Attitudes to cash management and investment strategies have evolved rapidly since the low interest rate environment unleashed by the financial crisis of 2008 has become more and more embedded in western economies. Money Market Funds (MMFs) are, and will continue to be, important cash investment vehicles for treasurers in the US and elsewhere, but there is no denying the low yield environment and the changes brought on by regulatory pressure since 2008 have shifted the MMF landscape.
Investors need to embrace and understand these changes but also be aware of alternative options that are available, which may be better solutions for treasuries cash management needs.
Navigating the New World of Cash Investing: Beyond MMFs
Finding a suitable return and a safe home for the large cash reserves that many treasuries are sitting on, while still being able to call on the cash quickly when needed, is not an easy task in the new low interest rate environment prevalent in western economies. There are a number of issues to consider:
Acceptance of share reduction mechanisms: As has been the case for some time now, trading conditions in money markets remain challenging – indeed, recently money market instrument yields have traded negatively. In these highly unusual circumstances fund providers, recognising that investors accrue considerable value from the availability of share classes with a stable net asset value (NAV), have determined that it is in the best interests of shareholders to implement a form of share-reduction mechanism, which enables a stable NAV to be maintained on days when the net yield on the fund is negative.
The mechanism works as follows: On days where there is a positive net yield, dividends will be accrued normally. However, on days where the net yield is negative a number of shares with a NAV which equals the amount required to maintain a stable NAV per share may be redeemed. The redeemed shares will be cancelled and the value attributable to those shares will be retained by the fund provider to offset the net negative yield. This will enable the NAV per share to remain stable. Therefore, shareholders would incur a reduction in the number of shares they hold.
Unrated Money Market Funds: Unrated MMFs provide an investor with the option to invest in a portfolio of the same high quality assets that are held in an externally rated MMF, just without the constraints of credit rating agency (CRA) guidelines. This may be a risk for some treasurers, but equally the efficiency of CRAs has often been questioned by treasurers since the 2008 crash. An example of a possible ‘constraint’ is where the same high quality names that cash investors are used to seeing may be invested in, but with slightly longer durations or in slightly higher concentrations. This provides the client with the potential for a yield pick up over funds that have an external rating.
Credit analysis and review is not absent in unrated funds. ‘Unrated’ refers to the rating applied at the fund level, which analyses the adherence to specific guidelines established for rated MMFs. BlackRock considers external ratings as a preliminary screen in its own independent credit review: that is to say, the firm uses the ratings as a ‘starting point’ in its assessment of an investment, formulating its own independent ‘credit opinion’ about an issuer or a specific investment instrument. Our assessment does not end when we purchase a security. Just as each rating agency may upgrade or downgrade issues, our 45 credit analysts apply an assessment of each security throughout the period that we hold the security in a portfolio, which includes monitoring rating agency changes. Over the past 10 years the BlackRock credit team has anticipated ratings downgrades, and withdrawn securities from the approved list or restricted the maturities of these issuers, an average of eight months ahead of the rating agencies. Some treasurers may have taken on this role themselves since 2008, with risk now prevalent in many treasurers’ minds, but the service is there for others that may not have this capability or desire.
Short Bond Fund Alternatives: As part of the European Securities and Markets Authority (ESMA) guidelines there are short term MMFs which are the most commonly known form of short bond fund alternatives, but they have also defined a set of guidelines for MMFs with a slightly longer duration. Typical features of these funds include:
- A longer investment horizon than short term MMFs (6-12 months).
- Fluctuating NAV.
- Maturity limits (fixed): 397 days.
- Maturity limits (floating): 2 years.
These short bond fund alternatives, or long MMFs, also have the potential for a yield uplift compared to short term MMFs and often have a total return objective.
When considering longer duration funds, the concept of cash segmentation is making a reappearance as these funds are ideal for cash considered ‘strategic’ that can be invested for a longer period of time. It is important for treasurers and cash investors to conduct a thorough evaluation of their cash needs and pinpoint their risk profile before acting. Effective forecasting of liquidity needs and the assessment of risk tolerances allows for the best opportunity to achieve excess returns within a cash portfolio, and to quantify how much cash is available for strategic investment in these types of funds.
Figure 1: The Advantages of Short Term Bond Funds.
Separately Managed Accounts (SMAs): Separate account strategies represent a unique way to achieve investment objectives for all types of cash – whether it is working capital, core or strategic. An institutional separate account is a segregated portfolio of short duration assets managed by an investment manager on behalf of a company treasurer. Various banks offer these options. A separate account differs from a MMF in that the investor directly owns the portfolio of assets rather than owning a share in a pool of assets. The separate account investor can customise the portfolio to their liquidity needs and investment guidelines, while leveraging the trading, portfolio management and credit analysis of an outside investment manager.
Separate accounts are appealing to investors for a number of reasons, one being the ability to obtain extra yield over that of a MMF. As discussed previously, the current low interest rate environment translates into extremely low yields on cash investments leading many treasurers to look to separate accounts in order to create a portfolio that can produce a higher yield, but without a significant increase in risk.
Figure 2: MMFs v Separate Accounts.
Preparation and flexibility are key requirements for treasurers in these challenging times. However, the principles of security and liquidity should never be compromised at the expense of yield. While a turnaround in rates is dependent on a number of factors – such as government stimulus packages, budget deficits, economic weaknesses/strengths, and consumer confidence levels – current conditions support BlackRock’s view that low interest rates are likely to remain for a while. Consequently, to thrive in this challenging environment, the fittest treasury investors will need to be more nimble in their approach, more adaptive in their thinking, and more flexible in their search for opportunities.
If you are concerned about the challenges ahead you are not alone. A survey conducted by BlackRock found that 90% of clients would need to amend their investment policy to implement any of the alternatives outlined above, and many are not yet prepared for change. For cash investors and some treasury managers, particularly of smaller firms, the past few years have seemed like a fight for survival. But there are ways to adapt to the new world, to make the shift from survival to revival. For treasurers at large multinational corporations (MNCs) there are also good returns to be won out there in the new low interest rate environment.
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