We again excerpt from our recent Bond Fund Symposium conference, which took place in Los Angeles March 22-23 and focused on the conservative ultra-short bond fund market, below. Today, we quote from the session, "Keynote Discussion: Ultra-Shorts vs. SMAs," which featured PIMCO Managing Director Jerome Schneider and J.P. Morgan Asset Management PM and Head of Managed Reserves Dave Martucci. The two discussed a number of issues impacting ultra-short bond funds and separately managed accounts, and agreed that the next wave of growth for ultra-shorts is likely to be 'outside-in' (from longer-term bonds) and not 'inside-out'. (Note: The Powerpoints and recordings for Bond Fund Symposium are available to attendees and subscribers at our BFS 18 Download Center. Also, mark your calendars too for next year's event, which will be March 21-22, 2019, in Philadelphia.) Watch for more BFS coverage too in the upcoming issue of our Bond Fund Intelligence and in our next Money Fund Intelligence newsletter.
Schneider commented, "This is clearly a growing segment of the marketplace. The notion of liquidity management and capital preservation is something that's been ... on people's minds over the past 10 years, and it's taken a long time for people to actually think about how it should be articulated. We all work with different clients in different ways.... So the purpose of these discussions for the past year or two has focus[ed] on offering products, offering solutions to clients that help fill various risk factors.... The evolution of Pete's franchise is simply an acknowledgement that investors are moving around in there thinking more about ... ways to manage capital."
He continued, "PIMCO's presence in the front-end market has been pervasive for almost 40 years. We launched our first ultrashort bond fund 30 years ago. The PIMCO Short Term fund is almost 31 years old now.... I have been at PIMCO almost 10 years now.... PIMCO is really focused on active management, that's no secret.... We think there's a place for money market funds within the liquidity universe, but really our forte has really been managing risk attributes ... and balanc[ing] income with capital preservation. Our strategies include mutual funds and separate accounts. But ... over the past few years we've had an emerging ETF platform that's really been a focus of growth in terms of the $200 plus billion dollars we manage on the front end."
Martucci told host and moderator Pete Crane, "Thanks again for bringing focus to this area.... Your approach to separating the conservative ultra-short from the ultra-short, I think that's been very beneficial.... There's a much broader range of investors that invest in the space." On his background, he said, "I've been at J.P. Morgan 18 years ... managing money, SMAs and mutual funds, as well as out the curve [in the] immediate bond funds space. Traditionally J.P. Morgan global liquidity has been known for its money market fund business which is the largest in the world across the globe."
He added, "What we really tried to do when we launched the Managed Reserves platform was take the best practices from our money market expertise and build that out into the ultra-short space. Post crisis there was an opportunity for clients wanting a little more yield, and we felt that we had that expertise and really grabbed onto that opportunity.... [Our] platform has grown in the ultra-short space, we call managed reserves, to around $65 billion. We have mutual funds, SMAs and most recently we launched an ETF.... Now with rates [rising] it seems like a very attractive place and making cash more relevant for all of us."
Schneider also told us, "No matter what we think about the risk factors of being in the short-term space, there are hazards within [it]. I think as practitioners, we all need to be cognizant of the fact that it's our collective responsibility to understand that even though we might be managing short duration portfolios -- a year, 2 years, 5 years, whatever -- it doesn't mean there's any less risk.... When you do get 'left tail' events, it is our responsibility to help explain to investors, preserve that capital and steer clear of it. So, the danger we collectively run into is one whereby one bad apple spoils the cart. We have to collectively be vigilant especially in times like these where things seem relatively okay."
He stated, "At PIMCO, what we've done is clearly incorporated our macroeconomic views, our top down views, of how the world is evolving.... What we call the 'new neutral' ... drives our ultimate investment process, even for managing short duration cash. [We] then incorporate ... bottoms up [analysis].... The goal here is to try to preserve capital and do so in a lower volatility state of the world. That's typically where we try to find opportunity sets and incentivize clients to move out the curve from money market funds, or ... try to get what we call 'core bond' investors."
