Investment by category
Now we will look more closely at the three example cash categories we mentioned earlier and consider how they may be treated from an investment perspective. Individual companies will, of course, have different requirements and will identify and adapt the use of instruments to meet their own business challenges. It is imperative that all investment decisions are fully supported by judicious research and understanding of the counterparties, markets and investment instruments to be used.
Operating cash (short-term)
Liquidity and security is the key for any investment instrument involving operating cash, yield is a nice to have but not a must. As such, treasurers will tend to look to invest in overnight accounts, money market funds (MMFs) or other instruments that offer access to cash after a short-time period determined by when the cash is needed. These products typically offer a low, but steady yield. Investments in fixed income instruments are generally avoided when investing operating cash unless there is a highly liquid secondary market or extremely short maturity date.
As treasurers are acutely aware after the financial crisis, in order to limit the counterparty risk, diversification of funds is of great importance.
Reserve cash (medium-term)
When looking to invest its reserve, or core cash, treasurers can begin to look at some more exciting investment options, including reverse repos and short-term bond funds, as well as high quality corporate debt. All of the investments instruments listed under operating cash can also be used but treasurers can also look to seek more yield whist affording proper protection of the original sum invested in order to meet expected obligations. Since the financial crisis, security has been the primary requirement for this cash, with yield being second. Due to the medium-term nature of this cash, high liquidity is not of paramount importance. It is worth noting however, that this order may change depending on the risk appetite of the business and the market conditions it is operating in.
Strategic cash (long-term)
Finally, the strategic cash bucket is where treasurers have historically become more creative in their investments in the search for improved yield – but, accordingly, this will expose the cash to greater risk. The investment will have to ride greater volatility in the markets with a higher possibility of the cash principal being eroded. It is therefore important to ensure that investments can be maintained for the long term in order to overcome possible short-term turbulence in the markets. As with other cash categories, cash should be diversified across different instruments.
The treasury may invest in similar instruments that its reserve cash is invested in, but that return slightly higher yield. It may use instruments such as floating rate notes, or invest directly in equities – but the gain from these is generally achieved through investing for the very long term.
A tough environment
Whilst the above outlines how segmented cash might be invested in a perfect world, as treasurers are all too aware the current environment is far from ideal. It comes as little surprise to learn then, that, according to data from Bloomberg, European corporations were sitting on cash balances just short of €2 trillion in April 2014. This phenomenon is not restricted to Europe, however. Asian companies too have often been criticised for hoarding their cash and recent data has shown that Japanese corporates for example have around $3 trillion on their balance sheet. Thomson Reuters data also shows that China’s 500 biggest companies have $405 billion stockpiled.
For most companies, a large portion of this cash is being used as a liquidity buffer against external shocks, but many corporates are also struggling with the concept of low or even negative returns, as well as the impact regulatory change in the MMF sector. As such, the treasurer’s job is becoming increasingly difficult. And as market conditions continue to change, so will the parameters of corporate cash management – and the different requirements and priorities for investments. Regular reviews of cash and investment positions, exposures and policies are therefore recommended.