This month, BFI interviews Tracey Keenan, Portfolio Manager for Short Duration Strategies at GMO. GMO, also known as Grantham, Mayo, & van Otterloo, is a Boston-based institutional investment manager, which manages both mutual funds and separate accounts. We discuss their short-term strategies, and a number of other fixed-income topics, in our Q&A below. (Note: This profile is reprinted from the December 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 Friday.)
BFI: Tell us about your history. Keenan: I've been at GMO since 2002, and GMO has been investing in short term bonds as part of their asset allocation strategies for many years.... In 2014, we started to expand our cash investing to more customizable solutions with dedicated internal portfolio managers.
BFI: Tell us about your strategies? Keenan: We invest in U.S. and non-U.S. governments and agencies, all currency hedged. We focus on high-quality liquid assets, so we really want minimal currency exposure, and tend to run one-year maximum weighted duration with a two-year max maturity. What we found coming out of money market reform in 2016 was that there was a supply and demand issue around Treasury bills because of the [huge demand from] government money market funds. We were basically competing with the government-only money market funds in the same space with limited supply. So there was a lot of supply and demand dynamics in the market that we didn't really need to compete with. We decided to try and focus outside of that money market space, while maintaining the same liquidity and capital preservation as the govt-only money markets.
BFI: How are you positioned? Keenan: We try to move dynamically.... Right now, we own more floaters than fixed rate notes, so more on the Treasuries floater side and the Federal Home Loan Bank floater side.... Then we do have an allocation to Japanese yen bills, currency hedged. As the basis has continued to stay negative this year, [during] quarter-end or the year-end turn, that position became much more attractive. So being a dollar lender into calendar effect issues in the space ... has been good for us. It's good to be able to move dynamically when those conditions in the market are changing.
BFI: Is there anything you don't own or you're avoiding? Keenan: We don't invest in any credit in the portfolio or any asset-backed securities. We've kept our strategy strictly focused on U.S. and non-U.S. governments and agencies.... We try to keep internal constraints on what the risk and the diversity in the strategy is, because we feel that liquidity and preservation of capital is still what's most important to us. While we want to be well-diversified, we don't want to take any credit risk with the cash that we're managing.
We've done pretty well [this year].... A lot of the short-duration bond funds have been hurt this year with their longer duration with rates selling off. We keep it pretty clean. We're investment grade or higher, so it's essentially the G10. Our duration is really short; it's inside of a quarter of a year. We just want to be able to be positioned to capture the Fed hiking cycle. The Fed has indicated that they may be close to the end of their cycle, but we're not sure where that that neutral rate lies. So we want to keep it short while the Fed continues to hike rates. [But] we'll re-evaluate that once we know for sure when the Fed is going to be done.
BFI: Do you have any sector or diversity limits? Keenan: Right now we don't in the strategy, but we do look at how quickly we could liquidate.... So in that Japanese yen bill trade for example, there [may be] timing delays between the U.S. open [or if] Asia is closed for the day. We want to make sure that we still have enough of the strategy to be able to liquidate T-0.... That's really what we're looking at -- being well diversified there and not having all of our eggs in one basket.
BFI: What are the other big, liquid "bill" markets? Keenan: We look at ... anything that has safety, liquidity and preservation of capital, something that's well supported by the government. Germany would be an area that we would look at, but the ECB is still involved in their quantitative easing program.... We'd be looking at more opportunities like that -- higher credit quality government markets like Germany, possibly France, and the U.K. But there's just not the availability of bills ... as there are in the U.S. and Japan.
BFI: Who are the investors in the funds? Keenan: Right now, we are more institutional. So we're concentrating the strategy in our traditional client space.... We're always looking for ways to help our clients around the world. So we work closely with our asset allocation team, working with clients and making sure that we can offer customizable cash solutions to them. One really interesting thing that we've seen in the ultra-short space or in the cash space this year is this phenomenon, which I know you've seen before, called 'inside-out' and 'outside-in.'
So we've seen money market investors who have their operating cash in a money market or custodial sweep, now looking for more yield with similar liquidity to their govt-only money funds. Then you have the short duration bond fund investors, who have really gotten hurt this year performance-wise, that are looking to bring some of that [in]. They're willing to forgo that higher yield to make sure that they have that preservation of capital. So we've seen this migration into this ultra-short space from investors on both side of the cash spectrum.
BFI: What about your Fed outlook? Keenan: We're following what the Fed's been saying closely, because it's really important to how we're investing. We're not exactly sure where the neutral rate is going to actually end up resting. While the Fed is still in play, we're still positioned to capture higher rates with an allocation to floating over fixed.... We also continue to be a dollar lender while borrowing still remains so expensive. We expect the Fed to over communicate, as they have done in the past, and in 2019 they're set to have press conferences after every single meeting.
I think Powell potentially got caught off guard [by market reactions]. I'm not sure he's used to having every word he changes in his statement having that kind of market impact. I think he's going to really be conscious of his language going forward, because two words make a huge difference in the cash space. The other big news is the curve inversion. Now you have the short end (2s/5s, 3s/5s) inverted. We're following that and trying to understand the implications on the business cycle and where we are, though that's still outside of the space that we're investing in. So again we are really conscious of the Fed and when they will be done with their hiking cycle.
BFI: What is your biggest challenge? Keenan: I think the biggest challenge in the ultra-short space is that there needs to be more disclosure around what the funds are invested in, because the space is really broad and not well defined. That requires working with clients and making sure they understand what's in their portfolio or strategy. I think there is the availability of assets in the space. There's plenty out there, and the Treasury is set to increase issuance.... Going into the end of 2018 [and] definitely in 2019, the Treasury has some bills to pay. So we'll be looking for more issuance there, which will move rates higher. We think that we're well positioned for higher rates going into 2019.
BFI: What about the future? Keenan: This year, there has been so much attention given to the cash space. I think after years of earning zero on cash, investors were forced out on the curve to get any sort of yield. So I do think that clients will be [bringing] some of their allocations back into cash, specifically [cash] above their operating cash for that yield enhancement with safety, liquidity, preservation of capital. Getting that extra yield and being able to have that safety and liquidity in cash I think will be really important to investors in 2019.
To sum everything up, what we're looking to do here is provide our clients with customizable solutions around their cash investing and make sure that they have that liquidity and preservation of capital by keeping the investments in U.S. government and non-U.S. government [securities], all currency hedged. So what's really important to us is the quality of the investments in the cash that we're running.
