This month, Money Fund Intelligence speaks with Northern Trust Asset Management's Director of Short Duration Fixed Income Peter Yi, who has steadily returned to work following a car accident last year. He tells us about Northern's pioneering role in cash "segmentation," the gradual recovery of prime fund assets, and their views on differentiation in the ultra-short space. Our Q&A follows. (Note: This interview is reprinted from the November issue of our flagship MFI newsletter; contact us at info@cranedata.com to request the full issue.)
MFI: Tell us about Northern's history. Yi: Sure. As you know, Northern Trust Asset Management has had a long, successful history managing cash and liquidity products. We've been managing liquidity products since the 1970's, when our trust department created our first cash sweep vehicle. Not only do we have the experience, but we're also one of the largest cash managers, whether you simply look at money market mutual fund assets or if you look at it comprehensively with our nonregistered STIFs, separately managed accounts and security lending reinvestment collateral pools. This gives us a formidable presence in the liquidity business.
Northern Trust thinks of cash management as a core capability and a product that really caters to both our institutional asset servicing business and our retail wealth management clients. Right now, we are managing about $240 billion across all of our money market and short duration strategies. As you know, having experience and leadership are critical in the money market business. This has served us well in successfully navigating not only challenging credit and interest-rate environments, but the changing landscape driven by regulatory reform.
In terms of my history, I have been at Northern Trust Asset Management for more than 17 years. I have seen all the multidirectional excitement in the money market industry from its extreme lows to extreme highs. Certainly, it has evolved and it is going to continue to evolve.... We continue to have constructive conversations internally and externally with clients. We continue to spend a lot of time thinking about the next generation of cash management products.
MFI: On a personal note, welcome back! Yi: Thanks. It's great to be back to overseeing our 2a-7 money market mutual fund business, our STIFs, and our securities lending reinvestment, as well as our ultra-short fixed income. I still have purview over anything that is short duration. So we're back to business as usual.
MFI: What is your biggest priority now? Yi: Cash segmentation is definitely really important to us and an area where we've had great success. We were one of the first asset managers to create a cash segmentation framework and devise a "bucketing" strategy. Back in the early 2000's, we were thinking, 'How can we think about ways to optimize cash?' Today, not a whole lot has changed. We continue to spend a significant amount of time talking to clients. Our main objective is [understanding] their liquidity needs. A big strategic focus for us is our ultra-short product offerings. We have really been challenging our clients to rethink cash in a way that really truly optimizes their expectations for risk, liquidity, and return.
MFI: Are you done tweaking your funds? Yi: We still have the offerings we did before money market reform. We did do some consolidating of funds, just from a rationalization perspective, combining government funds. Our flagship fund is now our Treasury money market fund. Just given the simplicity of it being a government fund and not being subject to a variable NAV [and] not having any fees or gates restrictions, has enabled it to grow exponentially. But we still offer prime and municipal funds both on the retail and institutional side. And we share the observation that both prime and municipal money market funds are starting to gain much more traction today, one year after reform. Again, we're challenging our investors to rethink cash.
MFI: Can you talk about Prime flows? Yi: There's been a meaningful return to prime funds, but it's been slow. Investors are looking for a track record now. They're looking for stability in the NAV of a prime fund, and they're looking for an attractive yield spread over a government fund. From a net asset value perspective, time has really shown that they have been incredibly stable since October 2016. This is despite the fact that the Fed has been raising the Fed funds rate.... The other thing [is that] the spread has been widening. It ranges from 25 to 40 basis points. That seems to be the key level for some investors to jump back from a government fund to a prime fund.
MFI: What other challenges do you see? Yi: From a portfolio management perspective, there are challenges all the time in terms of sourcing the right type of investments. From a credit perspective, we're always managing and assessing risk in the marketplace. Managing credit risk has been the number one priority for our prime funds. The challenge is, we need to make sure that we find the right supply dynamics and get paid for taking on any type of credit risk. This dynamic has gotten better after the industry shifted into government funds and spreads widened. But we continue to be very focused on high quality issuers with short maturities.
MFI: What are you buying? Yi: The industry has been very resilient. It's still around $2.7 trillion despite all these changes. Like many predicted, the reality is assets have shifted to government funds in a very meaningful way. We like one-year Treasuries right now, just given our forecast for a shallower path for rate increases.... [W]e've been taking duration through these fixed rate securities. And even for our prime funds, we're maintaining a strong overweight to government securities and taking duration with one-year Treasuries.
MFI: What about fees and expenses? Yi: Fee waivers are not really a headline for us anymore. Today, they're public and they're immaterial. In terms of recouping some of the waivers we had in the past, we think that is extremely unlikely and it's not something we are pursuing. Having robust money market offerings -- that is what is really guiding our fee strategy. More likely than not, we're going to see fees actually go lower across the industry rather than higher.
MFI: Any final thoughts on reforms? Yi: It's nice to look forward, and say, 'We're done with reform for now and let's look to the future.' Last year's reforms were significant. We invested a lot of time and capital to ensure that we were fully prepared for all the changes. We think the money market industry continues to thrive. We're continuing to listen to our clients to fully address their liquidity needs. There has been chatter about trying to pull back on some of the reforms but we're not spending a whole lot of time thinking about that. We know there are a lot of other things that are much higher in priority on the legislative agenda. We spent a lot of time, and effort and money, and now it's time for us to market what we have and continue to grow the business, understanding that liquidity is valued in every market cycle.
MFI: Talk about ultra-short bond funds. Yi: We've been seeing much more demand for ultra-short fixed income.... Right now, we think it's in the investment wheelhouse for fixed income. We've seen corporate treasurers starting to reach out for a little more yield, and finding high credit quality products in the ultrashort space with a 50-75 basis point premium relative to a money market fund. Then you have core fixed income investors that are afraid of rising rates, moving down the yield curve.... So, our ultra-short fixed income products continue to resonate and do very, very well.
MFI: What about other cash pools? Yi: We do manage other liquidity products outside of our 2a-7 money market mutual funds business, like our STIF funds, as well as our securities lending reinvestment pools. They're managed [similar to] our registered money market mutual funds. Many of these funds were able to take advantage of recent wider credit spreads, they've been much more popular over the last year.
MFI: Any thoughts on the future? Yi: Money market reform has passed now. We're optimistic, we're excited, we're spending a lot of time thinking of the future. We're still doing wide-ranging analysis on how we think the money market industry is going to evolve. I personally spend a lot of time thinking about the next generation of cash management vehicles.... Here at Northern Trust Asset Management, we have a catchphrase, 'Liquidity is valued in every market cycle.' So despite money fund reform, we still think the industry is going to continue to survive and be highly valued."
