Today, we excerpt from the keynote discussion at Crane's Bond Fund Symposium, which took place earlier this week in Philadelphia, Pa. The session, "Ultra-Shorts vs. SMAs: Round II," featured Rich Mejzak, Managing Director at BlackRock, and Jerome Schneider, Managing Director at PIMCO. Moderator Pete Crane commented, "We want to talk about both [SMAs and ultra-short funds], since separately managed accounts are a big chunk of the enhanced cash, beyond-money fund marketplace.... We're trying to get some representation of some other segments of that space beyond money funds." Attendees and Crane Data subscribers may access the Powerpoints, recordings and conference materials at the bottom of our "Content" page or our via our Bond Fund Symposium 2019 Download Center.
Schneider commented, "For PIMCO for much of the past 40 years, we were one of the first in the mutual fund space for short term in the ultra-short space and we've evolved that over the past few decades. I think the one thing that differentiates PIMCO is our focus not necessarily on the traditional money market fund segment, although we do a good amount of SMA's in that arena. The bulk of the $300 billion that we manage is quite honestly in the ultra-short and short term and low duration space. For us, the focal point has always been trying to find client solutions and in that over time we've developed products some are which are more focused on risk and return, the others are focused on liquidity. Some others more recently the theme has been more volatility management. In all of these, the solution is simply to try to find products that more precisely fit the demand functions that we're seeing from clients."
He explained, "In order to do that you have a pretty broad team, I think that's one of the key things that differentiates PIMCO. The team members that we have primarily based in Newport (Calif.), we have 10 portfolio managers focused on all different aspects of the market. Again, the acumen of these people is typically outside the money market space. A lot of people like to point to the fact that we've had exceedingly low turnover on the portfolio management team over the past decade since I've been managing it."
Schneider said, "It's been focused on bringing high quality risk adjusted returns to clients. The products that we've introduced over the past decade or so, including our short term ETF MINT which is the largest actively managed ETF.... It's about $12 billion now in size. [Also] our Short Asset Investment Fund, they've really been focused on providing risk adjusted returns, and more importantly a nuanced allocation. So as an example, no derivatives in MINT is something that's actually been a focal point of marketing.... I think the key thing ... is trying to find the balance between risk and return, and sometimes those are very different things to very different people."
He told the BFS crowd of 130, "We've been at the forefront of this notion that growth would be low for a while. We called it the New Neutral 4-5 years ago and that sort of stuck ... even the Fed started calling it that. And at the same time, we don't really see a lot of impetus for growth to be much higher than 2, 2 1/2 here in the U.S. More importantly, it could be a case of seasonality, where you have a very weak Q1 and Q2, and maybe a little bit better back half of the year. Just as 2018, we're probably preparing more to the downside risks and the upside risk at this point in time, preparing for what we call 'rude awakenings' or just tail risk situations -- being a little more selective in terms of corporate credit, doing our homework in those regards and trying to find other avenues to produce income. Some of that is mortgages or other things with a sprinkling of TIPS and inflation securities.... So just sort of playing it safe, keeping it keeping it sort of near the benchmark so to speak."
Schneider added, "But at the same time when we sort of look at where we think rates are headed, you could make a case for a rate cut because, hey the market's pointing to more than two rate cuts at this point in time. It seems to us at least around the investment committee table that most likely turn would be higher as opposed to lower. But you never know. These things have a way to go to sort of create evolutionary reverberations that might push it lower eventually."
BlackRock's Mejzak explained about SMAs, "[They've] changed a bit following two things. One, following Reform, clearly fees and gates were a game changer for the way a lot of clients looked at this business. And then secondly, you know at least more recently fees and fee compression has been a real driver.... Now our case has always been you know just because it's short duration doesn't mean it's simpler and should be cheaper. The reality of it is, it's more labor intensive. There's more active management, there's more frequent maturities, there's more cash to be invested. But from where we sit I think the main driver more recently has been the combination of those two. It's been money fund reform and it's been fee compression."
