Capital Advisors: SMAs Deserve Closer Look; Wells on Holdings, Prime
Capital Advisors Group writes “Using Separately Managed Accounts (SMAs) to Ride the Tides of Uncertainty,” which explains, “Recent events serve as a prelude to what is to come from the new administration. Active cash portfolio management with a separate account solution helps manage policy uncertainty, market volatility, headline and geopolitical risk. Fiscal and monetary policies, international relations and political conflicts may bring more uncertainty in 2017 than in other recent years. SMAs deserve a closer examination as active risk management tool in this age of uncertainty.” We review this update below, and also excerpt from a Wells Fargo Securities piece on portfolio holdings and a Wells Fargo Asset Management piece on Prime and Muni MMFs.
CAG’s Director of Investment Research & Strategy, Lance Pan, writes, “Without repeating too much from our recent commentaries, we are mindful of a number of sources of uncertainty that may impact cash investment decisions…. While the general market consensus is for interest rates to move higher, we do not know how soon or how much federal infrastructure spending and tax cuts will work their way through interest rates. The pace of rate hikes by the federal open market committee (FOMC), consisting of a fresh set of voting members and the administration’s appointments to the two vacant seats, remains an open question. We cannot quantify how much monetary tightening may counteract fiscal stimulus. In the event of policy failures, or successes for those impeding growth, interest rates could reverse directions. In short, uncertainty exists for both short and long term rates and anywhere along the yield curve.”
He continues, “As a separate account manager of institutional cash for more than two decades, it has been our philosophy that SMAs are appropriate for institutional treasury organizations primarily as a risk management tool. Besides higher income potential over money funds and bank deposits, it is portfolio customization that makes them a valuable cash alternative. With the passing of prime money market funds as the predominant institutional cash vehicle of choice, SMAs deserve a closer examination…. There exists an erroneous conception in the cash management world that separate accounts actively trade securities beyond traditional money market credits with substantially longer portfolio duration and total return objectives. While these products can prove valuable for a segment of the market, SMAs also can exist as liquidity vehicles constructed primarily with money market securities, with minimal trading and with income objectives.”
The latest Capital Advisors paper tells us, “Uncertainties are by definition difficult to forecast. Without a crystal ball to tell which and how a number of risk factors may affect financial markets, we as liquidity managers will want to be mindful of evaporating market liquidity in uncertain times and equip ourselves with a high quality, diversified portfolio of assets…. Liquidity risk often arises from one of two sources — perceived credit problems with specific issuers or asset classes and the reluctance to trade by nervous market participants for fear of disappearing liquidity. For example, the Federal Reserve pointed out the risk in the repurchase agreement (repo) market when bond dealers or investors may be forced to sell asset collateral either before or after their counterparties experience liquidity problems. Commingled investments such as prime money market funds and ultra-short bond funds may experience liquidity crunches and contagion trying to satisfy waves of sell orders. SMA investors may set aside a portion of their portfolios in highly liquid government securities as backup liquidity.”
It also states, “Regardless of objectives or asset choices, diversification remains a key risk management tool for uncertain times. A sufficiently diversified portfolio among asset types, industry sectors, and geographical locations may greatly reduce the impact from a specific unexpected event. For example, high-grade sovereign and supranational securities may be viable supplemental investments in a corporate bond portfolio. Similarly, a portfolio of unsecured bonds may weather risk better with asset-backed securities, which offer the double benefits of instant diversification and asset collateral…. Born out of investment policy requirements, most liquidity portfolios justifiably have a high credit quality bias to provide a ratings cushion against negative credit events. Recent credit market performance, we think, anticipates the implementation of Trump’s economic policies that suggest more down side risk from policy disappointments. The additional yield benefit from lower quality bonds in the current environment may not justify the added credit and liquidity risks.”
Finally, Capital Advisors’ Pan comments, “While there remains much debate on the net effect of Trumponomics on risk assets, many stock and bond strategists urge caution and recommend active portfolio management to cope with policy and event uncertainties and steer clear of looming risks. We recommend the same for short-duration cash portfolios. We should note that this year’s landscape is not all about the new administration’s policies. One needs to keep an open eye on the Federal Reserve and interest rates, post-money market fund reform asset movements, the states of the European Union and China and their respective financial institutions, property markets in Australia, Canada and the UK and their banks, credit performance of energy portfolios in distress … the list goes on. While dealing with uncertainty is nothing new in treasury investment management, this year may bring more surprises than in recent memory. For investors switching out of prime money market funds and unsure about the alternative liquidity vehicles, SMAs deserve a closer examination as an active risk management tool in an age of uncertainty.”
