Funding & Investing

Behave like a bank: making the most of short-term investments

Published: Sep 2019

Close up of screen with financial stock exchange figures

When it comes to investing short-term cash, there are many factors to consider – and while bank deposits and money market funds may account for most treasurers’ short-term investments, there may be other options worth exploring. Meanwhile, some forward-thinking companies are taking inspiration from banks as they seek a more sophisticated approach to this area.

Deciding where to invest cash is a key part of the treasurer’s role, but there are a number of competing goals and other factors to consider. While bank deposits may be an obvious choice, many companies also use money market funds very effectively – and beyond that, there may be further options for treasurers willing to take on additional risk.

So what are the key investment goals for treasurers in Asia, where are the most significant challenges – and what are the options for treasurers wishing to look further afield than bank deposits and money market funds?

Security, liquidity, yield

Aidan Shevlin, Head Global Liquidity Fund Management, Asia-Pacific, at J.P. Morgan Asset Management, points out that understanding and clarifying investment goals is the critical first step for treasurers. “Typically, an organisation’s investment policy should provide a solid foundation for cash investment decision, defining objectives, acceptable levels of risk and return requirements,” he notes.

Where objectives are concerned, any investment decision requires the investor to weigh up the competing goals of security, liquidity, and yield. A highly liquid investment is unlikely to offer as attractive a yield as an investment with a longer maturity. And a high-yielding investment may not offer the security that is likely to be a top priority for treasurers. As Warren Buffet famously remarked, “Rule No. 1: Never lose money. Rule No. 2: Never forget Rule No. 1.”

That said, the importance of liquidity is not to be underestimated. “When it comes to investments, access and availability are key,” says Anton Abraham, head of International Advisory at Bank of America Merrill Lynch. “If treasurers are going to place an investment, they need to know how easily they can get their cash back if they need it in a critical situation. Can that be done electronically or do they have to fill out forms? And are there any penalties around accessing that cash?”

Access to cash also needs to be weighed against the need for return on investment, which leads to something of a balancing act as treasurers aim to maximise yield while still having the desired level of liquidity.

“In the region I often see treasurers looking to banks to see if they can price their normal operating accounts with a higher rate of interest, comparable to what they might get in a one-week term deposit,” notes Abraham. “Obviously there is going to be a higher yield if they go for a longer tenor – but there has definitely been a move over the last few years to price operating accounts to a level where banks can still keep cash in those accounts. And that helps the treasurer with convenience.”

Challenges in Asia

Security, liquidity and yield may be perennial goals. But market conditions are more of a moving target – meaning that it’s important to stay on top of current trends and developing opportunities. Treasurers also need to understand the specific challenges of Asia’s heterogeneous landscape, such as:

  • Regulation. “Regulatory differences across Asian countries are one of the biggest challenges when managing short term investments in Asia,” comments Gordon Rodrigues, Director, Head of Asian Rates & FX, HSBC Global Asset Management. He notes that in Asia, even if a treasury department has set up a regional treasury centre, “there are still cross-border sweeps, time zone differences, intercompany lending and various other factors that make getting to a reasonable final cash position by currency a challenging task.” Adding to this, he points out the potential multi-currency pooling complications of having one currency to place investments in, or the challenge of investing each currency individually.

  • Sell side challenges. Likewise, Rodrigues says the same challenges exist on the sell side, “where providers rarely have the same cash management toolkit available in every currency or market.” He explains that this makes it extremely challenging for a treasurer to have a consistent short-term investment approach across the region.

  • Trapped cash. The issue of trapped cash can make it difficult to access balances in certain markets. “The main challenges are around some of the restricted countries and currencies,” says Abraham. “While you can still get optimised interest and put your cash into call deposits, or various products offered in different countries, the issue remains for treasurers that if cash is trapped, it’s trapped. So you might be able to get a return on your cash, but you still can’t get it out.”

