December 4, 2012
|Joseph Lynagh, portfolio manager of the T. Rowe Price Ultra Short-Term Bond Fund.|
On December 3, 2012, T. Rowe Price launched the Ultra Short-Term Bond Fund as an investment vehicle for those who are willing to accept a degree of price fluctuation in exchange for greater income potential than what is currently available from a money market fund. In this Q&A, portfolio manager Joseph Lynagh, who also manages T. Rowe Price's money market funds, discusses the benefits and risks of the new fund.
The Federal Reserve's commitment to maintaining very low interest rates until the economy shows significant and sustained improvement—which could take a few more years, according to the central bank's most recent projections—has left many searching for a higher-yielding but still low-risk alternative to money market funds and bank savings accounts, where almost $12 trillion is invested today at near 0% interest. With low rates likely to prevail until mid-2015, and perhaps longer, we believe this is a good time to launch a fund that offers the potential for greater income than what money market funds provide, but with less risk than traditional short-term bond funds. Unlike a bank savings account an investment in the Ultra Short-Term Bond Fund is not insured or guaranteed by the FDIC or any other government agency.
This fund enhances our clients' choice of lower-risk bond funds by filling the gap between money funds and traditional short-term bond funds in terms of a risk/reward trade-off. While the fund cannot offer the same level of stability as a money market fund due to its floating net asset value (NAV), it does represent less risk than a traditional short-term bond fund whose average maturity could be as much as three or even five years. We expect the fund's average maturity to remain at or below 1.5 years.
The Ultra Short-Term Bond Fund is a practical option for those whose investment goals are about one to two years away. Such investors may be currently invested in a money market fund and are interested in earning a higher yield without significantly increasing their risk exposure. Money market funds, which are managed to maintain a stable NAV, remain a more appropriate choice for investors with shorter-term goals and for those who do not want price fluctuation. We do not consider this fund to be a substitute for a money market fund. An investment in a money market fund is not insured or guaranteed by the FDIC or any other government agency. Although the fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in them.
Ultra Short-Term Bond Fund investors will have no restrictions on trading into and out of the fund because it is not subject to the firm's 30-day excessive trading policy. The fund also offers shareholders the convenience of checkwriting capabilities for easy access to their investment. However, T. Rowe Price Brokerage customers cannot use the fund for a sweep account.
It's a highly diversified portfolio of short-term investment-grade corporate and government securities, which include mortgage-backed securities, money market instruments, and bank obligations with maturities ranging from one to three years. At the time of purchase, all securities will be rated investment grade by at least one of the major credit rating agencies. If we want to invest in an unrated security, our credit analysts must give it an internal investment-grade rating.
As with any fixed income investment, rising interest rates and credit rating downgrades are the main factors that could impact fund performance. Investment decisions reflect our outlook for interest rates and the economy, as well as our assessment of each security. For instance, if we expect rates to rise, we may allocate more of the fund's assets to securities with shorter maturities—including money market instruments—to reduce the risk of price depreciation. From time to time, we may purchase investment-grade corporate bonds from higher-yielding sectors with unique risks—such as health care, utilities, or transportation—if our credit analysts can identify good investment opportunities.
Generally, when interest rates rise, bond funds lose value as bond prices decline. However, our conservative positioning of the Ultra Short-Term Bond Fund should reduce price declines relative to traditional short-term bond funds in a rising interest rate environment. We believe this fund has the potential to offer a yield advantage over money funds while interest rates remain low, and it has the potential for reduced portfolio volatility versus typical short-term bond funds when rates eventually start returning to normal levels.
T. Rowe Price has decided to waive any fees and absorb any costs that would cause the fund's expense ratio to exceed 0.35%. This expense limitation will remain in effect until September 30, 2015.
We believe T. Rowe Price's research capabilities and trading resources are what set us apart. Our credit analysts and traders have extensive experience in all the fixed income sectors—including corporate, municipal, and securitized products—in which we invest for this fund, and being able to draw from their knowledge and experience could give us an advantage.