Where to invest short-term cash holdings in a global environment of low interest rates is a key concern for corporates. The amount of cash on the books of some companies is significant. For example, ratings agency Moody’s estimated that as of 30^th June 2013, Apple had cash holdings of $147 billion, a figure that accounted for nearly 10% of all corporate cash held by non-financial companies in the country.

The total of $1.45 trillion in cash stockpiles across the US was concentrated among 50 companies, including Microsoft, Google, Cisco Systems and Pfizer. Companies with the largest stockpiles of cash were from the technology sector, followed by the health care and pharmaceuticals industries. In Europe, according to research published by Standard & Poor’s in early 2013, non-financial companies have over €1 trillion on their balance sheet in cash and equivalents.

Bank deposits and money market funds (MMFs) tend to be the most popular venues for short-term cash investments for corporate treasurers. But unanswered questions regarding possible regulatory changes for MMFs and the prevailing low interest rates for bank deposits have boosted interest in separately managed accounts.

Separately managed accounts

First developed in the 1970s, separate accounts were designed to accommodate clients who needed to meet specific objectives that did not fit within the constrictions of a mutual fund investment. “More recently, there has been increased interest in separate accounts because there are a number of companies holding significant cash balances and they want better yields,” confirms Colin Cookson, Managing Director – Liquidity at Aviva Investors. “Also, there is some nervousness about which way regulators will go in terms of money market funds.”

US-based Money Management Institute (MMI) says the total separate account sector – retail and institutional – posted a 3% asset gain during the third quarter of 2013. Its SMA Advisory category recorded $11 billion in net flows, nearly doubling its $6.4 billion intake during the second quarter.

So what exactly is a separate account? A separately managed account offers a personalised approach to investing using a customised portfolio of securities owned by an individual or institutional investor. It is an individual managed investment account offered typically by an investment company through one of its brokers or financial consultants and managed by independent investment management firms (or money managers). Varying fee structures characterise the sector.

Separate accounts tend to be highly diversified and have a particular focus. However, unlike mutual funds the separate account portfolio manager buys individual stocks for his client’s account and not for a general fund. A corporate treasurer investing in a separate account will not be buying into a pool of assets, but will be buying – and owning – the individual assets.

MMF regulation

Money market funds hit their peak of popularity in January 2009, when total investments were estimated at $3.92 trillion. Enthusiasm has since cooled for this sector, with funds invested now estimated to be worth $2.6 trillion. It could cool further still as financial regulators seek to strengthen investor protection by increasing regulatory oversight of money market funds.

The Securities and Exchange Commission in the US laid out its plans in June 2013, which included a provision to require prime funds used by institutional investors to move to a floating net asset value (NAV) – at present shares are valued at $1 each. A second proposal would give fund boards for institutional and retail funds the authority to impose liquidity fees and redemption gates during times of stress. That would give funds the power to stop an outflow of investor money. European financial regulators are also tackling MMF regulation and in September 2013, the European Commission proposed a European framework designed for MMFs. But the final picture for regulation of MMFs is yet to emerge.

Interestingly, several recent surveys have found that total corporate assets in money market funds would fall by circa 60% if a floating NAV were introduced. Separate accounts are a likely beneficiary of such outflows.

Separately managed accounts can play an important role in a corporate treasurer’s short-term cash strategy because of the special benefits they offer, albeit at higher investment minimums. Because treasurers can customise these funds, individual financial goals can be better matched than in, say, a MMF. The features of professional money management are combined with the flexibility, control and transparency of owning individual securities.

In summary, a separately managed account is a portfolio of securities directly owned by the investor and managed according to specific parameters and/or style by a professional investment manager. Account owners have the ability to customise their accounts by excluding certain securities or industries.

While separate accounts have been popular in the US for the past 20 years, Jason Straker, Managing Director and Client Portfolio Manager for the short-term fixed income group at J.P. Morgan Asset Management, says a better understanding of the short-term markets among European treasurers and corporations is boosting interest in them in Europe at the moment.

“The credit crisis proved to be a lesson for many treasurers when it came to money market funds, which they had previously treated as a commodity,” says Straker. “Now treasurers are asking more questions of the securities in which they invest.” This greater understanding has led to an increase in the popularity of separate accounts. “One of the biggest benefits of separately managed accounts is customisation; we and other providers can offer a corporate treasurer complete customisation of the portfolio.”

Source: Cerulli Associates Managed Account Research Quarterly Summary. As of 31^st December 2012.

Says Aviva’s Cookson: “A treasurer can be very specific about the underwriting criteria used for the investments in a separate account, whereas in a MMF there is no direct control of the underwriting. A separate account’s underwriting criteria can match the treasurer’s risk/return objectives. For example, if you don’t need some cash for six months, the duration of the separate account can be tailored to meet that expectation.” They also offer greater transparency into the underlying assets in the fund, with more detailed reporting than is available with MMFs.

This customisation comes at a price; separate accounts are more complex to set up than MMFs and require lengthy discussion with investment managers about specific goals and requirements. Documentation and legal work is extensive and in addition to appointing a fund manager to undertake the fiduciary responsibilities of the fund, a corporate also has to appoint a custodian to safeguard the assets. Extensive due diligence of the fund manager and the custodian must be undertaken.

