Funding & Investing

Liquidity, security, yield: finding a new balance

Published: Jul 2020

It’s always been ‘liquidity, security, yield’, in that order, for treasurers. With markets in turmoil and revenues under pressure, short-term portfolios come under close inspection to see if finding a balance is possible.

Finding a new balance, a mouse balancing on top

The mantra of ‘liquidity, security, yield’, when it comes to treasury investments, has always seemed like an unwritten rule, to be followed in order of appearance. Ensuring liquidity has always been part of the treasurer’s day job, capital preservation remains foremost, and senior executives often encourage investment optimisation. Whilst this three-part edict implies a defined ratio between them, with an expected formulaic outcome, Mark Stockley, Head of EMEA Treasury Sales and Strategy at Invesco says the reality for most exists in achieving the right balance between each.

With the events of the last few months having demonstrated how quickly the fundamentals of entire industries can be decimated in a truly short space of time, liquidity access for most has shifted front and centre: ‘right balance’ can thus be taken as a dynamic proposition, especially in the worst of times.

Greg Person, VP Sales and Account Management, UK&I, Kyriba, refers to a ‘dash for cash’ as many US and European corporates pre-emptively drew down some US$130bn against their revolvers as their essential liquidity buffer. With that buffer having become in recent months “a competitive advantage” (reported, he says, in earnings calls and IR communications), it seems that the quest for yield is but a distant dream.

However, by judicious effort it is still possible to find the right balance between seemingly conflicting components. For Paul Baram, Director of Capital Markets and Treasury at treasury consultancy firm, Actualize, doing so in the prevailing environment is not so much a matter of avoiding taking a sophisticated stance on investments, as being conscious of the maturities of the investments being considered, and understanding the ability to mature them early if there becomes a need to repatriate investments at short notice.

“I don’t see that security has to be sacrificed for liquidity or yield,” he says, seeing liquidity as a “precursor to yield”. With the functionality available in treasury management systems (TMS), specifically bank statement integration, providing “a great basis for cash visibility”, when allied to robust processes for cash forecasting, treasurers nowadays he says “can feel ever more comfortable about liquidity”.

Indeed, Baram suggests that having a clear view on the timeframe of available funds can allow slightly longer-term investments to be made, thus potentially enhancing yield. The current climate has of course heightened the need for accurate forecasting, along with the ability to amend it as required. The amount of contingency to apply to those forecasts is, he concludes, a key factor in determining available liquidity.

For Stockley too, investment strategies need to be flexible, based upon how the corporate has structured or segmented its cash. Within this, it is essential to be able to differentiate between operational cash, where preservation of principal is vital, and longer-term strategic cash, where enhanced returns could be sought. “I don’t think there can be this equally balanced three-legged stool of liquidity, security and yield; it has to be about balancing security and liquidity first, and then looking at yield having segregated operational and longer-dated cash.”

Unequal access

For many treasurers, implementing a highly proactive, more sophisticated investment strategy is simply not feasible, notes Justin Meadows, non-executive Director at TreasurySpring and FXD Capital, and former academic economist. “They do not have enough resources, the required expertise or infrastructure, legal agreements or access to securities markets to make this happen.”

In many cases too, he notes there is a perception that there is no need for a dynamic and diversified approach. “If MMFs and deposits are good enough for the largest organisations, then they should be good enough for everyone, they reason. But the reality is actually very different from this.”

Meadows says the reality is well illustrated by an analysis of the cash holdings of Alphabet, Amazon, Apple, Facebook and Microsoft, who between them hold less than 10% of their cash in MMFs and bank deposits, compared to nearly 85% held in government and corporate bonds and the remainder in mortgage backed seecurities.

So perhaps the question should be that if these are good enough for the largest and most sophisticated treasuries, why doesn’t every organisation have a similar portfolio mix, Meadows muses. It is of course for all the reasons he mentions earlier: lack of resources, expertise, market access, infrastructure such as custody arrangements, and legal expertise to get the required and often complex agreements in place.

“The reality is that until recently, all but the largest organisations have been effectively excluded from the securities markets, and hence prevented from following a similar strategy to the largest players,” he explains. “Given the current environment, it is no surprise that the market has seen a number of emerging initiatives looking to ‘democratise’ access to new investment opportunities.”

Indeed, Treasury Today has looked at such initiatives, with TreasurySpring for example seeking to open up access to the bond and repo markets for organisations that could not do this for themselves simply because few have the infrastructure in place to execute their trade settlements.

Under pressure

With that balancing act in mind, in more normal times, when liquidity is not quite so front and centre, there will often be a healthy tension between the senior executive and investment committee desire for enhanced rates of return, and the treasurer’s need to explain the impact and risk dynamics of how cash can be invested. However, sometimes external circumstances play a key role in investment decision-taking.

