This month, Bond Fund Intelligence excerpts from a session entitled, "UltraShort Bond Funds, SMAs & Alt-Cash" at our recent Money Fund Symposium conference. The segment featured Dave Martucci of J.P. Morgan Asset Management, Michael Morin of Fidelity Investments, and Peter Yi from Northern Trust Asset Management. The three discussed segmenting cash, the various shades of ultra-short, and separately managed accounts. Highlights of the Q&A follow. (Note: This "profile" is reprinted from the July issue of our Bond Fund Intelligence publication. Contact us if you'd like to see the full issue, or if you'd like to see our most recent Bond Fund Portfolio Holdings data set.)
Martucci says, "We want to make sure our clients know what they’re getting, that these are different animals. It's not just interest rate risk, but you also have spread duration risk. Clients typically want to restrict some kind of investments.... More clients are willing to go down in credit to get diversity away from the financial space ... and have gotten comfortable with the SMA space.... Much of the portfolios, say 3040%, are invested in typical money market instruments, CP, CDs, repo, etc."
Yi comments, "I will offer two perspectives here. First, to Dave's point earlier, the ultra-short space has largely been SMAs until probably about ten years ago. We've been managing ultrashort, sometimes called enhanced cash, since the late '70s but we launched our first two ultra-short mutual funds in 2009. It has been a great success story for us and continues to be a wheelhouse within short duration at Northern Trust. We have grown our assets exponentially since then. Our two mutual funds now represent about $6B in assets under management. Investors are starting to migrate from a customized SMA structure to a more standardized mutual fund structure. We are also starting to see peer groups develop, so it makes it easier for investors to compare funds."
He continues, "Different flavors of ultrashort are starting to evolve. There is Conservative Ultra-Short, there is UltraShort, and there is Ultra-Short Extended with some including sleeves of high yield that may be appropriate for certain types of investors. Even in different interest rate and credit cycles, the industry will continue to evolve. Unlike the more mature money market industry, I think the ultrashort product has enormous opportunity for innovation to unfold."
Martucci adds, "Really, in the ultrashort space, the only requirement is a year or less duration. Other than that, we see a bunch of different accounts, a bunch of different guidelines…. The way we differentiate ourselves is really through our credit process ... and how we manage duration. I think those are the two biggest processes.... When you're talking about a year or less portfolio, most clients are concerned with credit.... They know that this is really the thing that can really go haywire. So we think we have a very robust credit process, and we have a lot of resources devoted to it.... This is a very important aspect that has resonated with our clients."
Morin comments, "We just want to make sure the investor understands ... that you can get a little bit more return but you’re going to have more risk."
Martucci tells us, "When you have stress and interest rates move ... that is an opportunity for us to demonstrate our risk management process and to show that we still can deliver a low volatility product and deliver an attractive return."
He explains, "Now that the market has settled down, yields are very attractive. Clients have said, 'I can get basically 70% of the 'Agg' yield with less than 10% of the duration.' That is very attractive ... with the Fed ... on a path to higher rates. That to me is a good selling point."
Yi states, "I agree with you both. The next wave going into the ultrashort space is going to be core fixed income investors that are afraid of rising rates that go down the risk continuum. Meanwhile, over the last 10 years, it was actually the other way where money market investors looking for more yield were moving into ultrashort. Now that cash is considered a real asset class again -- the 3-month Treasury yield is equal to the dividend yield of the S&P 500 -- it is becoming more attractive and industry assets are growing again."
Morin says of the new breed of "conservative" ultra-short bond funds, "What we've been able to demonstrate since some of these ultra-shorts have now been around 6-7 years [is minimal volatility]. What the industry has attempted to do was to create a new set of guidelines [and] to take some of the lessons learned from 2007-2008.... When you think about designing these funds, they were really designed to minimize volatility [and] risk.... They're been very successful to date. Of course, you could argue that the environment hasn’t been too challenging. But I think investors have been extremely pleased with how low the NAV volatility has been on these funds."
On Northern's offering, Yi tells us, "We absolutely market and make representations that the ultra-short strategy is a total return strategy. It is differentiated from a money market fund, even from a variable NAV prime market fund. When we think about the sweet spot [in the] ultrashort space, we target 6 months to one year target durations. We are very active in the new issue market. We are still operating in a new issue market where you get new issue concessions, even as wide as 2-5 bps, [that] is really attractive. That is why scale in the fixed-income marketplace is incredibly important. Prior to 2010, the roll-down trade was a trade that every ultra-short manager tried to take advantage of. You’d buy a 2-year instrument and when it rolled down to 13 months, it became money market eligible and would fetch a good bid. You’d get some gains that way."
He continues, "Right now, we think the new issue market seems to be a great opportunity to differentiate ourselves from a performance perspective. From a yield curve perspective, the market has repriced expectations of where the Fed is going to be in terms of the raising rates. The two-year has not performed very well at all YTD. We are starting to see one-year tenors look more attractive right now. From a technical perspective, short end rates are being boosted by increased Treasury bill supply. It is a little bit shorter than where we can see some of these bid-lists that are, as we understand it, a result of repatriated cash. The one year part of the curve feels like a good spot to be in fixed rate, at least temporarily due to technical factors."
When asked about where the SMA are, Martucci tells us, "Out of that [JPMAM's] $50B, I would say, most of it is not hugging money market funds.... Our client base can go everywhere with an asset maturity of an 18 month to 3 year range using investment grade corporates, governments and ABS."
Yi also commented on tax-advantaged funds, saying, "We have a Northern Tax Advantage Ultra-Short Fund that has really grown in assets since 2009 when we launched it. Right now, it is about $3.8B. What we like about this fund is that it is 'tax advantaged.' We do not market it as the tax exempt fund, so what that means is generally speaking, roughly 75-90% of the fund is generally in tax-exempt instruments. We have the option to put it in corporates, and we do. It allows us to be nimble portfolio managers. We like to think of yield from an after-tax perspective. If we can find an attractive taxable corporate security that is consistent with the high quality portfolio we want to construct, the yield on an after-tax basis can be better than our opportunities on the tax exempt side. We think this type of product and approach is differentiated and a little bit unique."
Finally, Martucci comments on ETFs vs. funds. He says, "It is really about investor behavior. Our ETF is JPST. It launched in May 2017 and we are over $1.4B. It is actively managed.... Most of that money is retail coming down the curve. The retail community wants ETFs, and if we are able to deliver it to them, [we will]. The timing has been great given the yield curve."
