The Changed Landscape for Short-term Investing Post SEC Money Market Fund Reform

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1 The Changed Landscape for Short-term Investing Post SEC Money Market Fund Reform April 4, CRC Exp. 02/23/2018 FOR INSTITUTIONAL USE ONLY AND MAY NOT BE USED WITH THE GENERAL PUBLIC.

2 A Challenging Landscape Has Increased the Complexity and Cost of holding liquidity U.S. MMF Reform EMEA MMF Reform The supply and demand for cash assets has been altered by MMF Reform and Basel regulations. Political & Economic Uncertainty Monetary Policy Basel III Investment Options will need to be reconsidered as the industry continues to react to change. The complexity and cost of holding liquidity will continue to be a challenge for many organizations. 2

3 The New Money Market Fund Paradigm INSTITUTIONAL PRIME AND INSTITUTIONAL MUNICIPAL FUNDS GOVERNMENT FUNDS FNAV User experience changes Potential for emergency liquidity fees and redemption gates No changes Portfolio management changes 3

4 Migration of Assets from Prime to Government The prime fund universe has decreased by over $1 trillion since November 2015, with the majority of cash moving into Government funds AUM ($Bn) 2,500 2,000 1,500 1, Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Government Prime Source: imoneynet, Data as of January 31,

5 Fewer Institutional Prime Fund Options Exist The number of institutional prime funds larger than $1 billion has decreased dramatically Data as of January 31, 2017 Number of Funds Greater than 5 billion 1 billion - 5 billion 500 million - 1 billion million Less than 100 million October 31, 2015 January 31, 2017 Source: imoneynet, Data as of January 31,

6 Prime Institutional Money Market Funds Shadow NAV Number of Funds /31/2017 Source: imoneynet, Data as of January 31,

7 Financial Company CP Outstanding Has Declined A result of the shrinking prime fund universe Assets ($Bn) Feb-15 May-15 Aug-15 Nov-15 Feb-16 May-16 Aug-16 Nov-16 Source: FOMC CP Outstanding, not seasonally adjusted, Data as of January 31,

8 Libor Has Been Driven Higher There was a significant spike in LIBOR in the summer of 2016 due to the decrease in AUM of prime money market funds Yield (%) Dec-15 Feb-16 Apr-16 Jun-16 Aug-16 Oct-16 Dec-16 3M Libor 3M OIS Source: Bloomberg, Data as of January 31,

9 Fed Reverse Repo Facility Use by Money Market Funds Has Increased A substantial increase in the usage of the Fed RRP facility following the growth in AUM of government money market funds ($Bn) Feb-16 Apr-16 Jun-16 Aug-16 Oct-16 Dec-16 Source: OFR, Data as of December 31,

10 Consequences of the Big Shift Decrease in fund s demand for Short-term bank debt Short-term corporate debt Short-term municipal debt Increase in fund s demand for Treasury debt Government agency debt 10

11 Supply / Demand Dynamics Reverting to Prior Form? Money market funds continue to be managed differently Some slow build back of prime fund AUM Opportunities persist for investors as they are more aggressively considering alternatives for prime money market funds 11

12 Yield Spread between Government and Prime MMFs The yield spread between prime and government funds is widening January 1, 2016 December 30, Yield (%) Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Prime Institutional Government Institutional Source: imoneynet, Data as of January 31,

13 What Investors Are Thinking? Will only stay in government funds forever Will use prime funds to some extent Will look to new investment options 13

14 How do you navigate the environment? Liquidity Strategy Comparison Features Money Market Funds Conservative Ultra Short Bond Fund Income Liquidity Capital Preservation Customization N/A N/A Yes Separately Managed Account Prime Liquidity Strategies Operational Complexity Low Low Medium Custody Embedded Embedded Segregated Fees Fixed Fixed Flexible Gates & Fee Option Yes N/A N/A Portability N/A N/A Yes Transparency Medium Medium High Accounting Simplicity High Medium Medium Investors continue to evaluate alternative strategies to prime money market funds including conservative ultra short duration bond funds, separately managed accounts and bank balance sheet access. This is for illustrative purposes only and is not exhaustive. 14

15 HP Investment Allocation FY16 Initiated shift from conservative Treasury/Gov t MMF strategy to include more TD exposure 100% % of Portfolio 80% 60% 40% 20% 0% 27% 29% 33% 33% 37% 36% 45% 41% 36% 35% 22% 26% 1Q16 2Q16 3Q16 4Q16 Cash MMF TD/CD 1 HP Confidential

16 HP Investment Alternatives HP is focused on Security-Liquidity-Yield prioritization while looking at investments Return Prime Funds Earnings Credit Money Market Funds Deposit Accounts Sight Deposits Time Deposits Short Duration Funds Separately Managed Accounts Asset Backed Commercial Paper Income Funds Asset Backed Securities Investment Horizon Primary Liquidity (Daily) Primary Liquidity (On Demand) Secondary Liquidity Tertiary Liquidity Investment Horizon Overnight Less than 3 months 3 months or longer Indefinite Cash Flow Volatility High Medium to High Low Very Low Objective Preservation of capital and immediate liquidity Preservation of capital and T+1 liquidity Preservation of capital and enhanced yield Greater emphasis on maximizing return Strategy Money Market Limited Maturity Obligations Enhanced Income Broad Fixed Income 2 Current investments include products in blue Assessing potential yield benefit of alternative products before proposing any additional shift in strategy beyond increased utilization of time deposits HP Confidential

