This month, we interview Northern Trust Asset Management's Director of Short Duration Portfolio Management and Head of Taxable Credit Research Peter Yi. We discuss Northern's history and presence in the cash sector, the latest challenges and issues facing money market funds, and a number of other issues. Our Q&A follows. (Note: The following is reprinted from the August issue of Money Fund Intelligence, which was published on August 7. Contact us at info@cranedata.com to request the full issue or to subscribe.)

MFI: Give us some history. Yi: Northern Trust Asset Management has a very rich history managing cash and other liquidity products. We've been managing money markets since the 1970s, when our trust department created its first cash sweep vehicle. We view cash management to be a core capability and a product that caters incredibly well to our institutional asset servicing business, as well as to our wealth management franchise. We're managing about $238 billion in AUM across our money market funds and other liquidity products. History tells us that experience and leadership are critical for the money market business. It's served us well in successfully navigating different credit and interest rate cycles.

Personally, I've been at Northern Trust since 2000, and we've seen significant growth in our liquidity business since then. I oversee the teams that manage our 2a-7 money market mutual funds, our common and collective STIFs, our offshore global cash funds and our separately managed accounts, as well as our security lending reinvestment. I also recently took over as head of our taxable credit research team that covers strategies ranging from money market all the way to high yield across the yield curve.

MFI: Talk about the non-2a-7 vehicles. Yi: A lot of people recognize Northern Trust for its significant presence in SEC-registered money market mutual funds, but that only represents about half of our liquidity-focused AUM.... Looked at more broadly, we focus on designing solutions, whether they're commingled or customized through separately managed accounts. Our product offerings range from registered money market mutual funds, roughly about $117 billion, to our collective and common STIFs, which represent about $50 billion. Our global offshore funds represent about $22 billion in three different currencies: U.S. dollar, euro and sterling. The rest of our assets are customized separately managed accounts or securities lending reinvestment vehicles. The other pools are important because it gives us scale, which is critical to being very competitive. In addition to our $238 billion, we have roughly $20 billion in ultra-short assets under management, which has been a real growth area for us and certainly a strategic focus over the last few years.

With regards to our offshore global cash funds, they underwent changes from the implementation of European Money Market Reforms earlier this year. We came through that experience with a much stronger fund lineup with structures that better accommodate client needs. We don't think we've compromised the risk profiles of the funds in any way, and believe, in terms of the three currencies, [we're] positioned well in this new European money market fund landscape.

MFI: How similar are these vehicles? Yi: Without a doubt our investment philosophy and investment process have always been consistent across all our liquidity funds. Some of our funds may have different structures, whether they're CNAV or LVNAV or even Variable NAV in Europe. We've always prioritized principle preservation and liquidity above all else. For example, our conservative philosophy is always focused on fully understanding risk, whether it's credit risk or interest rate risk. We're always assessing whether the benefits outweigh the risks in the marketplace.

Similar to how our investors think, we recognize the money market business is an asymmetric one. Investors don't want to compromise their principle or access to liquidity for a few extra basis points. We're constantly debating the question, 'Are we getting paid for the risk?' In these situations, relative value assessments become really valuable to our portfolio positioning. But as it relates to how we think about our liquidity products within our cash management business, we use the same robust risk management process as well as the same credit research teams as enterprise tools to ensure that we are implementing the same credit views across a very conservative asset class.

MFI: What about your clients? Yi: Our client base for liquidity solutions is very broad-based. As I mentioned before, cash has been a core capability for the organization. The investor base for our asset servicing business gives us a sophisticated institutional presence across a variety of market segments, and that ranges from public funds to ERISA clients to foundations and endowments. We also have a very strong service model for corporate treasurers, who are looking more for direct investment vehicle options. Then, on the other side of the house, we have a strong wealth management franchise that allows us to offer thoughtful solutions for retail investors.

MFI: Why do they choose Northern? Yi: We employ a solutions-based approach when thinking about client needs. We spend a considerable amount of time talking to clients and focusing on their liquidity needs. Whether it be an institution that is preparing for scheduled benefit payments ... or a high net worth individual that might be having a liquidity event, all of those conversations are really important. It's our relationship management and our ability to provide thoughtful solutions to these different types of clients that differentiates us from competitors. Our clients value our conservative investment philosophy that prioritizes principle preservation and liquidity, but also offers a very competitive yield. They're attracted to our unwavering investment process that emphasizes strong risk management and credit research. With all that, our clients are quite happy with our approach.

MFI: What are you buying? Yi: We like to overweight secured instruments. One example is repurchase agreements that are over collateralized and backed by high-quality transparent collateral and serviced through an independent tri-party custodian. In addition to those safeguards, we select the largest and strongest repo counterparties. Repo tends to be a very attractive investment option for managing portfolio liquidity and comes with competitive yields. We also like instruments like asset-backed commercial paper, again a securitized instrument. We're looking for structures that have full liquidity and credit support from strong and highly rated bank sponsors. We try to be opportunistic and overweight in that asset class as well.

MFI: What about your challenges? Yi: Some of the bigger challenges include: money market [funds] positioning for lower rates.... We saw the Fed lower rates last week, and history tells us that money fund industry assets fall on average about 7 percent after the first rate cut. But, the magnitude of that cycle and the reasons behind the rate cuts do matter. If the easing cycle is much shallower, we think the industry assets will be resilient and won't see a dramatic drop.... But if the Fed ends up being much more accommodative and rates start to move toward zero again, we could see a meaningful drop in assets.

Positioning around this is going to be the biggest challenge for portfolio managers today. We are long duration as a strategy, using high quality instruments like government securities, because our view is that we can have a low growth and low inflation environment for an extended period which translates into a more accommodative Fed.... The reality is, this recovery is the longest expansion we've seen, and at some point, the credit cycle is going to turn. That could prompt a much more aggressive Fed.

Another challenge is money funds differentiating themselves in a commoditized asset class.... The money market business is likely to be more commoditized than any other investment sector because of the stricter constraints the SEC puts on it. There are only so many levers that can be pulled to differentiate, and just a few basis points can be the difference between the 2nd quartile and 1st based on yield performance.

We have been very up front saying we differentiate ourselves through implementing our interest rate views. Obviously, that serves us well in an industry that is highly weighted now towards governments. But even for our credit and prime strategies, we put more weight around our interest rate and duration views.... We implement credit barbell strategies. We take credit exposures shorter but take duration with longer maturity with high-quality instruments like government securities.

MFI: Are you looking at ESG? Yi: ESG, minority-owned, all of these new social headlines and directives have been front and center at Northern Trust Asset Management. ESG has become a hot topic across asset management and is something that the money market industry continues to explore. We've spent an incredible amount of time thinking about how to thoughtfully incorporate ESG into our liquidity solutions. We've certainly had clients engage in conversations with the desire to learn more. But the concept is still in its infancy domestically, at least with regards to incorporating it into money market funds. As an industry, we haven't seen a meaningful shift in assets into ESG-sensitive products yet. Most of the requests that we've been seeing have been for customized solutions. But we do think ESG will have a place, and we're expecting to hear more from clients about it.... We've spent a lot of time developing our own proprietary scoring frameworks for various money market instruments.

MFI: What about the future? Yi: The money market industry will continue to thrive but could see some volatility ... as we undergo a Federal Reserve that pivots into an easing cycle.... I think the biggest benefit to being in money market funds will always be their ability to preserve capital and provide access to liquidity.... Liquidity is valued in every market cycle. Money market funds will always play a critical role in an overall asset allocation. While those allocations can vary depending on factors such as risk profile, having some level of cash allows investors to be more opportunistic in the marketplace.

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