, that will continue to be the case."
Mejzak explains, "I think about three years [prior to] prime money fund reform, when the interest rate environment was zero. We knew ... there would need to be some option other than a prime money market fund. We went out and launched three products from our cash desk.... We launched an ETF, and we launched two different short-duration bond funds, one with a 90-day WAM and one with a 180-day WAM. They struggled. We saw very little traction with those early on.... Offering a 50 or 75 basis point return ... to an investor that was finding 2, 3, 4 percent returns [in longer-term bond funds was] very frustrating. The conclusion we came to was that maybe being money market guys, we saw the shades of gray, but perhaps the broader market did not."
He states, "We have since consolidated our offerings ... in the short duration space, where we've locked in the 180 day WAM product. On the separate accounts side, I think [we saw] the same thing. That represents a significant part of our business, and I'm not sure it's grown meaningfully since reform. We manage externally about $400 billion in money fund assets, and about $75B of that is SMAs. We run an additional $40B and change that is just outside money funds, run by our short duration team in New York. But I think [we saw] the same kind of themes there -- interest was driven by wanting more return when rates were zero, and now it's about finding an alternative instead of finding a prime money market fund."
Roever also queries, "What is the marketing cycle like for these products, and who do you primarily market to?" Cunningham answers, "There is a broad market from an underlying client perspective, but ultimately, the marketing cycle is a very long one. You mentioned, Alex, that sometimes regulations need to be changed, and almost always, investment policy needs to be changed. Whether it be adding language that was not necessarily tied to 2a-7, that wasn't necessarily tied to stable net asset value, that wasn't necessarily tied to things that have been historically, hallmarks within the industry. So, [we've had] a lot of investment policy discussions, and ... discussions ... over the context of the size of funds."
She adds, "There used to be $1.9 trillion in prime money market funds, and if you didn't have a fund that was $30 or $40 billion in size, you were probably at a disadvantage in the market. Well, now there aren't any funds that [big]. As far as the separately managed accounts side of the equation, you are talking about larger sizes there too, and if you are tailoring it to something that is very much to meet your own firm's needs, then you want to take a little more time. You don't want to simply copy a strategy which has ... worked historically over a long period of time. That may not be the case in the current environment. You want to think about it, and the cycle is extremely long, especially in comparison to what we have been used to over the course of many decades in signing up and undertaking new investment participants in traditional 2a-7 money funds."
Mejzak comments, "I think we have had … similar experiences as well. As far as investment policies [and using an ETF], it being an equity introduces an entirely new challenge. [Though] the underlying bonds or cash instruments, the fact that an ETF is an equity ... seems to be a challenge with your typical cash investor. I agree, [another] challenge to investor policy statements is the size of funds.... [T]hat was a challenge we endured trying to launch our small product three years ago. [Y]ou ultimately need some sort of retail base, because a $100 million fund isn't getting it done. And I think that has led us to our separate account business. When you have somebody with $200-300 million, they might want a comingled product. But sometimes we find them going to an SMA because that's a better place to be."
Roever adds, "So to be clear, you're not trying to run a small fund, you want to run a large fund. But in terms of growing the thing as a percentage of that, it's hard to manage one large investor or a couple large shareholders." Mejzak responds, "`I think in our experience, most investment policies have a 5 or 10% limit, so it is very difficult to grow a fund with $10 million subscriptions. That is why a focus of ours has been to go to the retail side, but that is a big challenge." Cunningham adds, "And in addition to the 5 or 10% [limit mandate], a lot of them have [policies like] 'nothing less than $100 million, nothing less than $500 million, or nothing less than $1 billion.' So put the two of those together and you have almost nothing, no availability."
Finally, Cunningham adds on private funds, "[U]ltimately, our goal in starting one in September of last year, was to basically recreate and give institutional investors the same experience they had been enjoying for the past 40 years in a prime money market fund. Ultimately, the objectives of daily liquidity, at par, with a reasonable return on a prime yield basis are essentially what the requirements are for our private money market fund. Because it is registered as a 3c-7 product and not a 2a-7 product, we are able to achieve those same things without gates and fees, and without using the words 'money market fund' in the descriptors of it."
She adds, "They are same-day, T+0 settlement. Because we use amortized cost, they flow very nicely on a continuous basis up until 5pm, which is the cutoff time for the product. I think honestly when we look at a lot of the flows that exited the institutional prime space in the second or third quarter of last year, much of it had to do with the fluctuating NAV and the gates and fees side. But I have to say a substantial amount of it had to do with the cutoff time for those products moving to 3 pm and even early in some instances. People were used to transacting up until 5 pm. We get a substantial amount of flows between 4 and 5 pm. When prime was not an option at that point, the only place to go was government. So this product in its private form, and use of amortized costs, allows us to go back out to 5 pm."
