Stepping Out From Cash: Short-Term Strategies for Today’s Markets

Jerome Schneider, Head of Short-Term Portfolio Management, breaks down the headwinds facing money market funds given today’s rate environment and provides actionable ETF ideas to capture attractive yield potential.

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IMAGE: NYSE logo; TEXT ON SCREEN: NYSE, THE ETF Exchange with Dougles Yones,

TEXT ON SCREEN: Douglas Yones, Head of Exchange Traded Products, NYSE

Douglas Yones: Welcome to the latest episode of the ETF exchange, brought to you by the NYSE. I’m Douglas Jonas, your host. I’m joined today by Jerome Schneider. Jerome is the head of short-term portfolio management at PIMCO. As a reminder, today’s interview is for informational purposes only. The NYSE does not recommend any investments or investment strategies. Let’s get to it. Jerome, thank you for being here with us today.

Jerome Schneider: Thank you, Doug.

Douglas Yones: I want to get right into it. You and I have had a lot of conversations about the idea of high cash balances and short-term money market positions, if you will. How are you and your team really framing out that conversation as we're entering into 2021 here? How are you working with clients around those positions?

TEXT ON SCREEN: Jerome Schneider, Head of Short-Term Portfolio Management, PIMCO

Jerome Schneider: Thanks, Doug. We think, actually, 2020 to 2021 is proving very similar to periods that we've had in the past, where we've had very low rates, people are focused on capital preservation, perhaps a little bit of defense. And in doing so, they have to be more constructive with how they think about their cash allocations, quite simply.

We have a period ahead of us of low interest rates, benchmark rates. We have also a period at the very front end of the US yield curve which is going to be pretty much close to zero interest rates for the next few years.

TEXT ON SCREEN: TITLE – Dash to Cash; SUBTITLE -- In 2020, as in 2009, cash holdings hit record highs as returns on Money Market Funds began multi-year lows – a historically persistent drought.

IMAGE: A line graph shows AUM in trillions of dollars from 2008 to 2021 with MMF Total AUM in gray, Institutional Prime Yield in magenta, and Institutional Government Yield in teal.

We've seen a period of this a few years back, 2010 to 2016, where we had these low rates, and specifically the period of 2013 through 2016 was one where we had very low rates, subdued activity in terms of opportunity sets, in terms of what treasury yields could offer. But at the same time, we had an extreme defensive position, with a lot of funds in money market asset… lot of assets in money market funds. Today, we have a similar experience. We have more than a trillion dollars moving into money market funds. We see people looking to take opportunities and risks in perhaps places they shouldn't, and at the same time, we are seeing people look for opportunities to move beyond that zero yield that they're finding in overnight repurchase agreements, t-bills, and even money market funds backed by government treasuries.

So, the key here is to find balance between the triumvirate of capital preservation, liquidity management, and ultimately some total return. And that total return is really where active management can come in, in our ETF space today.

Douglas Yones: Jerome, you brought up money market funds. I’d love to capture your view there, in particular on money market funds, as we start to think about the idea that interest rates may change. There’s a lot of news and conversations about whether or not they’ll go higher this year. How do you think about money market funds?

Jerome Schneider: Quite honestly, what we're saying to clients is that we need to be aware of two facets here. One, recognize that there’s a very low rate environment, one that’s dominated by an overwhelming amount of money market assets near zero interest rates, whether that’s t-bills or money market funds or overnight repurchase agreements, and then combine that with the fact that investors are looking for opportunities to take steps out of those money market fund segments, perhaps for a little bit more income, perhaps for a little bit more yield, and in doing so, they need to be prudent.

TEXT ON SCREEN: TITLE – Dash to Cash; SUBTITLE -- In 2020, as in 2009, cash holdings hit record highs as returns on Money Market Funds began multi-year lows – a historically persistent drought.

IMAGE: A line graph shows AUM in trillions of dollars from 2008 to 2021 with MMF Total AUM in gray, Institutional Prime Yield in magenta, and Institutional Government Yield in teal.

Well, there’s two things to keep in mind here. There’s a growing amount of assets under management in that money market fund space. You've had a trillion dollars move into that money market fund space over the course of the last year alone. In other risk-off environments, we've seen similar episodes, back right after the financial crisis, similar reaction function.

And so, we can extrapolate from some of those periods, back seven, eight, nine years ago, to understand the dynamics of safety that people are finding in money market funds with the low rate environment. What we’d say is that investors need to be prudent. Simply, we want to find a balance between the triumvirate of liquidity management, capital preservation, and then total return. Some of the go-to solutions, which include prime money market funds, should actually be given a second look at this point, not because they're the go-to, but because there’s actually, the foundations aren’t as solid as they once were. We've seen creaks in the foundation with prime money market funds, those that take commercial paper and other types of credit risk, back in March of 2020. There’s going to probably be regulatory responses over the forthcoming year on how to deal with that. But, at the same time, we think that investors need to be really prudent and thinking about the credit risks they're taking, and more importantly, how far down the credit spectrum they're doing.

And so, doing so is an important question, but making adjustments to these cash management portfolios really takes a knowledge base which helps to transcend what has happened in the past, but what could potentially happen in the future. Having the resources and understanding to do that is incredibly important.