  • Weighing up risk and return. As Shevlin explains, the range of money market instruments, issuers and structures available to investors across the Asia Pacific region has expanded rapidly in recent years. “This has given treasurers more choices than ever before, but with a major caveat – risk has also increased,” he adds. “Even in China where historically all fixed income instruments had an implicit government guarantee, the link between risk and return is strengthening as defaults increase and the government guaranteed fades.”

Cash flow forecasting

When it comes to investments, cash flow forecasting has a crucial role to play in giving the treasurer visibility over how much cash is actually available for investment. “It helps you to understand how much you can optimally invest, and for how long,” says Abraham. “If you don’t have the forecast, you may have the situation where you are breaking your deposits or need to call them back early. Or you may keep too much operating cash, which then impacts your ability to get a better return on excess cash.”

The benefits of effective forecasting are clear – and PwC’s 2019 Global Treasury Benchmarking Survey, Digital Treasury – It takes two to tango, found that cash flow forecasting was the top priority on the agenda for both treasurers and CFOs.

However, this is also an activity that many treasurers struggle to perfect. Obstacles to cash flow forecasting may include inefficient processes, inaccurate data, a lack of dedicated resources and a communication gap between the treasury and other teams that may need to provide data for the forecast.

That said, there is plenty that companies can do to forecast more accurately, from streamlining processes in-house to leveraging suitable technology. “Companies looking to improve their forecasting should aim to drive a cash culture within the organisation, which may be aligned to key performance indicators and incentives,” Abraham notes. “This, in turn, impacts the company’s ability to optimise short-term investments.”

From bank deposits to money market funds

For treasurers in Asia, bank deposits have long been the instrument of choice. “Historically, time deposits provided a simple method for local treasurers to invest cash balances,” says Shevlin. “Long-term, close relationships with banks and limited alternative options in certain countries meant that time deposits were often the only investment choice.”

But as Shevlin explains, a decline in high quality counterparties – together with the introduction of Basel III and the growth in corporate balances – has forced treasurers to look beyond bank offerings and diversify into other investment options.

Money market funds, or liquidity funds, can be an attractive alternative. Shevlin notes that liquidity funds are generally “an excellent option for corporate treasurers for placing short-term cash balances.” He adds, “Amid the recent complicated investment and economic environment, they offer an efficient investment solution that satisfies many of the risk and return requirements sought by cash investors – including excellent security, good liquidity and a competitive yield. In addition, the strict guidelines and oversight by regulators and rating agencies have greatly improved the liquidity, security and resiliency of these funds over the past decade.”

That said, corporate investment patterns can vary considerably from region to region. “In the US, about 20% of corporate cash ends up in money market funds,” says Rodrigues. “In Europe, that number is around 13-15%. Across Asia (excluding China), that number is less than 5%.”

In China, however, Rodrigues says it is a different story. “Historically there have been strict limits on the level of interest that could be paid on corporate deposits that were not tied to market rates,” he says. “Having significant amounts of cash onshore creates a supportive environment for the growth of money market funds.” Consequently, he points out that China is now the second largest money market fund market in the world, “with almost half of that coming from corporates and institutions, with the rest being retail.”

What else can treasurers use?

While bank deposits and money market funds may account for most corporate short-term investments, some treasurers may be open to exploring other options – albeit while keeping a close eye on the company’s risk appetite, policies and corporate philosophy.

Key to this is the ability to segment cash balances in accordance with the company’s liquidity needs. “Obviously, operational cash – for day to day needs – must be liquid and secure,” says Shevlin. “But for reserve and strategic cash balances, which may not be required for several months, reducing the amount of liquidity held and broadening the range of money market instruments and credit ratings allowed can help boost the overall returns achieved.”

Rodrigues says that the investment options open to treasurers in APAC are expanding at an increasing pace. He notes that there has been more adoption of separately managed mandates for large pools of cash, with such arrangements allowing treasurers to create a specific set of investment guidelines that exactly match the company’s risk appetite, “and allow an asset manager to create and manage that portfolio on their behalf.”

