With many more companies today holding significant cash balances, the quest for better yields in this ‘lower for longer’ interest rate environment has given the separately managed account (SMA) a new lease of life. Cerulli Associates research cited by Morgan Stanley showed that between 2010 and 2017, SMA uptake rocketed by 84%.
The key to the success of the SMA is that it takes a bespoke approach to cash investment (hence they are sometimes referred to as bespoke mandates). Unlike with mutual funds (such as money market funds), a SMA portfolio manager buys individual assets for its client’s investment guidelines unlike a pooled vehicle. The investor is thus not buying into a pool of assets, but buying – and owning – the individual assets. These assets may reflect the investor’s liquidity requirements, from the short to the long term, and, crucially, their unique investment guidelines.
SMAs are typically used by institutional investors (and some ultra-high net worth individuals), some of which may prefer direct ownership of the underlying assets rather than being in a pooled vehicle. “It affords them the ability to fine tune the risk and reward of their portfolio,” explains Tony Callcott, Head of Pan-European Liquidity Client Solutions, Aviva Investors.
To be effective as a portfolio, the right scalability of investment is needed. Assets under management for a client portfolio can start at around 200m currency equivalency, with no set ceiling. The bespoke nature of SMAs mean they can be more expensive to manage than pooled funds. Providers argue that the bespoke mandate and the broad segment of cash being invested (from short to long term), means increased scope for yield enhancement.
Ultimately though, says Dennis Gepp, Managing Director and CIO, Cash at Federated Investors (UK), “set-up costs will come down to the amount of hand-holding and personalisation required”. In any case, if the Cerulli Associates figures referred to earlier are accurate, it is seemingly worth the cost for an increasing number of investors.
By customising the portfolio according to individual financial goals, it enables the investor to better meet and manage their own guiding principles (such as risk appetite, need for liquidity or ESG drivers). In essence, says Gepp, SMAs are characterised by “flexibility, control and the transparency of owning selectable individual securities”.
KYC (know your…cash flows)
Treasurers with “significant but relatively well-known cash flows over an extended period” can leverage an SMA most effectively, says Gepp. For a corporate with a substantial purchase scheduled for a more or less predictable future date (an M&A for example) it can be fruitful. Rather than locking-in cash for an extended period and running the risk of not being able to redeem on time (or tolerating very low returns for the duration in the short-term space), he argues that SMAs can help companies maximise returns on their overall cash pot and allow them to unlock it close to the required date.
Aiming that cash at what the client considers is likely to be happening at a future date, and then maximising investment opportunities around that, is what Gepp calls the “focused flexibility” of SMA portfolio management.
This might be easier for some to do than it is for others. Investors with well-defined cash flows have easier and more accurate forecasting at their disposal; this enables their cash to be invested with a higher degree of certainty across a range of tenors. However, for many, such predictability is a challenge, notes Caroline Hedges, CFA, Global Head of Liquidity Portfolio Management, Aviva Investors.
Indeed, investors whose cash flows are largely dependent on price-volatile commodities, such as oil, understand only too well how market movements can affect their performance. “It’s important for all businesses that do not have predictable cash flows to map what proportion of their cash flow is volatile, so they can optimise their portfolio to get the best return,” says Hedges.
For Gepp, this deeper level of understanding enables the treasurer to be in control of their portfolio from the outset. “The aim is never to be in a position of forced sales, because it nearly always takes place at the wrong time,” he warns. “We do not want to be taking unnecessary capital risks for the client so, at all times, the investment manager has to balance likely movements of the client’s cash with the overall look of the portfolio and the desired results.”
Structuring a portfolio always starts with a consideration of the investor’s goals over the longer term (say, five years), taking into account their known and anticipated cash needs within that timeframe. This way, the investment manager should be able to build-in sufficient liquidity, whilst still optimising returns.
Since 2018 (2019 for existing funds) in Europe, this has translated into a regulatory requirement to maintain a daily minimum of 10% overnight liquidity, and a weekly minimum of 30% liquidity (the US has slightly different rules). With an SMA, these liquidity rules (and thus their impact) are not applicable as the investor and provider have pre-agreed the investment guidelines and liquidity requirements for the mandate.
An SMA requires administrative work as part of the set-up. This may include the provision of a custody agent (a large treasury may already have one on board) and preparation of legal documentation, for example.
Callcott says Aviva Investors has been an established and diversified asset manager for a number of decades, and has a well-honed set of processes and experiences to deliver the expected outcomes from a bespoke mandate. Gepp similarly says Federated has comparable longevity and experience. Both say they are on hand for the duration to guide clients through the set-up (Callcott quoting a turnaround of “no more than eight weeks in total”, from initial approvals, via establishing guidelines, to taking it to market).