The inability of money-market funds to generate yields for investors because of ultra-low interest rates in developed markets has led managers of cash products to develop bespoke products that extend duration.
Marcus Littler, director of institutional liquidity sales for ex-North America at BNY Mellon, says the bank is now for the first time offering segregated mandates for cash-like exposures, and is orienting its custody and asset-management arms to collaborate on winning institutional requests for proposals (RFPs).
As a result, however, BNY Mellon finds itself not just competing against its traditional competitors in the money-market arena, such as BlackRock and JP Morgan, but with bond houses such as Pimco.
Although a segregated structure can involve a modestly higher fee, the main benefit to the bank is twofold.
First, stability. These accounts are less liquid than a commingled money-market fund (MMF), and appeal to clients that want some yield on part of their cash. Therefore they can expect to hold onto the assets for a year or more.
Second, risk mitigation. In the wake of Reserve Fund Management's 'breaking the buck' in September 2008, cash managers have been wary of the liabilities of managing MMFs. But segregated accounts keep the onus of risk on the client, as these are investment mandates like any other asset class.
Yield in such accounts is usually obtained by extending duration, although this also means the segregated account must sacrifice the triple-A rating that money-market funds covet. BNY Mellon must therefore sell trust in its brand and process, as with a more conventional investment product. Setting up a separate account also takes a few weeks, versus the instantaneous access MMFs provide.
Clients therefore are also moving money out of MMFs in favour of bank deposits as well as segregated accounts. "Money-market funds have become the poor relation," Littler says. "We never received a request for a segregated account before the middle of 2009; now one in three calls is a request for yield."
Although at some point interest rates will rise, Littler says there may still be life for segregated mandates in cash. This is partly because more institutions will have been exposed to the option of structuring their own cash products. It is also because of regulation.
In the United States, the Securities and Exchange Commission has changed rules for money-market funds to make them more conservative. The weighted average maturity has been reduced from 90 to 60 days, and the weighted average life has also been restricted, putting an end to the practice of synthetically extending duration by including floating-rate notes.
The upshot: MMFs in future will be more conservative and yield less, even should interest rates rise.
BNY Mellon established an internal unit called cash investment strategies early last year, which is intended to coordinate the custody bank's actions with affiliated fixed-income asset managers Standish and Dreyfus. Littler says the bank is hiring around the world, including in Hong Kong, to add to the sales and client-servicing team for liquidity products.
In theory, cash segregated accounts can be given bells and whistles, such as FX hedging, which would make them even more like mainstream bond products. But Littler says this adds complexity, and therefore cost, to a product that is meant to extract yield net of fees.
That said, these accounts can take exposure to instruments as far out as three years. If clients want to extend duration further, these really do become bond products and the liquidity team will pass the RFP to Standish.