Treasury Today Country Profiles in association with Citi

Five investment options for your short-term cash

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With the short-term investment landscape in a period of flux, many treasurers are reviewing how they invest their company’s cash. Treasury Today investigates some of the trending options available to corporates.

The short-term investment landscape is in a period of flux. This is largely being driven by the arrival of several conflicting regulations. First, there is Basel III, which is seeing banks charging more for (or being unwilling to hold) non-operational deposits. Then there is the reform in the US and European money fund industry which is causing headaches for treasurers who use money market funds (MMFs) alongside, or as an alternative to, bank deposits.

To complicate matters, corporations around the world are holding more cash on the balance sheet than ever. As a result, finding a secure home for this cash becomes increasingly important. And that is before treasurers think about yield in this time of historically low interest rates.

These are certainly challenging times for the corporate short-term investor, but there is also an opportunity. It’s all too easy for short-term investors to follow the status quo and use less-than-optimal solutions. Treasurers, therefore, should ideally be looking to review their investment policy now, to ensure they are aligning their short-term investment objectives with their company’s goals. They should also be reviewing the products they are using and consider alternatives that might better help them meet their investment objectives.

Here are some of the latest trending short-term investment options.

MMFs

MMFs are designed to preserve capital while providing liquidity and an attractive rate of income relative to short-term interest rates. These attributes make MMFs an important tool in many corporates’ short-term investment strategies.

MMFs offer numerous benefits to corporates, says Kim Hochfeld, Head of EMEA Liquidity Distribution at Morgan Stanley Investment Management. “They provide corporates with a secure, diversified investment option,” she says. “This is especially important at critical times, such as year-end when banks are reluctant to take short-dated cash on the balance sheet. Beyond this, using MMFs rather than deposits also frees up credit capacity with relationship banks. Corporates can use this credit capacity for more complex transactions, such as derivatives, FX and lending activity.”

After some negative press and an incident during the financial crisis where the reserve fund “broke the buck”, MMFs were subject to heightened scrutiny by the US and European regulators. In the intervening years, US and European regulators have sought to strengthen MMFs and to increase transparency for investors, resulting in changes to how these funds operate.

Some of the most notable changes that the new regulations have brought about in the US and EMEA are the requirement for floating net asset values for certain fund types and the provision for liquidity fees and/or redemption gates based upon certain triggers for specific funds.

MMFs are designed to preserve capital while providing liquidity and an attractive rate of income relative to short-term interest rates. These attributes make MMFs an important tool in many corporates’ short-term investment strategies.

In the US, institutional prime and tax-exempt MMFs must transact at a floating NAV and have the potential for trigger-based fees and gates. Government MMFs can maintain a stable NAV and do not have fees/gates. Meanwhile, in Europe, there are three new fund structures – public debt CNAV, LVNAV and VNAV. Public Debt CNAV and LVNAV offer the closest operational utility to MMFs today, but are subject to trigger-based fees and gates and LVNAV funds must trade within certain collars to maintain the constant NAV. VNAV funds utilise market-based pricing and are not subject to trigger-based fees and gates.

In the US, the new rules, which were introduced last year, led to significant outflows from prime MMFs, with clients moving into government funds to avoid fees and gates. Money has since started to trickle back into prime funds as corporates have become more comfortable with the new product landscape.

In Europe, the new rules come into force in January 2019 for existing funds. And while industry experts don’t expect the impact to be quite as extreme as in the US, there is debate amongst the investor community around how money funds will be used going forward.

Investors in Europe shouldn’t be concerned, says Hochfeld. “The changes should enhance the appeal of MMFs,” she says. “The products will continue to provide daily liquidity, yield, diversification and outsourced credit analysis to corporate investors but with enhanced transparency and investor protection.”

Hochfeld adds that the new rules will also provide corporates with more choice. “There are short-term and standard VNAV funds for yield-driven investors and CNAV and LVNAV for those looking for operational simplicity and stable NAV. This will enable treasurers to pick a product that more closely matches their investment objectives.”

Hochfeld expects MMFs to remain a key investment option for corporates post-January 2019 due to these factors. “Many corporates rely on the utility offered by MMFs,” she says. “They will struggle to find alternative investments that provide the same credit diversification, capacity and liquidity.”

