Treasurers investing cash are likely to face a slow-growth global economy and the corresponding low returns for the foreseeable future.
The BlackRock-sponsored TIMPG meeting in October focused, not unexpectedly, on current investment issues, with investment alternatives and liquidity taking up much of the discussion. Sessions also covered the global macro and markets overview as well as how to hire and fire investment managers.
1) A future without demand. BlackRock Chairman and CEO Larry Fink explained the factors behind his view of a slow-growth global economy for the foreseeable future, both in the US and abroad, including China. At least the US has cheap energy.
2) Floating NAV, the lesser evil. Regulatory guidance clarifying that floating net asset value (NAV) funds will be considered cash equivalents has made liquidity fees and gates the bigger impediments to investing in money market funds.
3) Liquidity challenges. Traditional bond market liquidity is more likely to worsen than return to previous levels, so treasuries must look to electronic markets and other new and growing sources of liquidity. Standardizing bond terms may be another solution, especially for more-liquid bond tranches.
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Peer to Peer Questions
These issues were brought up by members during the open forum.
- How to discuss loss positions with top management. Feedback included placing a “memo in the file” that notes the allocation, cost, unrealized gains or losses, and other key metrics, showing for the record that treasury is aware of the situation and is monitoring it.
- One custodial bank recently scrutinized custodial clients’ accounts and has pressured them to lower the cash held there, in at least one case to hold none at all. It has appeared to back off the more extreme stance, but members agreed that the amount of cash that can be held at custodians will be a lot less. Another member had heard that the US Treasury department was suggesting custodians charge a 100-basis-point premium for additional cash deposits.
- The benefits from using “unconstrained” funds, which provide managers with significantly more discretion in terms of investment types and durations and typically are not measured against a benchmark, remains an open question among peer-group members.
Heightened volatility means treasury executives are likely going to have to explain more losses to their boards, if only to cover their buttocks. Leaving cash at custodians, even for relatively short periods, is likely to become more expensive.
Cash Investing Post-Regulatory Reform
A substantial portion of money market fund (MMF) reform goes into effect next fall, and peer-group members are exploring alternatives, given the anticipated shortages of investments in now-liquid markets. BlackRock executives covered issues including MMF market dynamics and risks, assessing the new floating net asset value (FNAV), gates and fees, and emerging products.
Key Takeaways
1) Portfolio changes bubbling. The NeuGroup’s pre-meeting survey revealed that 38 percent of respondents are considering switching to government-only MMFs, 10 percent to separate accounts, and a third to “other.” Nearly 20 percent are not concerned about regulatory changes. A majority said they do not anticipate changing their investment policies due to new regs, and those that do anticipate changes by 2Q 2016.
2) The big switch. Upwards of $200 billion of prime funds has converted to government-only funds, with more transfers anticipated from both institutional funds and investors. “There’s going to be a lot of demand and not enough supply to go around,” said Richard Hoerner, Co-Head of Global Cash Management Business at BlackRock, which has stated its commitment to prime funds. It is repurposing one fund to be a short-maturity prime fund with a seven-day maximum maturity, providing a few extra basis points but avoiding the new FNAV and gates and fees requirements.
3) Missing teeth. If a money market fund’s minimum level of weekly liquid assets falls below 30 percent, company boards can implement a liquidity fee of up to 2 percent and also declare a gate of up to 10 days within each 90-day period. If the level falls below 10 percent, a liquidity fee of at least 1 percent is “required,” at the board’s discretion. Nevertheless, no board will want to publicly announce liquidity has dropped below a threshold and post that information on its website, BlackRock executives said. In any case, recent history suggests dropping below the 30 percent level is rare.
4) It floats, but just barely. The new FNAV will be measured out four decimal places. However, going back to 2002, and despite major market upsets in between, the floating NAV of one of BlackRock’s large prime funds barely budged. “The marked-to-market NAV was actually stable for most of the time in that 13-year window, and when it did move it was only by one basis point 98 percent of the time,” said Thomas Kolimago, Co-Head of Cash Portfolio Management at BlackRock.
Outlook
With inflation anticipated to remain low and the Fed only gradually raising rates, and with new capital requirements prompting banks to reduce corporate deposits, companies must search for investment alternatives. Despite concerns about the float NAV, BlackRock’s experience suggests floating NAVs remain very stable.
