Today, we again quote from our recent Money Fund Symposium conference, which took place in Minneapolis, June 20-22. This time we excerpt from the "Senior Portfolio Manager Perspectives" session, which featured J.P. Morgan Securities' Alex Roever moderating a discussion with SSGA's Todd Bean, J.P. Morgan Asset Management's Doris Grillo and U.S. Bancorp Asset Management's Jeff Plotnik. The PMs discussed a number of topics, including money market supply, rising rates, money fund regulation, Fed repo and more. (Note: Thanks again to those who attended Money Fund Symposium! The recordings and materials are available in our "Money Fund Symposium 2022 Download Center." Mark your calendars for next year's show, June 21-23, 2023, in Atlanta!)
Roever comments, "I'll take a couple of minutes here to ... set the stage. Obviously, last week we had a fairly big shock to the front end of the market in terms of the Fed shifting its view from ... doing a 50 basis point [to] a 75 basis point hike.... One of the big takeaways from that ... is that it dramatically shifted forward expectations for how high rates are going to go and how fast. I think it's more the pace than it is necessarily the altitude of the adjustment at this point.... I think that matters a lot in terms of in terms of our discussion today, because it changes how I think maybe portfolio managers are thinking about their portfolios and maybe what the risk around certain maturities might be."
He continues, "Then you can also see it has had a broader impact across the curve. Rising rates have obviously shaped the broader fixed income markets ... just absolutely, probably the most horrible year I can remember, total-return wise. The interesting thing though is, even though it's been a really tough return year, it's not necessarily been a bad credit story here. I think there's a general sort of theme ... that the credit has held up sort of remarkably well. So, we'll want to sort of touch on that as a theme."
Roever tells us, "The other thing I would say is that as we're thinking about money market funds versus other alternatives in the front end of the curve, money market funds have actually outperformed pretty much everything else.... But you can see more duration in this environment has hurt -- it kills.... As markets continue to have volatility, we're seeing cash come in from these from these other markets to some degree. But that's just sort of built on top of cash that we've had had already building up in the markets from the liquidity space.... The other place we're seeing inflows is from deposits.... The reality is, short term rates are going higher, and money market funds are more efficiently passing those through."
He adds, "In terms of the supply and demand imbalance [it's all about] the decline, relatively speaking, of T-bill outstandings relative to demand. And you can see the offsetting power of the RRP versus what's happening in T-bills space. It becomes sort of the parking place of last resort for money funds.... We're continuing to see ... crowding into short term assets. Unfortunately, we don't necessarily have enough short-term assets relative to the demand at this level.... So, bills and repo are the big categories.... How do you think it's changing your portfolio management approach?"
Bean responds, "I wouldn't say that we've changed our portfolio management approach much since November, to be honest with you. I think when the whole cycle first started to change and the rhetoric out of the Fed shifted with ... comments about retiring 'transitory,' that was a huge red flag that times were going to change, and you really did need to start to evaluate the risks and look at how you position portfolios.... We always take the kind of top-down approach to how we structure the portfolios. [W]e start with the macro level, with the way the economy was [and] the risk that rates are moving higher.... [T]he next level down in your investment process, you look at your portfolio characteristics and say, well, 'How can I best structure the portfolio to take advantage of higher rates?' You shorten durations; you build liquidity. So that doesn't really change either."
He continues, "Then in terms of our security selection, we use a relative value approach. When you look at the investment options out there, it's been really hard to beat Fed RRP. You know, when you look at the T-bill curve ... that's really hard to justify putting in your portfolios.... So, I wouldn't say that we've actually had to change our thinking or our process much. It's been very similar. We've been running our portfolios with extremely low WAMs, tons of liquidity, increasing amounts of repo as our other assets mature, and that's really benefited the returns."
Grillo tells us, "For the prime fund, it's challenging but manageable. For us, the mission on prime is preservation of capital, liquidity and a return. Obviously, our clients are happy with the return they're seeing [of late]. [But other factors are] making it a lot more difficult for us to manage a prime fund through this [buying] RRP and competing basically against our own government fund.... As far as liquidity, there definitely is liquidity in the marketplace. However, bids are never going to be available, whether it's a rising rate or decreasing rate environment, and also size seems to be a problem. Looking for bids in this marketplace, it's been challenging but it is manageable. It definitely makes you see the prime money market funds in a different spectrum."
Plotnik weighs in, "Our strategy hasn't changed. We saw that the Fed was going to raise rates [and] we started to shorten our portfolios. But we've seen throughout the course of the last five or six months that what we thought the Fed was going to do has changed dramatically.... Historically, in a rising rate environment, when you're unsure or something like this, you can buy some 3 months and hide out. And if you're wrong, you don't get slaughtered.... But everyone out here owns something yielding 25 basis points, and you've got to wait nine months for it to roll off. So, I think what's missing from maybe from historical tightening cycles is that there's not a lot of places to go.... It's a little riskier, and even more so on the prime side when you have NAV risk on top of it."
He says, "From a credit standpoint, were very comfortable with everything. It's just really running those break-evens, when you really think that you're getting close enough for that terminal rate, where you're not going to be really far underwater for a period of time. So ... maybe we get to the end of the year, [and] we're kind of going to get to the top and that point where you're going to have to start making some decisions on really maybe extending a little further out."
Asked about the $2.2 trillion in the Fed RRP, Plotnik answers, "I don't see any reason why it would go lower at this point in time. The things that we have rolling off are going to roll right into the RRP. There's not another investment option unless or until the time comes, we're going to start extending out into a longer paper. So, I would suspect that we're going to see continued increases in the RRP in the near future. It will probably start to turn at some point. I think they were expecting perhaps early next year, end of this year, we'll maybe start to see the peak and it start to come down. But we're going to be seeing increases for a period of time."
Bean adds, "I would just say there's no shame in investing in RRP. As balances increase, more and more clients are asking about it.... I just say it's the highest yielded repo option we have [and] the highest credit quality.... So why are you uncomfortable? ... Doing what we do for a living involves diversification. It's great, but it does feel uncomfortable at first. But when you really stop and think about it as a matter of perspective, there's no shame in being the best trade. Yeah, we [expect it to] continue to grow. We've got a quarter-end coming here in just a couple of weeks."
Finally, Grillo comments, "It's been, as I said, a really challenging time for us in Prime.... When you look at your six-month paper, you're like, wow, that's another mark to market you have to worry about.... So 'what sucks least?' just investing at the Fed is that at this point ... and SOFR. You have to buy floating rate in a rising rate environment and the only option is SOFR, whether you like it or not."
Bean adds, "When I look at the Prime space, one of the things that sucks least is asset-backed commercial paper. I don't feel like people talk about it a lot, but it has a lot of benefits for us. It's probably one of the few places where we actually added new names over the course of the last year. I think there's obviously a slight yield pickup to be in that versus some bank paper. But beyond that, the liquidity is really strong in the dealer community, really does step up."
