If corporate treasurers have seen the brighter side of the Federal Reserve’s anticipated hike of short-term rates as increasing cash investments, they may want to think again and instead consider more alternative investments for part of their portfolios.
That was the consensus of several professionals specializing in short-term investments that gave presentations during the “Cash Management 2015: Now What?” webinar that featured experts from StoneCastle Cash Management, Standard & Poor’s, Goldman Sachs Asset Management (GSAM) and Pimco.
A key factor maintaining ultra-low short-term rates in the foreseeable future will be investors shifting out of prime money market funds (MMFs) to MMFs that invest only in government bonds, which in turn will find a shortage of investable assets. Driving that shift will be the Securities and Exchange Commission’s new MMF rules becoming effective in October of next year, which imposes liquidity fees, redemption gates and a floating net-asset-value (NAV) for prime funds.
“With all these changes, there’s going to be more demand than supply,” said Jerome Schneider, head of Pimco’s short-term funding desk, adding, “What that ultimately translates to is very low T-bill yields, very low repurchase-agreement yields, and, generally speaking, investors will be searching for alternatives.”
Barry Weiss, asset strategist at S&P, said the spread between prime funds and government funds is likely to widen before the new requirements become effective next fall. However, that spread, along with investors’ growing accustomed to the new rules, will likely bring investors back to the prime market.
“We would expect a tipping point, where the yield provided by the prime funds along with some education—when investors see that the floating NAV doesn’t move as much as anticipated—entices people back to prime funds,” Mr. Weiss said. He added that it won’t be “necessarily to the level they are at currently, but at some point they’ll capture much of what they lost as we approached [the rule] implementation period.”
Even so, none of the panel members suggested MMFs would return to their former glory, when they made up 39 percent of corporate short-term-investment allocations in 2009, according to the Association of Financial Professional’s Liquidity Survey. MMFs’ percentage declined steadily after that, bottoming out at 16 percent in 2013 and 2014.
In addition to the new MMF rules, Basel III’s liquidity coverage ratio (LCR) requirements started going into effect earlier this year, prompting banks to take a closer look at their customers and shun certain types of uninsured deposits, such as non-operational deposits and those from financial institutions, said Brandon Semilof, managing director at StoneCastle Cash Management.
“Some clients may have experienced or will experience a drop in yield, and in some cases they may be told to move their deposits out of the bank,” Mr. Semilof said, adding that estimates suggest close to $1 trillion could be leaving MMFs and bank demand deposits.
At the same time companies are building record cash on their balance sheets, especially technology, healthcare and industrial sectors, prompting them to come up with a “Plan B,” utilizing alternatives. Mr. Semilof and panel participants from Pimco and Goldman Sachs each had suggestions on such alternatives, including their own products and services.
StoneCastle’s Federal Insured Cash Account (FICA) distributes deposits among its 600 well-capitalized participating banks, enabling up to $50 million of federal insurance per tax ID. Mr. Semiloff said yields range between 24 bps and 33 bps, noting there’s no market or credit risk, no term on deposits, and depositors have ownership in specific deposits. Deposits and their locations can be viewed in real time, and redemptions are on Mondays and Wednesdays.
Pimco’s Mr. Schneider said there won’t be much reprieve from ultra-low, short-term rates for some time, requiring treasurers to actively re-evaluate and manage their cash positions, under the auspices of their investment committees. Solutions will vary by company, favoring partnerships with an asset manager that has deep resources and experience in identifying and implementing the right approach, Schneider said. He added that one approach is to tier liquidity. For example, identifying bank deposits and MMFs for quickly accessible tier 1 liquidity, and extending beyond that, perhaps into longer term credit products such as high-yield for tier 2, less immediately available liquidity.
Separately managed accounts (SMAs) may also be a tool to build tiers, giving corporates the ability to customize the amounts and types of risk they’re willing to take. John Olivo, global head of short-duration strategies at GSAM, said the evolution of managing corporate liquidity typically starts with cash and cash equivalents, and then companies look to extend duration to increase yield. The introduction of credit products comes next, followed by securitized risk and higher beta strategies—companies with large balance sheets and experience managing multi-sector portfolios may even dip their toes into high-yield and emerging market debt, and bank loans.
“This speaks to the levers many corporates have used over the last few years to manage their liquidity and increase returns on their cash balances,” Mr. Olivo said.