In other news, Wells Fargo Securities’ Garret Sloan and Vanessa Hubbard commented Friday on the latest Money Fund Portfolio Holdings, writing, “The breakout in holdings for the first month of 2017 shows that in the government institutional space, durations extended slightly, with a decrease in overnight maturities of five percent and an increase of weekly maturities by approximately the same amount. Agency holdings rose by 3 percent to 42 percent of overall exposure, split between discount notes and agency floaters. The Treasury repo holdings fell from 25 percent to 21 percent of holdings, or just under $51 billion. Repo holdings fell primarily at the Fed, falling from $191 billion to $69 billion. By contrast, now that year-end has passed, private-market repo has ramped back up significantly. At year-end Nomura was the largest private-market repo counterparty to the government funds, offering $26.3 billion in collateral, followed by RBC with $25.3 and BNP Paribas with $24.5 billion. BNP Paribas surged higher in the January data, offering $47.8 billion in repo to the government funds, or almost doubling its total repo exposure. Total repo outstanding fell in institutional government funds, from $428 billion to $404 billion.”
They tell us, “U.S. non-Fed counterparties accounted for $61 billion in government institutional funds in December, which climbed to $68.7 billion in January. Non-dealer/bank counterparties are rising in the repo space as well, with Harvard, and two branches of Prudential delivering collateral to funds in December. In January, Met Life Insurance was added to the mix, with $700 million given to the 2a-7 funds. While a number of repo counterparties increased their total offered collateral in January, the almost doubling of repo collateral by BNP Paribas from $24.5 billion to $47.8 billion stands alone as a stark example of calendar-based balance sheet contraction and expansion.”
The update adds, “On the prime side, looking at the entire prime universe, CD holdings in January rose from 29 percent to 33 percent, and financial CP rose from 13.4 percent to 16.3 percent. Declines in the prime funds were seen in Treasury repo, ABCP and VRDNs, though we would note that the allocation to VRDNs only dropped from 5 percent to 4.6 percent…. France pulled into second place this month behind Canada for single biggest non-U.S. exposure in prime funds. Canada fell from 14.7 percent to 12.9 percent and France rose from 8.9 percent to 11.1 percent. This is likely partially the result of BNP Paribas’s jump in repo market activity. Japanese exposure dipped slightly from 9.7 percent to 9.5 percent, with CD exposure maintaining the lion’s share of Japanese product in the funds, climbing from 62.6 percent in December to 68.7 percent of Japanese exposure in January.”
Wells Fargo Asset Management also commented on Prime MMFs in their latest “Portfolio Manager Commentary.” They write, “The prime money market space continued its stabilizing trend during the month of January as industry assets moderately rebounded and yields continued to adjust higher, reflecting both ongoing support for the product and a positive sloping yield curve. According to Crane Data, prime money market fund assets — including retail funds — increased by roughly $8 billion to $381 billion during the month. The positive slope to the yield curve for nongovernment assets can mainly be attributed to a few items: the anticipated future path of Fed policy; upcoming regulations that could force issuers to lengthen liability profiles; and the subdued demand resulting from a reduced buyer base as assets shifted from prime to government funds.”
The piece says, “The stabilization of the asset base has allowed fund managers to opportunistically redeploy excess liquidity to add incremental yield without taking a disproportionate amount of risk. Throughout the implementation period and heading into year-end, we maintained an overweight to municipal variable-rate demand notes (VRDNs) as this product offered an attractive trade-off between liquidity and yield…. Since the New Year, as VRDN yields held steady and LIBOR (London Interbank Offered Rate) continued to increase, we began to reposition a portion of our portfolios out of this product and into floating-rate notes and longer-dated fixed-rate products to capture incremental yield offered by the positive sloping yield curve.”
It adds, “The municipal money market sector got off to a strong start this year as seasonal reinvestment cash drove demand for tax-exempt paper throughout the short end of the curve. Investors were able to take advantage of elevated tax-exempt yields that had adjusted higher in response to the FOMC policy shift in mid-December. After closing out the year at 0.72%, the Securities Industry and Financial Markets Association Municipal Swap Index (SIFMA Index) settled into a comfortable range between 0.66% and 0.68%, indicating evenly balanced supply and demand dynamics. The SIFMA Index continued to reset at roughly 92% of one-week LIBOR during the month, preserving the relative attractiveness of tax-exempt floating-rate securities for both traditional and crossover buyers. Further out on the municipal curve, incremental demand resulted in tighter yields on tax-exempt commercial paper, notes, and bonds. Yields on one-year high-grade paper fell slightly to 0.90% from 0.97% at year-end.”