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Putnam Bets on Capital Preservation in ‘Floating-NAV World’

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Investors have taken a trillion dollars in assets out of money market funds since the Lehman crisis in 2008 and now Putnam Investments is looking to create a new home for these discouraged investors seeking safety but balking at low yields.

The Boston-based mutual fund giant on Thursday announced the launch of a fund meant to offer higher current income than money market funds but with less volatility than even the shortest duration bond funds.

In an interview with AdvisorOne, Putnam Investments’ head of global product and marketing Jeff Carney estimated there was as much as $11 trillion in investable assets–including $2 trillion in money market funds – sitting on the sidelines these days. With money market yields at historic lows – the average seven-day yield is currently 0.02% – many savers are using their resources to pay down debt and others, Carney says, are venturing into riskier assets.

Indeed, while money market funds have experienced a negative growth rate of 6.5% per year over the past three years, ultra-short bond funds have seen annual growth of 36% per year over that same length of time. As the shortest duration and least volatile asset class beyond the buck-a-share stability of money market funds, ultra-short bond funds would be a natural choice for nervous investors whipsawed by the markets’ high volatility.

But in introducing the Putnam Short Duration Income Fund (Class A: PSDTX), Carney and his colleague Michael Salm, co-head of fixed income, sensed an opportunity for a different kind of product that would offer investors something close to the safety and liquidity of money market funds but with return characteristics more typical of ultra-short bond funds. “We’re giving up yield here for better liquidity management and reduced volatility,” says Carney about the bond fund, which like the typical money market fund offers investors a checkbook to redeem shares.

Says Salm, the lead manager of the fund: “We’re aiming to provide an option for people … Just by straying from the boundaries [of money market fund liquidity requirements] you can pick up yield. For that extra yield, [investors] will have to absorb some NAV volatility,” but the Putnam team plans to significantly reduce that volatility.

Salm says the average volatility of an ultra-short bond fund is more than three times greater that of a money market fund. He expects to achieve less than double the volatility of a money market fund and have less than half the volatility of the average ultra-short fund.

Salm readily admits that while bond managers in the ultra-short space compete to offer the highest yields, his team is not going to play that game. “We sit between the money fund world and this ultra-short world. We realize we’ll be placed [by data services like Lipper and Morningstar] in the ultra-short world. We’re not trying to have the highest yields among ultra-short funds, but higher than money market funds.”

To achieve this balance, the fund will invest in traditional money market securities like certificates of deposit, commercial paper, time deposits, repurchase agreements and U.S. government bonds. But the fund will also invest in the asset-backed securities, investment-grade corporate bonds and sovereign debt that are more typical of short-term bond funds. Salm expects money market-type securities holdings to range between 30% and 70% of holdings, saying the flexibility is “really about avoiding volatility storms.”

He adds that triple-A-rated securities will be “dominant” among money-market-type holdings. In the ultra-short bond category of portfolio holdings, he says U.S. corporate bonds and asset-backed securities will predominate.

Putnam expects its new fund to yield some 40 to 70 basis points above T-bills; its expense ratio is 0.40% for single-A shares and 0.30% for Y shares.

And how would PSDTX perform in the event of another Lehman-like crisis–the event that triggered our current low-rate, high-volatility environment that has sent so many investors to the sidelines? “We expect to underperform because non-Treasury assets will underperform,” says Salm. “But relative to ultra-short, we expect to do much better. We aim to provide as much preservation of capital as possible in a floating-NAV world.”