He adds: “We are also seeing an increase in low and short duration vehicles that have a longer tenure than a money market fund but less than that of a bond fund in the main APAC currencies. These vehicles are being offered in both the traditional fund format and in ETFs.” According to Rodrigues, these vehicles can provide more interest to an investor than a money market fund or short-to-medium term time deposit.

“The most recent entrant to this space has been trade finance funds,” he adds, noting that while these funds can come in various options, “the principles remain the same.”

Evaluating opportunities

Naturally, treasurers need to pay close attention to the risks associated with any additional investment instruments. Rodrigues points out that all the new instruments coming to the market require the treasurer to have a more robust risk management approach, which might require different skillsets within the treasury, or investments in new technology to support the treasurer.

“These instruments are more for the strategic cash element of a portfolio where yield is more important,” he explains. “Whilst these may deliver more yield on average than the traditional cash products, the trade-off will be less certainty of capital preservation as they will not be AAA rated products.”

Shevlin, likewise, warns that care should be taken when tapping new opportunities to ensure they are within the framework provided by the organisation’s investment policy, and that the returns achieved are in line with the additional risk assumed. “Securities with longer maturities, lower ratings and more complicated structures will generally have lower or limited liquidity,” he notes. “Therefore investors should be comfortable with their ability to hold to maturity.”

Shevlin also highlights the importance of credit and counterparty research when it comes to longer tenor and lower rated securities, noting that this is needed to minimise the risk of selecting issuers or instruments that may face downgrade or default risk prior to maturity. “Across Asia’s less developed credit markets, monitoring liquidity and credit quality can be challenging; therefore, working with a trusted investment partner who has the necessary resources and experience is critical to avoiding these pitfalls,” he adds.

Shift in mindset

Another notable trend is that some companies are taking a more ambitious approach to investments. As Shevlin observes, regional treasurers “are now more sophisticated and seek to emulate best investment practices of global multi-nationals in their cash investment policies.”

Abraham, meanwhile, says that the most sophisticated corporates are “starting to behave more like a bank”. He explains that some are increasingly using structures such as in-house banks and funding desks, adding that the latter is a way of “optimising funding from the group and for the group at the cheapest possible rates, while also leveraging the investments they may place their excess liquidity into.”

He adds that by centralising all group borrowing onto a single platform, a funding desk can thereby reduce the total cost of group funding, minimise third-party funding, reduce funding costs and ensure a mechanism is in place to transfer price working capital efficiently to the group.

“A great example would be if the organisation needs funding in Australian dollars, and doesn’t have Australian dollars in their accounts today, they may have access to draw down on a bank line in Australian dollars – but they may also have excess sterling sitting in London,” he says. “They can then make a decision at the funding desk: ‘Is it cheaper for us to draw down our line, or should we swap our sterling into Australian dollars and fund that way?’”

In order to deploy this model effectively, Abraham says companies need to have a robust technology infrastructure, as well as having transfer pricing arrangements in place and employing suitably qualified staff. “I see that as the next frontier in terms of liquidity funding and investment management – at least for more sophisticated corporates,” he adds.

Technology may also have a role to play in helping treasurers optimise liquidity management and enhance yield. “The next wave we are seeing is how this can be more digitalised,” says Abraham. “So how the use of APIs can help this process be more automated and digital from an end-to-end perspective.” He adds that while companies can already access plenty of capabilities via electronic banking, the next step is for APIs to bring greater sophistication in connecting treasury systems with banks, leading to a more dynamic process.

In conclusion, while bank deposits and money market funds are likely to suit most corporations’ investment needs, there’s a growing trend for companies to adopt a more ambitious approach to short-term investments – whether that means adopting a funding desk approach, or taking advantage of nascent technology.

But whatever the chosen approach, it’s essential for treasurers to take a rigorous approach to managing their short-term investments, from weighing up risk and return to clearly defining the company’s investment goals.

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