Separately managed accounts

Separately managed accounts (SMAs) can provide corporates with a personalised approach to investing. When using these products, a treasurer mandates a fund manager to buy and hold securities on the company’s behalf. This is unlike a MMF where a corporation is a shareholder of a fund which owns the securities.

First offered in the 1970s, SMAs were developed to accommodate the needs of investors whose objectives did not fit within the constrictions of a mutual fund investment. This remains the product’s primary function today. “SMAs are bespoke products built to meet the investment objectives of an individual corporate,” says Jim Fuell, Managing Director, Head of Global Liquidity Sales, International at J.P. Morgan Asset Management. “They provide all the benefits of professional money management, combined with the flexibility, control and transparency of owning individual securities.”

They may also enable corporates to achieve greater returns. In fact, the desire to achieve greater returns is a key driver behind the growing corporate interest in SMAs. Fuell says SMAs are especially useful for those companies able to achieve good visibility over their cash, and segment it strategically. “They can then comfortably place some of this cash into an SMA to achieve greater returns, while taking a level of risk which is closely aligned to what is permitted in their own investment policy,” he says.

Corporates are also turning to SMAs because of Central Bank policy. Fuell explains that in Europe, many corporates are averse to negative rates. “Several companies are looking to overcome negative rates by taking on more risk,” he says. “This enables them to generate yield above zero. They are finding SMAs to be a vehicle that enables them to achieve this.”

The benefits offered by SMAs come at a cost, however. For instance, the bespoke nature of the product means that fund management fees may be higher than those in MMFs. There is also a minimum investment amount that fund managers request. This varies from fund manager to fund manager but typically is between US$25m to US$100m. Companies looking to use SMAs will need to appoint a custodian to hold the purchased securities and will also need to execute an investment management agreement with their asset manager.

Aside from the cost, setting up an SMA will typically require significantly more lead time to establish than an off the shelf fund offering. Fuell explains that it is crucial that the fund manager clearly understands the corporate’s investment objectives and risk parameters. “Doing this correctly takes time,” he says. “It’s also not a one-way street. The best fund managers will advise when the yield they are seeking is not in line with the risk appetite they have, for example. It is a true collaboration, and it’s important to get it right.”

Exchange traded funds

Unlike MMFs and SMAs which have existed for some time, exchange traded funds (ETFs) are an emerging tool that treasurers can use for their short-term investment needs. As the name implies, ETFs are investment funds traded on a stock exchange. These often track an index such as the S&P 500 or FTSE 100 and hold a portfolio of assets such as stocks, bonds or commodities. Investors can buy or sell shares in an ETF to gain exposure to a particular index or market. Unlike mutual funds, which are priced once a day, ETFs can be traded intraday.

These products have become popular with investors in recent years, as cost and transparency have become a bigger consideration. ETF holdings are published every day and provide intra-day valuations with live pricing on exchange. ETFs also often carry lower fees than managed funds.

Despite their popularity, corporate treasurers are not typical users of ETFs. “Early adoption can take time as institutions become comfortable with a new product,” says Ashley Curtis, Head of iShares EMEA Fixed Income Markets and Sales at BlackRock. “Corporate treasuries are no different and incorporating new investment wrappers can help bring efficiencies that may not have been available before.”

Curtis is seeing mounting interest, however. “Corporate pension ETF usage has grown quickly,” he says. “Also, those corporates with more flexibility in their strategic cash buckets are considering investing in short duration and floating rate credit ETFs. These enable them to ease balance sheet pressures and potentially earn better returns in comparison to cash-like investments.”

Interest will only increase through education. “There is a need for treasurers to better understand the mechanics of ETFs,” says Curtis. “Doing so will allow them to find ETFs suitable for their cash management needs. This will naturally increase the usage of the product.”

The industry is also evolving to meet the needs of corporates. This includes the development of ETF products which provide shorter creation and redemption settlement than the standard T+2. “Because of this development, ETFs will provide a complementary tool to more traditional cash or short-term investment products,” says Curtis. “This will allow for more flexibility in different market environments.”

Repurchase agreements

Another option for a company with surplus cash is to enter into a repurchase agreement (repo). Put succinctly, repos are financial instruments that enable a corporate treasurer to exchange overnight or short-term cash for high-quality security. The corporate holds this security until the original owner of the collateral repurchases it. More often than not, corporates will appoint a third party to manage the collateral. This structure is called a tri-party repo.

