Optimizing your cash strategy
by Laurie King, Wells Fargo Asset Management
Cash strategies play a big role in an ultralow-yield environment. Here to explain is Jeff Weaver, head of money market funds and short-duration strategies at Wells Capital Management, Inc.
Laurie: I’m Laurie King, and you are On the Trading Desk. Ultralow yields and upcoming money fund reform are putting pressures on fixed-income investors—today Jeff Weaver, head of money market funds and short-duration strategies at Wells Capital Management, joins us to talk us through these topics and share where he’s seeing opportunity. Jeff manages the Wells Fargo Conservative Income Fund. Hi, Jeff!
Jeff: Thank you for having me, Laurie.
Laurie: You manage a conservative investment product. Where on the yield curve does that fall?
Jeff: Just beyond the money funds. Many of the assets the fund invests in are very similar to those in prime money market funds, but the fund is also able to invest in securities with maturities beyond 13 months and even out to 3¾ years. The yield curve is typically steep beyond 13 months and can provide very attractive yields over money fund investments.
Laurie: And in the three years you’ve been managing this product, what are you trying to achieve for your investors?
Jeff: The Conservative Income Fund is for investors who want to earn additional yield beyond that of money funds while remaining high in credit quality without a significant increase in volatility. By keeping the fund’s duration relatively low and investing in assets with an A rating or better, we’ve been able to accomplish that.
Laurie: So, Jeff, what are you watching in the markets that have been driving volatility?
Jeff: Over the last year or so, the bond market has gone back and forth between a relatively strong U.S. economy and concerns globally, particularly with weakness in Europe and China and declining oil prices. As a result, short-term interest rates have fluctuated greatly—December witnessed the first increase in the federal funds rate after being at 0% since December 2008, and as such, 2-year notes reached a high of 1.09%, the highest since 2010. In the first quarter, yields dropped again as Chinese stock market volatility increased, and oil prices dropped significantly. More recently, an additional FOMC hike was being considered until we received a very weak employment report in early June—followed by a somewhat surprising Brexit vote at the end of June. In fact, June’s 30-basis-point [100 basis points equals 1.00%] drop in 2-year note yields represented the largest 1-month drop in 2-year note yields since January 2010.
Laurie: Yeah. Given all the market volatility, how are you managing volatility in your strategy?
Jeff: Well, it’s just the fact that we are maintaining a shorter duration.
Laurie: OK.
Jeff: You know if I compare it to being longer than money funds, we’re certainly benefiting investors. So, I’m trying to say, “Hey, rates have been volatile, and we’ve maintained a conservative duration stance.”
Laurie: Mmm hmm, and in terms of credit, what are you comfortable taking in a product like this?
Jeff: OK, in recent volatility, for example in the first quarter when China and declining oil prices led to a significant widening in corporate bond yield spreads, which led to underperformance in the sector, the emphasis on higher credit quality certainly benefited the fund.
Laurie: And how are you positioning for income?
Jeff: We continue to position the Conservative Income Fund with duration of just under a year. We continue to like the banking sector where continued regulation continues to decrease risk. Band securities tend to trade cheaper than equally rated nonfinancials and, as a result, we like the value offered. That said, we stay diversified on both an issuer and industry level. And as such, exposure to the banking sector is limited to 25%. In general, we like A-rated corporate bonds. With interest rates at lower levels, we like floating-rate structures that benefit from relatively attractive LIBOR [London Interbank Offered Rate] yields and that outperform as rates increase. We also like the asset-backed sector. We’ve been very focused on the auto sector with deals secured by auto loans and leases. We’ve seen opportunities in equipment deals that are secured by heavy equipment. And in addition to that, we like the credit card sector.
Laurie: And now, those are highly rated. You’re probably buying the triple-A-rated tranche? And you’ve got a nice yield pickup, right?
Jeff: Yes. These deals are all rated AAA and produce comparable yields to lower-rated corporate bonds.
Laurie: OK. Will you share a key takeaway or two?
Jeff: Well, I think it’s important that investors consider the options for optimizing the cash position in their portfolios. Money funds, both government and prime, can continue to be viable options, but, one should also consider ultra-short bonds to enhance yield without sacrificing liquidity and preservation of principle.
Laurie: Jeff, that’s all the time we have.
Jeff: Thank you, Laurie.
Laurie: And thank you for listening. Until next time, I’m Laurie King. Take care.
Duration is a measurement of the sensitivity of a bond’s price to changes in Treasury yields. A fund’s duration is the weighted average of duration of the bonds in the portfolio. Duration should be interpreted as the approximate change in a bond’s (or fund’s) price for a 100-basis-point (100 basis points equals 1 percent) change in Treasury yields.
Yield curve is a graphical representation of fixed-income security yields (usually U.S. Treasuries) at their respective maturities, starting with the shortest time to maturity and sequentially plotting in a line chart to the longest maturity. The yield curve is based on historical performance and does not represent future results.
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