Before 2008, the relative priorities of the three investment pillars of security, liquidity and yield were pretty much a given in that order. Preservation of capital was the overriding requirement within the liquidity framework set by known or forecast cash flow requirements. Yield was a distant third and more aligned to achieving satisfactory returns rather than maximising them - something that wasn’t too difficult at the time given prevailing interest rates.
Since then, says Justin Meadows, non-executive Director at TreasurySpring and FXD Capital, and former academic economist, interest rates have of course been much more challenging and, as they failed to improve, the balance between the three pillars slowly changed from the overriding focus on security at that time. “These developments were reinforced by structural changes such as money market fund (MMF) reform enforcing the shift from CNAV to VNAV for Prime funds and the removal of the opportunity for parent organisations to support their funds in times of stress as had happened in 2008.”
Basel III also created waves in the cash investment market as a result of liquidity coverage ratio constraints for the bank by significantly reducing their appetite for short term cash, adds Meadows. “Many organisations found that short-term bank deposits were no longer an option for them and increasingly this has led to many treasurers looking for opportunities to broaden their treasury policies to encompass a more diversified product portfolio.”
Slowly, investors have started to look to secure improvements in yield through limited relaxation of some of the security and liquidity constraints underlying their treasury policies. Principally this meant being prepared to accept slightly higher levels of credit risk and lengthening the maturity horizon for all but known or potential short-term cash requirements.
The arrival of COVID-19 has introduced yet more pressures, pulling treasurers in various directions. As Meadows notes, the economic uncertainty surrounding the implementation of unprecedented fiscal strategies to keep economies afloat has obviously created a lower level of confidence in the ability of financial institutions, including both MMFs and the banks, to withstand the storm.
This obviously would suggest a resurgence of security as the primary pillar of any cash investment strategy. However, the return of minimal or, in the case of euro, substantially negative, interest rates has increased the pressure to be creative in looking for the best return opportunities available out there.
The reality is that any organisation that does not think outside the box and put in place a more flexible and diversified treasury policy, is likely to significantly underperform compared to what is actually achievable with an actively managed investment strategy. And if more unexpected consequences of a COVID-19 world suddenly appear, the consequences for unprepared cash managers could be very serious indeed.
More proactive, more sophisticated?
“For many treasurers implementing a highly proactive, more sophisticated investment strategy is simply not feasible as they do not have enough resources, the required expertise or infrastructure, legal agreements or access to securities markets to make this happen,” says Meadows.
In many cases, he says there is also a perception that there is no need for a dynamic and diversified portfolio. If MMFs and deposits are good enough for the largest organisations, then they should be good enough for everyone. But the reality is actually very different from this.
This 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, with the remainder in mortgage backed securities.
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? It is of course for all the reasons he mentions above: 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,” says Meadows. “Given the current environment, it is no surprise that we have seen a number of emerging initiatives looking to ‘democratise’ access to new investment opportunities.”
One example of such an initiative is TreasurySpring, covered in Treasury Today last year. It has developed a solution to open up access to the bond and repo markets for organisations that simply could not do this for themselves, simply because few have (or would want to build) the infrastructure to execute their trade settlements.
In turbulent times such as we are experiencing at the moment, the only realistic way to ensure a dynamic balance between security, liquidity and yield is to implement a well-diversified portfolio of high quality products and counterparties, to guarantee the best chance of access to high quality liquidity.
However, for all the reasons mentioned, many organisations will not be able to do this for themselves in anything like a comprehensive manner, if at all. But, says Meadows, there are a lot of 'hidden gems’ out there by way of counterparties, as well as new product offerings.
Again, this is something the largest organisations can do for themselves as they have the resources with the expertise to maintain a deep understanding of the relevant markets and the counterparties in each. And again, because of these changing pressures, it is no surprise to see the emergence of platforms offering new forms of intermediation between investors and counterparties in selected markets.
Meadows points to FXD Capital (somewhat partisan, as he is a non-exec director) as looking to “redefine broking” in the deposits market by providing a direct, fully-disclosed money broking service for corporates looking for new high quality counterparties for their deposits. But he says the realm of ‘hidden gems’ also include highly-rated banks which are actively looking for cash, and hence offering good rates, but which are usually known only to experienced professionals in the relevant markets (including the largest treasuries of course!). “It’s clear that broader and deeper intelligence to an increasing range of markets, and ready access to them, will be essential to maintaining balance going forward,” says Meadows.
Joining the dots
The key to achieving the right portfolio balance is a treasury infrastructure that is properly joined up, from end to end, that supports the full range of treasury processes within an organisation. “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,” explains Meadows.
“But these processes should not just be internal; they need to also encompass external service providers where these are necessary to support access to the broadest possible portfolio,” he advises. “The new world will take us well beyond the stage when we can manage effectively with spreadsheets.”