Corporate treasurers need well-diversified investment portfolios at the best of times, and this is only more important in times of extreme volatility – such as we’re seeing with COVID-19. What does it take to maintain a solid investment strategy, and just how realistic is it during such seismic global events?
The investing mantra for treasurers, ‘security, liquidity, yield (SLY)’, is an “oldie but a goodie” according to Serina Hourican, Head of Asia Pacific Commercial Sales, Global Transaction Services, Bank of America. In times of uncertainty, going back to this basic principle is important. However, a new balance of the mantra is needed in times of crisis – as discussed in this recent Treasury Today piece.
Still SLY?
Throughout the pandemic, Hourican says keeping a focus on security is a given to ensure a company gets at least 100% of all deposits back. However, many companies also need to keep funds as liquid as possible in order to make sure that they can afford their day-to-day operational payments. “Given the pandemic, we’re seeing clients looking more at having access to turn their investments into cash very quickly – without having to pay any penalty fees,” she says.
Additionally, due to the globally low – and in some cases, negative – interest rates, many clients aren’t actually wanting to lock funds away in investments. Yield, meanwhile, is “at the back of the queue,” says Hourican. “Back in the day when interest rates were high, yield was important for treasurers because their KPIs would be focused on reducing fees and growing revenue,” she explains. “But now we’re in this pandemic situation, and yield has to be forgone to put a prudent risk management process and policy in place.” For treasurers in especially hard-hit industries, it’s even more important to keep more money as liquid as possible, she adds.
More recently, Hourican has been pleased to see that many treasurers are examining in more detail the policy and thresholds of the credit ratings of the banks and asset managers they’re placing funds with, and even the funds themselves. As many make a flight to quality, she is keen to emphasise the additional importance of diversifying investments: “Coupling the SLY approach with making sure you’ve got a well-diversified portfolio will help in these times of volatility.”
For Saurabh Chakravarty, Jt President, Finance at UltraTech Cement Ltd, the benefits of a well-diversified portfolio are simple: improve the risk-to-return ratio, and provide both minimal pains around losses and a simple and effective way to protect capital. He believes that diversifying funds acts as a natural hedge against volatility, and both he and Hourican agree that put simply, treasurers should not “keep all their eggs in one basket”.
It’s important to remember that diversification stretches beyond just different industry sectors though. As Chakravarty points out, “diversification across asset classes, currencies, countries, intra-asset classes, tenors and styles” are all necessary. In short, assets shouldn’t correlate with one another.
How long do you want it?
Length of investments is also a factor in diversifying funds. For treasurers, achieving an optimum balance between short, medium or long-term investment strategies is essential for maintaining the necessary liquidity.
However, Hourican also notes that determining the length of investments a company should have is more nuanced than many think. “It depends on your company, the investment policy, the industry, where the company is in its life cycle. Is it just a growing company? How do you define what is medium and what is long-term?” she asks.
For some corporates, short-term is anything under one year, medium-term is one to three years, and long-term is over three years. “But I’ve seen more recently the reduction of those durations,” she says. Instead, short-term has been overnight to three months, medium-term is three months to one year, and long-term is over one year. She predicts that corporates will be rebalancing towards short and medium-term investments, especially considering the extremely low interest rates across the world. “Before, long-term meant more risks but more rewards. But with most global interest rates being so low, where is the risk – reward trade off?”
Chakravarty is of a similar view. “The two-fold responsibility of the treasurer – to maximise return and minimise risk – drives them to balance between tenors to optimise yields,” he says. As a result, he believes medium-term investments are generally the best placed for this, as it is easier to see beyond the uncertainties in the medium-term. “[Medium-term investments] are more conservative than the long-term and more risk tolerant than the short-term,” he adds.
Keeping afloat
Hourican says she is seeing an increasingly common trend of treasurers drawing down on liquidity in different ways, mainly to ensure that they have enough of a buffer in the event they can’t make sales or pay their suppliers. “We’ve seen a number of clients draw down on their lending facilities – for example, if they have a revolving credit facility (RCF), they’re just parking that cash into a current account so they know it’s there when they need it,” she explains.
