Below, we reprint the fund "profile" from the March issue of our Bond Fund Intelligence, Crane Data's new publication which tracks the bond fund marketplace. BFI interviews Michael Reinartz, Fixed Income Portfolio Manager at T. Rowe Price, who co‐manages the $5.4 billion T. Rowe Price Short Term Bond Fund. This fund, along with the $327 million T. Rowe Price Ultra Short Term Bond Fund, provides investors with some additional options outside of 2a‐7 money funds. Reinartz tells us about the investment strategy, impact of regulations, and his outlook for interest rates. (Contact us if you'd like to see our latest Bond Fund Intelligence or the BFI XLS performance spreadsheet "complement".)
BFI: Can you tell us about T. Rowe Price's history in the short‐term bond fund space? Reinartz: Our Short‐Term Bond Fund was launched in 1984. At that time, we were coming out of the Volcker era, when rates had really been pushed to extremely high levels to tamp out inflation. When that began to unwind, money market investors were looking for alternatives and, of course, the yield they were earning started to drop rather precipitously. At that time, believe it or not, more than half of T. Rowe Price's assets were in our Prime Reserve Money Market Fund. The Short‐Term Bond Fund offered investors a slightly less liquid alternative where they would be able to benefit from that falling rate environment.
BFI: Tell us about your background. Reinartz: I currently manage the Short‐Term Bond Fund with Ted Wiese, who has been managing the portfolio since 1995. I have been involved with the strategy since 2000 and have been progressively increasing my level of responsibility over the years. I was named Associate Portfolio Manager in 2012 and ultimately joined Ted as a Co-Portfolio Manager in 2015. It's also important to note that we do offer an Ultra Short‐Term Bond Fund, managed by Joe Lynagh. That strategy was launched just over three years ago and is positioned between the money market and short‐term bond funds. We launched the Ultra Short fund in anticipation of that crossover money market interest.
BFI: What does the fund invest in? Reinartz: T. Rowe Price offers a broad range of fixed income bond strategies that span the risk spectrum from money market funds all the way out to Global Unconstrained. So, we have a lot of resources that we're able to draw upon. We view our Short-Term Bond Fund as an alternative for the money market investors who are looking for a little better return, but not a lot of additional risk. We're positioned as a pure investment grade fund versus many competitors in our category that have meaningful exposure to below investment grade bonds. As such, our style leans a little conservative where we look to build yield into the portfolio, but in a risk‐aware way.
Our goal is to provide consistent competitive long term returns, maintaining a disciplined approach through the cycle and being careful not to get over our skis in terms of risk. We do have capacity to go up to ten percent in non-USD assets, but we have never taken that allocation above five percent since I've been working with Ted. More typically, it's around two percent or less, but currently we don't have any non‐dollar exposure. We don't want to introduce a lot of out-of-benchmark volatility into the short‐term bond portfolio, so we only utilize that bucket when we have a very strong conviction in the direction of that currency.
BFI: Where have you found yield? Reinartz: T. Rowe Price is a fundamental, credit‐oriented shop. So, our approach is to build yield into the portfolio by overweighting credit sectors. We typically find the most value is in corporate bonds -- that's where we can leverage our deep bench of in-house credit analysts. When risk/reward is attractive, we'll carry a higher allocation to corporates. When we want to move more defensively, we'll dial back our corporate exposure in favor of bonds in the securitized space such as asset-backed, commercial mortgage-backed, and mortgage-backed securities. In these securitized sectors, the majority of our positions will be short AAA-rated tranches. So, the idea is to give up some yield versus corporates in exchange for lower volatility.
BFI: What are your duration and maturity guidelines? Reinartz: On an aggregate level, we're limited to a Weighted Average Life of 3 years. We buy bonds out to 5 years, but our preference is for 2-3 year bonds. Our benchmark is the Barclays 1-3 year Government Credit, and that's generally around 1.80 to 1.95 years in duration. Ted and I don't make large aggregate duration bets in the portfolio, but we will be more active in our positioning along the curve. Presently, we are underweight the 2-year part of the curve relative to the benchmark and overweight the 5-year part of the curve as we have been positioning for a curve flattening for the better part of two years now.
BFI: What types of investors do you have in the fund? Reinartz: Conservative investors. Earlier, I characterized the investors as those looking for a little more risk/return than money markets. Many use Short-Term Bond as a source of stability within their asset allocation mix. The retail Short‐Term Bond Fund has an Investor class and an Advisor class. In total, we manage $17 billion in the strategy, which includes Institutional separate accounts and a Short-Term Trust. The trust is a building block within our larger stable value trust. For the most part, the Institutional portfolios are mirror images of our retail fund. We do accommodate flexibility within specific guidelines, allowing clients to tweak them based upon their individual risk tolerances. But for the most part they look a lot alike. The stable value trusts are managed in a more conservative fashion, but you'll see the same themes running through those portfolios.
BFI: What impact are regulations having on the space? Reinartz: I haven't seen any impact from money market fund reform as of yet. However, we believe that money market reform has forever changed the cash management landscape for institutional investors and as a result corporate treasurers are also looking beyond money market funds into strategies like Short-Term Bond and Ultra Short-Term Bond. Going forward, we believe these strategies will become more essential tools as alternatives to traditional cash management strategies.
BFI: What is your outlook for the Fed? Reinartz: As far as the Fed is concerned, their dot plots [had] suggested four hikes in 2016. I don't think the market really ever bought into those projections, nor have I. With deflationary impacts from China and the already strong dollar, I have a difficult time seeing how the Fed gets to four hikes. In general, it's a very difficult environment for the Fed to be tightening. Given that backdrop, I think rates will be fairly well behaved this year, but that's not to say we won't experience episodes where the front end comes under pressure. We have this cycle where the market feels good about itself and then the Fed starts to turn up the rhetoric on rate hikes. The market responds by selling off, the Fed gets dovish, and the market comes back again. If the economy was overheating and the Fed was required to go on an aggressive tightening cycle, we would probably see some investors shake out of Short-Term Bond Funds. But that's not what we anticipate. We expect that the pace of tightening will be gradual and measured and in that environment, short-term bond investors can do quite well.
BFI: Have you seen any flows from either money funds or longer-term bond funds? Reinartz: I'd say some investors have come to us from money funds. But overall, I've been surprised at how static the level of money fund assets has been over the last five years. We saw a spike during the financial crisis as investors were understandably seeking safety. But while we're no longer at those levels, money fund assets have held steady at a fairly elevated level despite returns that have been anchored around zero. So, we're watching to see what effect money market reform has on investor behavior. Will we see more crossover interest in short‐term bond funds? I think so. Anecdotally, our stable value group has mentioned that they have seen quite a bit of interest in their product by plan sponsors who are looking to potentially replace the money market fund option within defined contribution retirement plans.
