Today, we reprint Part II of our recent Money Fund Intelligence profile, "Vanguard's Nafis Smith: Money Markets Compelling," which interviews Nafis Smith, Vanguard's new Head of Taxable Money Markets. (See yesterday's News for Part I, and contact us at to request the full issue.) MFI: What are customers asking about? Smith: I think investors are happy with money markets these days. However, something that has come up recently in this rising rate environment is why rates on bank products aren't rising at the same pace. In a zero-rate environment, they were able to fly below the radar on low-yielding bank products. But we've had several rounds of tightening by the Fed with a notable rise in short rates.

I think clients are starting to take a hard look at what they are getting paid on their cash. Then when you factor in a yield curve that's flattening and a little volatility in equity markets, money market funds are just starting to make a lot of sense for a lot of people. We're seeing it reflected in our cash flows.

MFI: Is there downward fee pressure? Smith: We've long led the way on the fee front. During the zero-rate era, we temporarily lowered the expense ratios on some funds to maintain some yield. But as rates picked up, yields in the fund increased, and we were one of the first firms to normalize expense ratios.

MFI: Any comments on 2016 MMF Reforms? Smith: I think that broadly as an industry, money markets are much healthier and more resilient now than leading up to the crisis and in the post-crisis periods. The institutional and retail segregation is healthy for the industry. Two years after the fact, the transition is done at this point. Regarding, stress testing here at Vanguard, we have a very robust process in place. On a daily basis, our risk management group goes through and tests the funds to basically confirm their ability to retain weekly liquidity, price stability, and to the extent that a portfolio has a variable NAV, to make sure that the principal volatility is low. They'll "shock" several different factors on a daily basis: shareholder redemptions, a rapid increase in short rates, and a widening of credit spreads. It's done to ensure investors in our funds are protected.

MFI: You didn’t see as big a shift away from Prime, right? Smith: Our Federal Money Market Fund became our brokerage sweep vehicle, so there was a shift, but not nearly as dramatic as in other parts of the industry. At its largest, Prime was around $150 billion. We got down to around $90 billion or so, but now it's back up to more than $110 billion.

MFI: Do you run internal MMFs or cash outside the MMFs? Smith: We do run the Market Liquidity Fund but it's not available to the public. It's an internal cash pool where we sweep any cash that sits in a Vanguard mutual fund. We run that fund in a very similar manner to Prime but in a slightly more conservative fashion.... In terms of ultra-short products, we launched Ultra Short Term Bond Fund in 2015. That's currently $5 billion in assets and is run by our credit bond group.

MFI: What about the investor base? Smith: Our investor base is heavily retail-focused. There are some institutional clients, such as 401k participants in some portfolios, but the flagship Prime fund is retail-only.

MFI: Any more thoughts on the Fed? Smith: If you look out over the next six months, we expect two more rate increases: one in December and one in March. The macroeconomic backdrop supports doing that. You look at conditions, like the labor market and inflation, it's very close to the Fed's target. Conditions seem to warrant raising rates at a measured pace. I think the Fed's been clear about their desire to go at a measured pace. In terms of how we position, for us it comes down to 'What's the view? What's priced in?' If securities are pricing in the number of tightenings that we expect and then some, then we're happy to be long. If pricing is not consistent with the view, then we might be a little shorter.

MFI: What about your outlook for cash? Smith: Through the end of October, year-to-date inflows to our Prime fund, our Government fund, and our Treasury fund are approximately $43 billion. In terms of 'What's to come?', rates are going higher, which just makes money market funds a compelling option for investors. If you think about what the curve is doing, if you think about some of the geopolitical risks, and if you look at what rates folks are getting some bank products, I think it's a fantastic time to be an investor in the space."

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