With an uncertain era of MMFs approaching, many companies are moving to separate accounts. But what does the process involve?
There is a lot of news lately about the coming new world of money market funds – the mix of variable and fixed net asset value regime, gates and fees, and other requirements. With that uncertainty, companies have been exploring alternatives to MMFs, including moving to separately managed accounts.
On a Goldman Sachs Asset Management-hosted panel earlier this year, the NeuGroup and several corporate treasury practitioners discussed some of the issues and challenges companies face in creating an SMA.
Many drivers
There are many factors companies consider when deciding to move cash from MMF. For separate accounts, factors include the flexibility offered as well as the size of the pool of assets that, say, are outgrowing an MMF. The downside is that they offer slightly less liquidity. For many companies, a separate account balance represents the carved out surplus cash of the company. This cash previously may have been wholly invested in an MMF and now, for regulatory reasons and to get some incremental yield it is going into an SMA. This doesn’t mean all the cash exits the MMF; there will be some left behind for the cash needed for daily needs of the company. The strategic cash can be invested in a separate account that has safety but offers yield, according to Goldman Sachs Asset Management and NeuGroup panel discussion.
The next logical step, if the company lacks expertise for internal management, is to look for an asset manager with whom to partner.
Stakeholders
The panel also discussed who in the organization owned the decisions related to separate account managers, including the decision to transfer assets to the account. Prior to the panel discussion, The NeuGroup polled its Treasury Investment Managers’ Peer Group (TIMPG) asking who the decision maker is at their organization to make the final decision on separate accounts.
The survey revealed that the CFO was the most cited final decision maker, followed closely by the treasurer. However, in most cases treasury leads the decision process and makes recommendations. The panel also stressed that is also very important to have accounting and tax involved with this decision.
Information from investment managers
The panelists all agreed that the managers offer great advice when setting up separate accounts. For example one panelist unfamiliar with impairment issues leaned on the company’s asset managers to walk the treasury team through the accounting mechanics. Those considering moving to an SMA should note that when investing only in money market funds, the accounting, while limited, is often provided. Moving to a separate account means the company now has to handle the accounting.
Picking an SMA provider
For many cash-rich corporations, the separate account management selection starts with the banking relationships. One of the corporate panelists noted that they started with the banking group first, but listened to others. Using asset managers outside the company’s banking group would require very compelling reasons. Word-of-mouth is a very common manner for corporations to get a list of managers to interview.
The other corporate panelist used referrals to build a list of asset managers to use. Panelist Barbara Shegog of The NeuGroup noted that members within the TIMPG groups are a great source of referrals for each other. Once the decisions are made the panelists recommend keeping a short list of managers as liquidity profiles can change quickly.
What is the selection process?
Important criteria for a request for proposal (RFP) includes size of investment business, peer referrals and experiences, returns over time, and also some data points on mandates performance vs other mandates. Also important is the credit research and analytics. Ms. Shegog explained that for TIMPG members, how much the asset managers understand the nuances of separate account management is critical to their selection. Operationally providing accounting services is a plus.
Determine the number of managers
There are no hard and fast rules for determining the number of asset managers used or the size of separate accounts they manage. What are you comfortable with? What feels right based on economics?
Three to four managers seems to be the sweet spot for the right number of managers. This will give investors some diversification and yet not make the job of managing the managers too cumbersome. For some investors, the amount they are willing to outsource to a manager is a set dollar amount with, for example, $1bn to $1.5bn the total amount to each manager regardless of the size of the portfolio. Once you hire more than two or three managers, the economies of scale will disappear, as many asset managers provide a sliding fee schedule.
Important investment guideline components
The panel decided that the following are the most important components of the investment policy:
- Capital preservation
- Risk tolerances
- Liquidity
- Yield
Each corporation must decide what their comfort level is around rating, kinds of securities, and then what percentage to allow in each security type. The asset manager can also share ideas on what is not currently in the investment policy. One piece of the investment policy that is often overlooked is the operational side of the investment program. The investment guidelines should address controls and responsibilities. Included in the document should be delegating authority to treasury (or another group) to make investment decisions. The panel noted that they appreciate comments from the asset managers with suggestions on what to improve.
Gold standard of client service
Ongoing client service is a necessity for the separate accounts. A portfolio review is expected at least quarterly through a conference call and at least an annual visit in person. Corporations expect to learn what is going on with the portfolio, what is working and what is not. Each corporation will have different needs, some more or less frequent contact. Most likely each corporation will have different reporting requirements, making it difficult for the asset manager to produce any type of standardized reporting. The panelists all agreed that they expect to hear from the asset manager on any type of negative credit event, especially if the event triggered a compliance violation. As an aside to the managers, given the significance of a credit event, those on the panel stressed that they expect to be notified with a portfolio manager on the call.
Monitoring asset manager performance
Given the nature of the separate accounts, the guidelines and gain/loss constraints, and measuring performance is not as simple as comparing investment returns to a benchmark. As a result, corporations have gotten creative to accurately gauge investment results. One of the panelists created a “score card,” including both qualitative and quantitative metrics. Some of the metrics they use is total return, Sharpe ratio and then more subjective metrics such as a rating for client service. The NeuGroup’s Ms. Shegog outlined that many members of the TIMPG have several managers and create a ranking among the managers and put the managers in competition against one another.
Separate account outlook
In the next few years, separate account management is expected to grow. The combination of money market fund reform and search for yield makes shifting out of money market funds attractive for cash rich corporations,” noted panelist Barbara Shegog. The other panelists agreed with this assessment.
Corporate cash balances are very high and growing; investors will need somewhere to invest.