Seeing the same trend, a BlackRock whitepaper, ‘Lessons from COVID-19: The Experience of European MMFs in Short-Term Markets’, noted that in the first weeks of the crisis, many corporates drew down on their RCFs. “When this happens en-masse, it creates a significant liquidity demand on banks,” the paper says.
“I think it’s just the uncertainty that’s making corporates and treasurers think that they have to keep funds liquid,” says Hourican. “And if they can afford to tie up funds, then they’re thinking ‘what’s the penalty fee?’, are they going to be able to break it? Are they going to be able to get their full investment back?”
Another trend that Hourican has seen is around M&A, with smaller suppliers being bought by larger businesses in order to keep the supply chain operational. “We’ve seen some instances where corporates have bought their suppliers to keep the business going and essentially help themselves,” she explains. “But in order to do that, you need to make sure you have enough cash to do that.” Given the high value of many M&As, Hourican believes this is where the role of the treasurer becomes even more important as they assess things such as the efficacy of working capital versus lending facility for funding a deal.
Communication is key
While it may not sound very encouraging, “Most investment strategies fail,” says Chakravarty. But, he adds, they don’t fail because of inherent flaws within the strategy, but rather because of the human application. “Whilst having a strategy is very important, what’s more important is the process,” he says. The process should eliminate the influence of any cognitive bias when implementing the strategy. “At each level of the implementation of the strategy, it is extremely important to delineate the biases from the processes.”
To begin creating an investment strategy, Chakravarty suggests starting by defining the objectives, the timeframe, the asset allocation, the risk management plan, and accessing information and data. The job can become more difficult if treasurers don’t have clear visibility of the organisation’s plans.
For Hourican, a similar step is also a priority. “Talk to the company’s board of directors,” she says. “What is actually within your investment policy?” She adds that she has seen many companies now relooking at their investment policies and notes that the risk appetite has changed. The risk tolerance is key to determining an investment strategy, particularly in times of such geopolitical uncertainty. Local developments in different countries should also factor into a treasurer’s plans.
Lean on partners
Of course, no investment strategy would be complete without consulting experts, such as banking partners, asset managers or fund managers. Hourican notes that banks will always understand that treasurers have many banking relationships, and it’s important to utilise all the relevant ones. Treasurers can thereby acquire the knowledge they need about the solutions and products available, as well as any possible fees for withdrawing and the relevant credit ratings.
Additionally, Hourican believes that understanding the past is an excellent way to contribute to an investment strategy. “Are there any key learnings they can lift from the 2008 financial crash? How did a particular company get through that crisis?” However, she does note that from a tax and accounting perspective, it’s important to acknowledge the drastic changes to the landscape since then. Treasurers therefore also need to ensure they’re educated on the various tax implications of different investment strategies or products.
Monitor and maintain
As with implementing an investment strategy, Chakravarty holds no illusions of ease when it comes to maintaining one. “It’s extremely difficult to maintain an investment strategy,” he says. However, he notes that a simple strategy that is all-encompassing and understood by everyone can be timeless. “A simple investment strategy needs to answer simple questions – what to buy, when to buy, how much to buy and when to exit.” If the rules are clear and the parameters defined, it can be run by almost anyone, he adds. Conversely, “The more complex a strategy, the more errors there are.”
Agreeing that investment strategies aren’t easy to maintain at these times of extreme volatility, Hourican says it’s important to review the strategy regularly. “I know some corporates who, through this pandemic, have been reviewing their strategies on a monthly, if not weekly, basis – just to make sure that they were going to be able to meet their payment obligations,” she explains.
Along with reviewing the strategy, it’s also necessary to monitor it. Treasurers should be actively looking at how the strategy is performing, whether changes are needed and whether it continues to reflect the appetite of the Board of Directors and the investment policy.
Finally, treasurers need to ensure the strategy is still within the cash flow needs of the business. As such, Hourican says a robust and accurate cash flow forecast is also key, because that will help to determine how much cash is needed in the short, medium and long term. “Having good cash flow forecasting and a good monitoring process will help treasurers make sure that they know they’ve made the right investment strategy decisions,” she concludes.