17 3 Separately Managed Accounts Overview Goal: To design an investment portfolio that achieves preservation of capital and liquidity while providing greater yield and diversification on Tier 2 and Tier 3 Cash Advantages of SMAs: Individually managed, custom portfolio tailored to HP-specific requirements (e.g. can direct financials exposure where we want it/away from where we do not want it) Can be run according to 2a-7 fund rules to mimic Prime funds without fees/gates and with potentially lower costs Individual securities in a segregated account (HP owns it) Cash management-specific reporting and compliance reporting/support HP-specific liquidity/risk profile Direct access to portfolio management team Higher yields relative to significant overnight and near-term liquidity held by traditional funds The ability to lock-in yields available on longer maturity issues Avoid volatility in traditional funds due to money fund redemptions and large withdrawals Challenges: Risk appetite Accounting requirements/implications of floating NAV (P&L volatility) HP Confidential

18 The Next Frontier European Money Market Fund Reform Agreement reached, implementation expected in second half of 2018 Outcome is different from the U.S. Some new concepts are in play 15

19 Important Disclosures The document has been prepared solely for information purposes and does not constitute an offer or a recommendation to buy or sell any particular security or to adopt any specific investment strategy. The material contained herein has not been based on a consideration of any individual client circumstances and is not investment advice, nor should it be construed in any way as tax, accounting, legal or regulatory advice. To that end, investors should seek independent legal and financial advice, including advice as to tax consequences, before making any investment decision. Any views expressed are those of the presenter as of the date of the presentation and are subject to change at any time due to changes in market or economic conditions. The views expressed do not reflect the opinions of all portfolio managers at Morgan Stanley Investment Management (MSIM) or the views of the firm as a whole, and may not be reflected in the strategies and products that the Firm offers. Charts and graphs provided herein are for illustrative purposes only. Forecasts/estimates are based on current market conditions, subject to change, and may not necessarily come to pass. Past performance is not indicative of future results. Any information regarding expected market returns and market outlook is based on the research, analysis and opinions of the presenter. They are based on current market conditions and subject to change. In addition, these conclusions are speculative in nature, may not come to pass, and are not intended to predict the future of any specific Morgan Stanley investment. No representation or warranty can be given with respect to the accuracy or completeness of the information. Indexes do not include any expenses, fees or sales charges, which would lower performance. Indexes are unmanaged and should not be considered an investment. It is not possible to invest directly in an index. Certain information herein is based on data obtained from third party sources believed to be reliable. However, we have not verified this information, and we make no representations whatsoever as to its accuracy or completeness. Morgan Stanley does not render advice on tax and tax accounting matters to clients. You should always consult your legal or tax advisor for information concerning your individual situation. Except as otherwise indicated herein, the views and opinions expressed herein are those of Morgan Stanley Investment Management, are based on matters as they exist as of the date of preparation and not as of any future date, and will not be updated or otherwise revised to reflect information that subsequently becomes available or circumstances existing, or changes occurring, after the date hereof. GLOBAL LIQUIDITY SOLUTIONS 16

20 Important Disclosures (continued) This communication is a marketing communication. It is not a product of Morgan Stanley s Research Department and should not be regarded as a research recommendation. The information contained herein has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. Morgan Stanley does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. It was not intended or written to be used, and it cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed on the taxpayer under U.S. federal tax laws. Federal and state tax laws are complex and constantly changing. You should always consult your own legal or tax professional for information concerning your individual situation. Morgan Stanley Investment Management is the asset management division of Morgan Stanley. Please consider the investment objectives, risks, charges and expenses of the fund carefully before investing. The prospectus contains this and other information about the fund. To obtain a prospectus, contact your financial professional or download one at morganstanley.com/im. Please read the prospectus carefully before investing. STABLE NAV FUNDS You could lose money by investing in the Fund. Although the Fund seeks to preserve the value of your investment at $1.00 per share, it cannot guarantee it will do so. An investment in the Fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. The Funds sponsor has no legal obligation to provide financial support to the Fund, and you should not expect that the sponsor will provide financial support to the Fund at any time. FLOATING NAV FUNDS You could lose money by investing in the Fund. Because the share price of the Fund will fluctuate, when you sell your shares they may be worth more or less than what you originally paid for them. The Fund may impose a fee upon the sale of your shares or may temporarily suspend your ability to sell shares if the Fund s liquidity falls below required minimums because of market conditions or other factors. An investment in the Fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. The Funds sponsor has no legal obligation to provide financial support to the Fund, and you should not expect that the sponsor will provide financial support to the Fund at any time. GLOBAL LIQUIDITY SOLUTIONS 17

21 Important Disclosures (continued) RISK CONSIDERATIONS There is no assurance that a portfolio will achieve its investment objective Portfolios are subject to market risk. which is the possibility that the market values of securities owned by the portfolio will decline. Accordingly. you can lose money investing in these portfolios Please be aware that these portfolios may be subject to certain additional risks. Fixed-income securities are subject to the ability of an issuer to make timely principal and interest payments (credit risk), changes in interest rates (interest-rate risk), the creditworthiness of the issuer and general market liquidity (market risk). In the current rising interest-rate environment, bond prices may fall and may result in periods of volatility and increased portfolio redemptions. Longer-term securities may be more sensitive to interest rate changes. In a declining interest-rate environment, the portfolio may generate less income. Ultra-short bond funds, like money market funds, are mutual funds that generally invest in fixed-income securities with short maturities. However, money market funds may only invest in certain high-quality, short term investments issued by the U.S. government, U.S. corporations and state and local governments and they are subject to strict diversification and maturity standards. Ultra-short bond funds are not subject to these requirements and may pursue strategies aimed at producing higher yields by investing in securities with higher risks. The net asset value (NAV) of an ultra-short bond fund will fluctuate Morgan Stanley Morgan Stanley Distribution, Inc. Morgan Stanley Investment Management is the asset management division of Morgan Stanley. GLOBAL LIQUIDITY SOLUTIONS 18