This month, Bond Fund Intelligence interviews Randall Bauer, Senior Vice President & Senior Portfolio Manager with Federated Investors. Bauer is Head of Federated's Structured Finance & Low-Duration Strategies Group and manages the $3.6 billion Ultrashort Bond Fund and the $1.3 billion Short-Term Income Fund. He discusses the ultra-short sector, strategies and supply, and maintaining a "balanced risk profile." Our Q&A follows. (Note: This profile is reprinted from the November 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 will be published Monday.)
BFI: Tell us about your history. Bauer: I've been with the firm since 1989, and before that I spent almost eight years at PNC as a commercial lender. So I have a credit background. I came to Federated and worked in the high-yield area for a couple of years, and then got into the bond area.... At the end of 1991, we repositioned one of our existing funds and wanted to make it a low-duration product.... It still exists today, and it's called the Federated Short-Term Income Fund.
We realized there was an arbitrage opportunity in the term asset-backed securities market.... We combined the concept of low-duration and the liberal use of asset backed securities with the addition of a multi-sector approach.... The main drivers of our low-duration strategy over the years has been that combination of corporates and securitized assets.
In 1998, we shortened the product line by introducing the Ultrashort Bond Fund into what we term the "Active Cash" sector, products having an effective duration of less than one year [and] and termed "low duration".... So from money funds out to three years is really the area of expertise for the low-duration group, which I now head up. [We're] under the aegis of our fixed-income group, headed by Bob Ostrowski, and of course, Deb Cunningham is still heading up the liquidity, or money market group.
BFI: Is Ultrashort your shortest? Bauer: In the active cash space, we actually think about the world in terms of a conservative, moderate, and broad approach to the investors. [In] the conservative approach, we don't use credit risk, so the [equivalent] area that on the money fund side would be a government fund. That's where we have our Government Ultra-Short Bond Fund in the active cash.... [In] the moderate strategy, we employ credit risk. But, it's always investment-grade credit risk. Then in the broad stretch, we also incorporate a small amount of non-investment grade, and we do that in our Ultrashort Bond Fund. We think of that as our "active cash broad" offering. There we do allow up to a 10% non-investment grade allocation.
On the low-duration side, we have similar offerings on the conservative side. We have our 1-to-3-year government fund. On our broad side, we have the Short-Term Income Fund.... In the moderate space, we don't have any funds per se, but we offer a variety of separate account strategies to our client base and we manage a lot of separately managed account portfolios there. We've really morphed it into "six boxes" on that active cash and low-duration space.... So we have in the ultra-short family of funds ... the Government Ultrashort, Municipal Ultrashort, and the Federated Ultrashort Bond Fund.
We brought Ultrashort Bond Fund out in '98, so it wasn't launched in a zero-interest rate environment. But it was a product where people were looking for limited volatility with greater total return potential than they would have in just a money fund. They were looking to deploy assets where they didn't necessarily need them to meet payrolls. What we've always tried to do with our active cash products is to accept a variety of risks in order to try to attain that additional total return. We always try to keep the risk profile of the portfolio consistent with that of the investor taking that first step out the yield curve. I almost think of that as a mantra for the Ultrashort Bond Fund.
BFI: Are flows and supply challenges? Bauer: In the old 2a-7 construct, pre-2016, we could take stuff that was 13-14 months, and it wasn't 2a-7 eligible yet. You could pick something up. Post-modified 2a-7 in October '16, we realized that maybe the corporate treasurers hadn't fully prepared.... With the shrinkage of the Prime money fund universe, there was more supply than demand. We were the beneficiaries of that trend for a while. But I think at some point ... corporate treasurers and bank funding desks realized they didn't need to issue quite as much in the space.... Now you're starting to see the reverse occur.... For investors looking for something over and above the Prime fund, they're still coming to us.
But the other areas that we are beneficiaries of, in terms of cash flow, are the people in the universe who want to lower their effective durations but don't necessarily want to go into a very limited volatility fund or a stable NAV fund. They come into the active cash base, maybe into the low-duration space. So we've been beneficiaries of that, too. Every time you get equity volatility going on, people get a little spooked. We're a favorite place for people to park money at least for a while.
To the extent that the Prime funds can't buy very much A-2 (and no A-3), that gives the entity that's doing its credit work opportunities.... We're following a lot of credits that are not AAA-rated or AA-rated on the long-end.... We're looking at a lot of BBB issuers that might have an A-3, P-3 program and we can use that in an active cash context as it adds value to the portfolio.
BFI: What can't you buy? Bauer: Because we think about maintaining a balanced risk profile on the product, we do pretty much anything. But we don't do a lot of it.... We have a [tiny short] position in Treasury futures [and] we have a 10% limitation on non-investment grade when we do use our non-investment grade buckets.... We're not averse to owning bank loans. But again it's a matter of magnitude and a matter of maintaining that relatively balanced risk profile.... We have not used CLO exposures.
BFI: What about your investor base? Bauer: Because of the evolution of the industry, a lot of our discussions occur with gatekeepers.... We find that people are asking more sophisticated questions, [and] we've always been ... a little more available at the PM level than perhaps some shops.... As to who's investing in our products, it could be an endowment, a university, and then obviously you've got a lot of retail in there through the intermediaries. Then [you have] the consultancy universe, and they could be the gatekeeper for any number of end user investors.
BFI: What do you expect from the Fed? Bauer: We think [the slow and steady hikes] are beneficial. It gives you a chance for additional income ... and it ties into our strategy of being heavily invested in floating rate paper where we are literally taking advantage of each Federal Reserve move.... We continue to expect them to move in December and then again in 2019. How often in 2019? The jury is still out.... As long as you're keeping your duration profile short, you don't have to worry about that capital value diminution occurring at too fast a pace. What spooks people in a portfolio like this is having ... your net asset values dropping, even if the income catches up over time.... We like the way things are going at the Fed now.
BFI: What about the future? Bauer: As long as the economy continues to go reasonably well ... and you're getting up to the top of where the Fed is going to be taking rates, you're going to have an attractive yield [and] you're going to have the opportunity for a little bit of capital appreciation. At that point, you think about your duration strategy. Do you start to extend it towards your maximum, which in our case is a year? Then what do you do with the overall credit quality in the portfolio? [We’ll be thinking about] all those things.
We've been in business in the ultra-short space for 20 years now, and we've had several ebbs and flows over that time. In general, you get higher lows and higher highs. The overall industry, the overall investable universe grows in size and it's important to have quality products in each space.... Hopefully, over the last 20 years, we’ve been able to generate that performance track record that will keep people with us.... In the last couple of years, we've been the beneficiary of inflows in the active cash, ultra-short space.... You'll lose some, but then you’ll get them back and then some. It's an organism; it lives and breathes.