TEXT ON SCREEN: TITLE – A framework for active liquidity management and short-term income generation; SUBTITLE – Liquidity tiering in practice

IMAGE: Three layers of liquidity tiers are shown: Tier 1 (top): Money market, Tier 2 (middle): Conservative ultrashort & ultrashort, Tier 3 (bottom): Low duration. TEXT ON SCREEN: Define the amount needed for immediate liquidity (Tier 1); Determine the time horizon for the remaining allocation (tiers 2&3); Consider risk/return goals and portfolio impact.

This is why we sort of think about our tiered liquidity structure in this regard. Using some government money market funds as that firm foundation for overnight liquidity, and then at the same time, keeping it very minimal, but judiciously moving some additional assets into what we call our tier 2 or tier 3 type of solutions, which seek to compromise and find opportunities into the premiums for the next few months, or even, perhaps, the next few years. And that’s where our MINT ETF or our low duration ETF LDUR fit in.

Douglas Yones: So, of course we're talking ETFs. This is the ETF exchange. At PIMCO, you offer two ETFs in this particular space. We have MINT, and LDUR. I wonder if you could help us kind of frame out those ETFs, and particularly, as we're talking about this cash balance and short-term investments.

Jerome Schneider: We think it’s a healthy relationship, understanding that there’s a need for immediate liquidity, perhaps with money market funds, but then again, tiering out your cash allocations over the next few weeks or months, and then obviously, to the next few months either even perhaps years. And in doing so, you're able to help capture some additional total return in a diversified manner, and really utilizing the short-term ETFs to really find ways to put your cash to active work. In other words, trying to monetize liquidity premiums that are in the marketplace, maintaining diversity, still being high in quality, but really recognizing the fact that you're not paying a premium through exceedingly low interest rates, perhaps zero interest rates, on your income, by moving out.

TEXT ON SCREEN: TITLE -- Short duration strategies can help investors solve multiple challenges

IMAGE: A graph shows potential return vs potential risk, with four boxes showing rising reward for risk from left to right: Money Market, Ultra Short & short-term, Low duration, Intermediate fixed income. TEXT ON SCREEN: Seek to offer attractive yield for a modest increase in risk (left); Aim to reduce market risk and hedge against rising rates (right)

So, MINT has done a very good job about creating this opportunity set for investors for more than a decade. Since we launched in 2009, it really has garnered and laid the foundation for many of those interests who want to take that step out of money market funds, and really find opportunities, and more importantly, total return over the next few months that they want to use these high cash allocations. We think that zero rates are here for a couple years at this point in time, especially in the front end. So the benchmark rate shouldn't rise. And if that’s the case, there’s going to be some structural premiums that MINT can offer that money market funds can’t. But we actually think this holding period is actually a little bit longer, in which case, we're going to think more strategically about how to embrace those longer periods. And that’s where our low duration ETF, LDUR, does come in. And we think there’s a growing opportunity. We're seeing good inquiries and good trends in terms of growth, in terms of the strategy, to really embrace what is going on into that 1 to 3 year sector, to find opportunities not only in corporate bonds, but diversifying to other arenas that include structured products, asset-backed securities, and the like.

So, creating a high quality portfolio for investors that have that foresight to utilize that tiered cash structure over the next few years, is really an advantageous way to think about producing some additional total return. And I think one of the bigger constructs here is recognizing the fact that both of these strategies, both MINT and LDUR, do so in the context of trying to earn a return, not only just above zero, but helps try to preserve purchasing power in an inflationary environment that is subtle but modestly growing over the next few years. And so, preserving the purchasing power of that cash sitting on the sideline will be a growing discussion amongst all types of investors: retail, institutional, pensions, et cetera, that will simply look to preserve purchasing power of that cash sitting on the sidelines.

So, here’s two good opportunities that we think to consider, creating a tiered structure within your cash utilizing an ETF structure.

Douglas Yones: Jerome, you certainly mention the idea of zero rates, or the lower end of where interest rates could be. I am curious, you know, when you start to think about the value prop of PIMCO, what is it you talk to your clients about what you bring to the table in this type of rate environment?

Jerome Schneider: Quite honestly, we've been here before. And, what you see is that it takes a tremendous amount of resources to not only find opportunities, but to know what to steer away from. This is the type of environment where people reach for a little bit more yield, because they view the environment as being safe. Whereas, we want to have the expertise and acumen to really draw upon not only finding those opportunities which we think are safe, and can produce a positive return for our clients, but at the same time, be critical and analyze and try to steer clear of assets that many others simply won’t find the writing on the wall that might be more hazardous, or create more volatility, to those cash management solutions. And so, over the past four decades plus, the short-term solutions at PIMCO have done exactly this. Look for an actively managed solution which takes into account the macro elements of where the economy is headed and where it is today, and then looks for bottoms-up solution to help present a balanced, risk-adjusted return subset for us to invest in. And even though it’s cash, it doesn't necessarily mean it’s easy. In fact, what we've witnessed before, it actually takes a lot of active management, a lot of research, resources, and more importantly, understanding how all these influences come together to really extract value even in this low rate environment.

And history would suggest that being defensive and prudent, coupled with opportunistically seeking different diversified solutions, can actually produce positive total returns for portfolios, even further cash, in this low rate environment.

Douglas Yones: Jerome, thank you very much for being with us here today. That’s a  wrap on the latest episode of the ETF exchange, brought to you by the New York Stock Exchange, the home of ETFs.



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