When asked about their keys to success, Schneider added, "Well it takes hard work; it takes teamwork.... Our team [has] had great stability over the past 10 years, and my hats off to them.... At the same time there isn't necessarily pressure to produce huge amounts of 'alpha,' although we do pretty well in that regard.... At the end of the day, if your clients can't get the liquidity, if there's not capital, then it really doesn't matter at all. The goal here is to create a suite of opportunity sets that have evolved over the years."
He also said, "If you're talking to an institution or a corporate treasurer, they don't really care about inflation, to be fair. They care about capital preservation, because they're worried about losing their jobs if they don't have liquidity. [But] if you're talking to a retail investor, or pension, or somebody who's focused on longer term retirement it resonates very soundly.... If they can simply make sure that they have a dollar of purchasing power a year from now, that's an important prospect. It's something that frankly these ultra-short funds, short-term funds, and low duration funds do pretty well, provided they mitigate their interest rate effects."
Martucci told the LA audience, "I would say that the opportunity right now is in the front end with Libor kind of spiking and with 3-month Libor well over 2% and core CPI well below 2%.... I think the next increase in demand that we're going to see in the ultra-short space [will be] coming down the curve. Historically, it's been coming out the curve ... money market funds getting zero percent or no return."
Schneider added, "I couldn't agree more that we are actually seeing a lot more interest coming in the curve than going out the curve at this point in time.... The danger that we highlight here is one whereby those investors who have become more complacent have been focusing on that income. [People] are waking up to the fact [that] rates recalibrated 100 basis points over the past six months.... People who are worried about higher rates are now differentiating themselves because how they differentiate themselves and reduce their interest rate risk and shelter themselves actually matters."
On active vs. passive, Martucci states, "J.P. Morgan, especially in the short end of the curve, [has] always been an active manager and we kind of pride ourselves on that. [O]ne of our biggest differentiators is our rigorous credit process and all the resources that that we have in the front end. I think that's very important when you're talking about principle preservation with a very low volatility.... We encourage our clients not to take on a credit type index in the front end of the curve.... When you really want to focus on principal preservation, you don't want to think about tracking an index and be forced into a specific purchase.... We really think that the front end of the curve in particular should be a place for active management. It is very important and I think a differentiator for both Jerome and myself. I think we can still continue to add value in that space."
When asked about his outlook, Martucci said, "I think we're seeing some opportunities being created here in the front end. I think what we're trying to understand right now is really the effects of this repatriation flow or expectation of this repatriation flow from short term credit buyers, typically corporate cash, versus the potential flow coming down the curve. This I think is the next big flow that we'll see, and [it could] overwhelm. When you look at it from an overvaluation perspective, we've had a big move in the front end of the curve already ... which is creating an opportunity."
He added, "We are very confident that corporate fundamentals should continue given the stimulus from tax reform and just the trajectory of the economy.... I think clients have to be aware of some curve steepening even from one to three year part of the curve. We're really sticking short, very positive on credit. To be quite frank there are opportunities ... in the front end when you can get a return of anywhere from 230 to 250 on six month paper investment grade. That seems to be a very attractive place to kind of hide out and let some of the stuff play out over the next six months."
Finally, when asked about separately managed accounts, Martucci commented, "We tried to go to with menu options on the SMAs. But the benefit of the SMAs, and why it's growing so much, is the customization aspect that we can deliver to clients.... Of [our] $65 billion, I would say roughly $50 billion is in SMAs. A typical client is going to be a corporate cash type client ... where really they just want a return in excess of a money market fund [of about] 20 to 40 basis points.... We've seen success there, and then most recently J.P. Morgan as a whole is starting to launch the ETF business. Given the success that Jerome and his team have had with MINT, we've seen that as an opportunity to grow."