Variations in interest rates, particularly by currency, are a case in point. When the ECB first moved interest rates into negative territory in June 2014, for quite some time many banks continued to offer a zero rate of return. Corporate investors were still able to ‘earn’ zero on their time deposits and call accounts, with the cost of the negative spread typically being offset by the banks against other revenue streams from their faithful corporate clients.

It appeared, for a while, that banks were taking a relationship management perspective by absorbing costs. In August 2019, the ECB cut rates again, from -40 to -50 basis points. This seemed to be a tipping point for banks, many revisiting their willingness to absorb negative spreads. Widespread action by banks followed as they sought to reduce balances on which they were offering that zero yield.

In turn, where corporates had been able to avoid having negative returns, many were forced to revisit their investment activities and consider alternatives. Whilst the majority continued to adhere to the key paradigm of ‘security and liquidity’ first, in euro at least, -50 basis points was effectively their new benchmark.

Most treasurers continued to invest in alignment with their guidelines and limits, using approved counterparties (including MMFs). But not all did, says Stockley. “Having been moved from zero into significantly negative territory, a number went looking for additional counterparties, increasing their banking relationships and leveraging opportunities where they could still achieve zero on cash balances.” Some, he observes, took to extending their investment strategies, looking at longer-dated investment profiles. A few headed for lower credit quality.

The inevitable downsides of increasing potential return in this way can include volatility, capital risk and reduced liquidity. As Stockley comments, pushing out and broadening an investment strategy by looking for other areas where higher levels of return are possible “can come at a price”.

If treasurers are to adopt a more sophisticated or creative stance on their investments, the exasperating reality is that they will always be tested most at the point where there is a problem (such as the current pandemic, and the global financial crisis of 2008).

Being a proactive and sophisticated investor is about being prepared. It means having the right policy and approach in place in good time, and not being forced into making retroactive and possibly suboptimal decisions when the real test begins. “Don’t be complacent,” warns Stockley. “If you’re at the point in a crisis where you have liquidity or capital preservation concerns, it’s already too late.”

Trust in technology

In the current pandemic, concerns have largely been about access to liquidity. This requires treasury to have a greater depth of understanding of elements such as changes in assets under management within specific funds, weekly liquidity availability, and the fund approach to portfolio structure. Of course, the longer the effects of the pandemic are felt, the more corporate cash flow will be stretched.

To date, notes Stockley, corporate treasurers have been largely “measured” in their approach to current risks. Where, for example, three or six month rolling deposits have been used, some have been shortening their investments, with an initial period of some dis-investment to ensure overnight cash in the bank, but generally he has not noted any wild shifts in their investment strategies and allocations.

‘Liquidity, security, yield’ can be revisited but being proactive is vital. Treasurers must take advantage of all the data and analysis that is available to them. Where this facilitates deeper cash visibility, more accurate forecasting follows. This leads to a more comfortable view of liquidity positions and better segmentation of cash into operational and strategic buckets. It follows that treasurers can better understand liquidity opportunities and risks, including taking informed investment decisions.

The key is a properly joined up treasury infrastructure, from end-to-end, that supports the full range of treasury processes within an organisation, says Meadows. “Full integration between cash flow forecasting, order management, trading, risk management, settlement, trade booking and reporting is essential as a more diversified landscape develops, and the need to react quickly and in an up to date informed way remains key,” he advises.

But, he adds, these processes should not just be internal but should also encompass external service providers, where these are necessary, to support access to the broadest possible portfolio. “The new world will take us well beyond the stage when we can manage effectively with spreadsheets,” he says.

Indeed, integrated technology, including using the latest APIs to create an active network of liquidity management, connecting multiple financial institutions to treasury via a single platform, is the “foundation” for this solid position, suggests Kyriba’s Person.

This, he says, should not only provide visibility over global cash balances, but also facilitate monitoring of the components that make up a corporate liquidity position, such as lines of credit, short and longer-term deposits, investment portfolios and inter-company funding.

He notes leading CFOs and treasury departments have been able to rely on real-time view of current liquidity within that framework, supplemented by analysis and insight of future liquidity positions, derived from various ‘stress-tested’ scenarios.

For many businesses impacted by the current pandemic, being able to understand, for example, the impact of slowing revenue streams on future liquidity positions, in terms of access to credit lines or money-fund redemptions, is proving to be a vital lifeline. As Person says, “a strong liquidity strategy is a competitive advantage”.

Indeed, his message is around a balanced liquidity structure that optimises sufficient funding today, whilst also ensuring business operations continue to operate smoothly in the future. Transparent and automated liquidity can provide CFOs with confidence to manage their businesses, whilst anticipating for up- and downturns, whilst minimising interest expense and optimising interest income through higher yield intelligent investment placements.

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