He continued, "Your smaller investors are normally inclined to go to a fund. We are trying to solve that problem, launching what we call a scalable separate account platform. BlackRock has a technology platform where were able to have a master structured portfolio and we can allocate trades accordingly over smaller asset base. That's a space that we're trying to enter, once again at a competitive fee structure to give a client an SMA solution. With more efficient pricing."
On what's attractive, Mejzak said, "Well that that's changing daily right now.... The only thing that hurts worst than buying a flat curve is buying an inverted curve. You need to really be a buyer of rate cuts.... These things have a way of forcing the Fed's hand, which I don't think is going to occur yet. [But] our expectation is that the second quarter will be stronger than the first and hopefully a lot of this most recent move that we've seen will move the other direction. We've been spending a lot of our time you know really it's been more about curve than it has been about really asset class, or credit. We certainly recognize the fact that we are towards the end of the credit cycle, so we're being thoughtful about that. The tighter the credit spreads are, the easier and cheaper it is to go up in quality so that seems like an easy thing to do right now and just pick sectors of the curve that you know aren't pricing in an aggressive rate cut as the market is currently doing."
He also said, "The floating rate market has been disrupted recently, a function of two things: certainly LIBOR and the outlook for where that will be in two years' time, and then secondly, the view on rates.... So there seems to be a kind of kink in the floating rate curve when you get out past there now.... I think that when you talk about something the money funds aren't buying that, if they continue not the buy gets to a point where it starts to look more and more attractive. To me that's one of those things."
Mejzak told the Philadelphia crowd, "Typically in these products, they wouldn't have traditional, Treasury agency collateral repo that you would utilize for a liquidity. We do utilize alternative collateral repo for yield, and that's starting to reprice too. That's a conversation we've been having.... We have a lot of collateral management systems where we're able to do that really well. So we have a very sizable alternative repo book, leveraged largely from our securities lending platform.... I wouldn't say that alternative term repo is a fit for a lot of these other products just based on the illiquid nature of it. But it certainly does have time and a place in some of our portfolios."
When asked about terminology, he commented, "I find the enhanced cash, ultra-short, short duration, I personally think it means more to everyone here in the room than it does to the investing public, that we certainly see the shades of gray that they don't.... Even this you know ultra-short or short duration peer group, it's even difficult in there to try to compare apples to apples with portfolios. You have a product that is very 'money market-esk', maybe a six month duration with a first tier minimum and a 3 year maturity compared to a fund that has high yield derivatives and emerging markets. And they're going to perform better at different points.... I've found that the clients are looking for us to make that decision."
Later, Schneider commented, "Your probably best trade the past six months has been on the 1-year bill.... At the same time in terms of what you're doing today it's about diversification. You know, we've been underweighting some corporate credits for a long period of time sort of waiting for idiosyncratic things to reprice as much as they did in the fourth quarter last year in favor of owning some high-quality commercial paper, non-financial mostly, with a sprinkling of agency mortgages.... I think TIPS now on a break-even basis are relatively attractive if you're going to sort of take a longer horizon view ... and there's some higher quality ABS deals.... You can get into some of the prime credit card deals that aren't sort of off the shelf there's some there's actually some spread concessions still there. So there's some good opportunities there. But again this is this is a world where our clients our investors should be looking to make three to maybe three and a half percent total return and once you have capital appreciation and that's a pretty good year and considering the volatility and everything else out there it's probably looks better than most other places in the investment world."
Finally, Mejzak added, "I think Jerome was accurate speaking about the fourth quarter. And your opportunities are typically coming in the secondary market when illiquidity or challenged liquidity is going to drive prices lower for different reasons. Currently our scale is to the point where we can take advantage of those where you know the 5's, 10's and 20-million-dollar trades still make a difference.... But you know the reality is our average SMA is probably in the two to three hundred [million] range. Those trades or are able to do something. A lot of the similar themes that he spoke to -- now we know why prices are moving lower on everything we like too -- some of the credit card stuff and the non-financial commercial paper is where we've been hiding out. We think that as I said we're not a buyer in this multi-rate cut scenario yet. And so we've been looking to just add carry and those are the two places where they've been."
