This month, Bond Fund Intelligence speaks with UBS Asset Management's David Rothweiler, US Fixed Income Portfolio Manager, and Thomas Cameron, Executive Director on the Global Liquidity Management team, about the recent launch of the UBS Ultra Short Income Fund. The fund, the latest entry in the growing category of Conservative Ultra-Short Bond Funds, has grown to over $1 billion in just over 4 months since its launch. Our Q&A follows. (Note: This profile is reprinted from the Sept. 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 BFI XLS performance spreadsheet, our BFI Indexes and averages, or our most recent Bond Fund Portfolio Holdings data set, which was published yesterday.)
BFI: Tell us about your history. Rothweiler: UBS has a history of managing a wide range of global fixed income assets, and our domestic money fund complex goes back four decades to 1978. We've been running short duration SMAs about as long, and presently, our short duration strategies have a significant presence globally at the firm.
I've been in fixed income for over 20 years, and I've been part of the liquidity management team at UBS Asset Management for almost 15 years. In that time, I've traded and managed a wide range of fixed income assets including intermediate accounts, 2a-7 funds, and ultrashort strategies. Cameron: This January, I will celebrate 18 years at UBS. I've been fortunate to work with Dave and Rob Sabatino and his PM team the entire time.
BFI: Tell us about Ultra Short Income. Rothweiler: UBS Asset Management has a broad range of fixed income products, and over the years we have experienced steady demand in our ultrashort duration separate account strategy. Recently we have seen demand coming from both ends of the curve. Clients with stable cash have sought additional yield vs MMFs without going too far out the curve. From the long end, we have seen demand from clients seeking to shorten duration and reduce principal risk as we enter a period of expected rising rates. With the Fed steadily raising the overnight rate, Treasury and credit curves have continued to flatten out and investors are finding the Ultra Short Income Fund’s current yield attractive given it is not that far off from a 10-year Treasury.
Cameron: There was clear demand from prospects in the ultrashort space. We continue to offer SMAs across the spectrum but those accounts require a higher minimum investment than that available at the fund level. We created the fund to fill that gap.
Rothweiler: With the Fed staying on course, we saw this as an opportunity to enhance our product offerings by introducing this fund to benefit a broader scope of clients. It appeals to investors seeking income with low volatility of principal and who want to maintain liquidity with a quarter year duration. It is somewhat of a sweet spot for the investment community.
BFI: What's your biggest challenge? Rothweiler: I think sourcing attractive corporate paper is probably at the top of my list. Front end corporate paper is very much in demand, so supply can be limited at times which is probably one of the more challenging aspects. To help mitigate this supply constraint, we manage the fund along with our money markets desk, so we are able to take advantage of the scale of our entire liquidity management complex. At times this allows us to purchase commercial paper offering better relative value than some short corporates.
BFI: What strategies can and can't you use? Rothweiler: I think one of the most important is the use of floating rate debt. Floating rate debt allows us to better manage interest rate risk. Within that space, I typically purchase longer dated Libor floaters with final maturities such as in the 2 year area. This is mostly outside of the realm of 2a-7 funds which presents an opportunity for the Ultra Short strategy.
Additionally, we utilize Tier 2 commercial paper, and in some select cases short-dated Tier 3. This commercial paper can sometimes present attractive opportunities in very short maturities. Getting back to the overall strategy of the fund, we can have a maximum duration of up to one year. But to minimize NAV volatility, we do not typically go that far out the curve. We're therefore hovering around the quarter-year mark. If you want to equate that to a WAM, it's roughly 90 days from an interest rate sensitivity standpoint, versus a typical 2a-7 fund that often has a WAM in the 1-month area.
BFI: Can you buy junk? Rothweiler: We cannot purchase junk or even split rated paper. We can only purchase investment grade debt. Our bottom credit rung is low BBB at purchase; if it's later downgraded below that level, we can still hold it. Typically, most of our BBB exposure is going to be mid-BBB and higher, so it's pretty clean from that standpoint. Another thing we invest in is asset-backeds. We typically buy AAA, prime with asset classes such as autos, credit cards, and some equipment-type structures that usually have less than a one year average life.
What we like about our current AAA-rated ABS exposure is that it enhances the overall credit quality of the fund. From a liquidity standpoint, AAA-rated ABS is frequently very tight on a bid-offer basis. We look at this ABS as oftentimes offering as much spread as some corporates, but are better rated and have better liquidity. Essentially, it's an attractive diversification tool.
BFI: Are you looking at other products? Cameron: We are working on similar offerings for other clients in USD as well as in other currencies depending on the demand for those offerings.
BFI: Tell us about your investors. Cameron: Our distribution model is very diverse. Currently the Fund's investor base is heavily retail, but as [the fund] reaches significant size we are seeing increasing interest and investment from institutions.
BFI: Can you comment on the economic environment and the Fed? Rothweiler: We do see the Fed raising one more time this year, probably this December. We see them raising probably two to three times in 2019. If you take the Fed at their word, they're aiming for roughly a 3% Fed Funds rate. U.S. fiscal policies are in essence pulling growth forward via fiscal stimulus such as tax cuts. But we believe growth will continue into 2019.
One thing we watch is financial conditions, and that still seems to be pretty favorable. But obviously as the Fed reduces accommodation, at some point financial conditions will begin to tighten which may, probably with a lag, start to slow the economy. We view that as more of a 2019, 2020 type story.
BFI: What are the risks? Rothweiler: A strategy with a duration of 0.25 years has somewhat diminished interest rate risk. One of the bigger risks is where we are in the credit cycle, as well as market liquidity. We look at a lot of our CP holdings as generally providing yield opportunities with generally shorter maturities. Not only does this enhance the liquidity profile of the fund, it can help reduce risk by having this exposure mature if credit volatility increases. For us it comes down to maintaining liquidity in the fund and monitoring the credit profile, which helps minimize NAV volatility going forward.
BFI: What about the future? Rothweiler: Higher fed fund levels should continue to support this kind of product. Looking at the S&P 500, investors have a dividend yield of about 1.8% with potential volatility. If you look at cash as an asset class, the investor often times has yield opportunities north of 2.0% with a fairly stable NAV. From a risk-return standpoint, these types of products offer significant value for the first time in quite a few years. I think as long as that continues, these funds will benefit.
Cameron: One of the comparisons that we point out to clients and prospects is that presently you can get roughly 80% of the yield of the 10-year Treasury using the Ultra Short strategy, with significantly less duration risk. Our portfolio management team continues to wisely use our credit resources and focus on low price volatility.