The treasurer will need to understand the risk/reward profile of all the instruments that the fund manager will invest into. He or she will also need to quiz the fund manager on their expertise; how long the manager has been managing separate account mandates; its track record and philosophy of investing cash; and how core separate accounts are to its overall activities.

Flexibility

Another benefit of using separate accounts is a greater potential to target higher returns or yield versus other off the shelf investments such as MMFs or bank deposits. MMFs are extremely liquid, but that liquidity comes at a cost, as between 20-40% can be held in overnight deposits. Some corporate treasurers question whether keeping large sums in overnight monies is a missed opportunity. With separate accounts, all of the liquidity belongs to the corporate and therefore the overnight proportion of liquidity can be reduced as required to suit the corporate’s cash requirements.

Flexibility is also apparent when it comes to the assets that make up a portfolio. A corporate’s individual view on investment types can be more accurately reflected in a separate account than in, say a MMF. For example, some companies are happy to invest in BBB-rated issuers, but MMFs do not allow such assets to be included in their portfolios. Straker points out that with credit ratings falling across the board, there are some very good BBB-rated issuers, particularly in the manufacturing and energy sectors.

By investing short-term cash into a separate account, a corporate treasurer can therefore gain greater diversification in their risk exposure. Because individual securities are owned by the corporate, there is full transparency of the portfolio of investments. This means that a corporate has more control in managing all of its investments and can ensure there are no overlaps.

Additionally, separate accounts enable positions to be exited very quickly. If the portfolio manager believes the market is due for a correction or wishes to exit a particular position, the necessary trade can be executed rapidly. Also, if investment circumstances change, for example if an acquisition or bond maturity is in the pipeline, the average maturity of the separate account can be changed to ensure the liquidity is available when required.

Suitability

While separate accounts have many benefits, they will not be suitable for all corporates. There is disagreement about the minimum investment required, however. Straker says companies turning to separate accounts tend to be in the very cash-rich sectors such as pharmaceuticals and technology. “Separate accounts aren’t suitable for companies whose cash balances fluctuate to a great extent. For example if a company has cash balances that go from 0 to 50 (million dollars) at any time, that level of uncertainty would mean it is unlikely you could invest in, and sell, securities very quickly. You’d be better off looking at a MMF.” Companies that can earmark a stable cash balance of around $50m or more should consider separate accounts.

Cookson disagrees, saying $50m is a ‘relatively small mandate’ for fund managers. The smaller the mandate, the less scope and flexibility there is for yield to be generated. “I believe a more realistic minimum balance for a separate account investment is about $100m. But the main question for a corporate treasurer is ‘do I have sufficient cash to use this approach?’.”

“We find many of our customers often link their liquidity and segregated accounts, using both elements to manage the different layers of cash,” says Cookson. “Balances in working capital and separate accounts can be linked and funds moved between the two as needed.”

Another advantage of separate accounts is that they enable corporates to generate yields better than those achievable in MMFs or bank deposits without having to employ internal resources to do so. Few corporates are in the position to be able to employ teams of credit analysts to manage cash. By choosing separate accounts, a corporate is outsourcing its credit process to an investment management company. The investment manager will use its expertise and understanding of markets to maintain the performance of the separate account portfolio. Corporates should choose managers they believe have good credit processes and sound underlying investment practices. This is why the due diligence process is so important.

Alternatives

As separate accounts become more popular, they will not be suitable for every corporate treasurer. The cash invested in separate accounts should be sourced from reserves that are not required on a daily basis (such as working capital balances). Rather, the funds should be those that can be spared for a year or more. Other options for investing cash include bank term deposits of one month or greater. These are very simple investments to set up, but there is a significant counterparty risk of placing unsecured funds with a single counterparty.

Exchange traded funds are also becoming more popular for corporate treasurers, although their growth in Europe is not matching that of separate accounts. These funds tend to be used by extremely large corporates in combination with their cash investments. However, knowledge and experience in trading securities on stock exchanges is a prerequisite.

Separate accounts at a glance

Advantages

Customisation.

Treasurers can select the parameters for their investments and specify a risk-reward profile that suits their requirements.

Potential to earn higher yield.

Separate accounts can enable the generation of improved yields when compared with MMFs or bank deposits.

Flexibility and control.

If investment circumstances change, the investment guidelines can be rapidly changed to reflect this and keep in line with the treasurer’s goals.

Transparency.

Assets within the fund are owned directly by the corporate, giving full transparency of the securities within the portfolio.

Disadvantages

Set-up.

Separate accounts require detailed guidelines, documentation and legal agreements, along with the appointment of fund managers and custodians.

Understanding.

Treasurers require a high level of understanding of the risks and rewards associated with each type of security in order that they can agree the investment guidelines for their portfolio.

Minimum investment.

A higher minimum is typically required when compared to MMFs.

Loss of liquidity.

In comparison to a MMF the corporate’s money may be tied up for a minimum period of time rather than being available on a same day access basis (one of the major benefits of a pooled MMF).

Fees.

Separate accounts attract higher fees than MMFs.