Although agreements between banks dominate the repo market, some corporates have found them to be a useful tool. A key reason for this is that corporates can adjust the ‘risk-and-return’ equation on their investment to match their internal investment policy. This is because corporates can decide on the spectrum of assets they wish to hold. Corporates can take high-quality relatively secure assets, such as German Bunds, and receive little return. Or they can generate a greater yield by taking corporate bonds or equities.

Repos are also a good tool for a corporate to use if it wishes to reduce its number of counterparties. By securing the investments with collateral, corporates do not have to worry about losing their investment if the bank collapses. This feature also means corporates can use repos to support strategic corporate actions, such as depositing a large amount of cash on the back of a sale.

However, there are high barriers to entry for corporates considering repos. One barrier is the Global Master Repurchase Agreement (GMRA), which governs the repo market. Although defined as an ‘industry standard’, it requires lengthy negotiation with each counterparty to iron out the specifics within the agreement. Corporates with little knowledge of the secured financing world, legal capacity or expertise in the repo market, can find the process time-consuming and off-putting.

Like SMAs, repos also require corporates to commit a significant amount of cash to the transaction. This is because the banks are used to dealing with large amounts of cash on their side of the equation, so corporates need to match these levels. As a result, repos are largely the domain of the multinationals.

Supplier finance

Investing in the supply chain is an alternative option for corporates wondering where to put their surplus cash. Whilst not a new concept, supplier finance, not to be confused with bank-offered supply chain finance, is capturing the attention of short-term investors. This is due to it being essentially risk-free and providing corporates with the opportunity to achieve a tidy return on their cash investment.

As a quick reminder, supplier finance is where a corporation uses its cash (or sometimes cash from a third party) to finance suppliers. It does so by paying approved invoices ahead of the due date in return for a discount. In theory, this creates a win-win; buyers save money on the goods purchased and suppliers can access a cheaper source of funding than they would from alternative sources. Supplier finance is generally regarded by suppliers as the easiest form of finance to access and it’s available to all businesses, regardless of size or geography, and with no cumbersome on-boarding process.

The discounts that corporate buyers can achieve using supplier financing – and thus the yield they gain on their cash investment – can be substantial. Colin Sharp, SVP EMEA at C2FO, says its clients are achieving between 7% and 8% APR return on their investments into the supply chain while at the same time reducing the cost of finance for their suppliers.

Anecdotally, many treasurers have or are considering updating investment policies and are looking at alternatives to bank deposits and CNAV MMFs.

“This is because suppliers, especially those down the mid- to long-end of the supply chain, need cash for working capital or to invest in the business,” he says. “Suppliers can offer a rate that’s appropriate to them (there is significant price elasticity) and C2FO’s market can blend these offers to achieve the target yield required by the corporate.”

Unlike other investment options, supplier financing also offers treasury the platform to act strategically within the organisation. “By working with procurement to offer supplier financing, treasury can help safeguard the supply chain,” he says. “It can also position the company as a preferred customer, enabling it to achieve exclusive deals and better pricing. It may also provide suppliers with the cash they need to innovate, thus resulting in your company receiving better products from them.”

Despite all the benefits that supplier financing can provide, it is arguably a more complex short-term investment solution than those already discussed. This is because, by its very nature, supplier financing is a cross-functional project that requires the buy-in of multiple stakeholders. This can be difficult to achieve in larger corporations, especially if treasury and procurement, for example, are working towards conflicting KPIs.

Sharp says ultimately the benefits are worth the effort, believing that supplier financing will only deliver more benefits as interest rates rise around the world. “As rates rise, companies will be forced to pay an even higher price for working capital,” says Sharp. “Corporate buyers can support their suppliers through this by providing supplier financing. At the same time, the corporate buyer will pick up enhanced yield on their own cash investment. It is a win-win.”

Flexibility is key

As the short-term investment environment continues to evolve, the impetus for corporate treasurers to change their thinking around short-term investments grows ever greater. Ensuring the investment policy is flexible is crucial, and treasurers may wish to establish the ability to use a wide variety of different investment options – even if they do not plan on using them immediately.

This process of adaptation appears to be already well under way. Anecdotally, many treasurers have or are considering updating investment policies and are looking at alternatives to bank deposits and CNAV MMFs.

Treasurers are also focusing on achieving a more accurate cash forecast and prudently segmenting cash. Doing so enables them to be more strategic in how they allocate cash, allowing them to use a wider range of products to meet the company’s investment objectives.