Global Macro and Markets Overview
Overcapacity in China will weigh on demand there for some time to come, pressuring economic growth and weighing on the country’s transition to a service economy, according to Peter Fisher, a BlackRock executive who served at the Federal Reserve and Treasury. Fisher criticized the low-rate “morphine” prescribed by many economists and emphasized the need for more investment in developed economies. In terms of US rate hikes, the actual timing is less important because the Fed has telegraphed its intent to raise rates very gradually. BlackRock fixed-income strategist Shayan Hussein said the asset manager has exercised caution across its investment platform and generally favors credit. Corporates shouldn’t shy away from BBB credits, which provide significant excess return over single-A credits with just 20% more volatility.
Addressing Market Liquidity
Fixed-income market structure is rapidly changing, partly due to new regulations prompting market makers to pare down inventories, and because brokers don’t want to return to excesses that led to the financial crisis. Electronic markets may create new liquidity, as could ETFs.
Key Takeaways
1) The times they are a-changing. Regulatory pressures have shrunk dealers’ bond inventories, pushing them to support trades on an agency basis. Electronic trading is picking up steam, similar to the equity market a decade ago. Trade size is falling and the frequency of transactions is increasing. “The days I could pick up the phone and move $100 million in a tight spread are gone,” said Ben Golub, Senior Managing Director and Chief Risk Officer at BlackRock.
2) New liquidity or just faster? Electronic trading is approaching 20 percent of overall bond trading volume, led by MarketAccess. Kashif Riaz, Managing Director, Global Capital Markets, at BlackRock, said that simply shifting the bilateral OTC market to electronic form can enhance productivity and efficiency. To create new liquidity, however, trading protocols must change; all-to-all protocol that places everyone in the same pool and indicates when positions are available for sale may be one answer. “In an all-to-all system, where buyers and sellers can see and trade more easily, and a bigger pool is being explored, there’s greater potential for liquidity to be improved,” Riaz said.
3) Reining in the bond market. Bond market issuers and investors have each sought to satisfy their very specific credit needs with each issue, resulting in a highly fragmented market and the resulting liquidity challenges. BlackRock has looked into the notion of standardizing the issuance framework, and it found fragmentation could be reduced by big issuers with more liquid bonds issuing in a more standardized format and with fewer nonsubstitutable tranches. Standardized coupons and dates to match those used in the derivative markets could ease hedging costs. Other findings:
- More standardized terms could push bonds onto exchanges or other trading venues, migrating liquid securities away from dealers and freeing up their balanced sheets, potentially improving their liquidity supporting the next tier of issuers.
- Empirical evidence may be lacking, but increased standardization should benefit corporate issuers because a more liquid security should lower the new issue premium and the absolute credit spread
- Given the adverse impact of tighter spreads on brokers’ profits, banks have pushed back, concerned that standardizing bonds could concentrate maturities and increase risk.
4) Will all that debt get refinanced? Record bond issuance by corporates after the financial crisis stretched maturities at historically low rates and lowered the cost of capital, prompting M&A and additional issuance, and more recently supporting heightened share repurchases. Will companies refinance that debt? History shows they will, since their financing needs grow alongside revenues, and the M&A cycle is likely to continue.
Outlook
Life has gotten more complicated for asset managers as the bond market becomes less liquid in the wake of new regulations. Adapting will include using the growing electronic bond trading venues and perhaps considering more standardized bond terms and the new risks that may involve. Issuers should find plenty of demand for new issues in the foreseeable future.
Risk Management – Metrics for Managing and Monitoring Portfolio Risk
One member practitioner, looking for a solution to manage trapped cash, polled the group to see what solutions members were using. His company’s current one-solution system is troublesome for monitoring compliance. “We’ve been putting it into TMS, but this is not great for monitoring compliance,” he noted. Another group member noted that the local managers currently invest in TMS/ERP, but haven’t found a very good way; if they do not have locals on the ground they have five service centers that will handle it. The previous employer of one practitioner used SharePoint, and this worked pretty well. Another member company has trapped cash in China and uses a JP Morgan money market fund. The BlackRock EUR money market fund used by one practitioner’s company just went negative last week, and this fund is expected to continue to move negative depending on flows. BlackRock does have a less negative option, an asset fund as opposed to a liquidity fund. The downside to an asset fund is that diversification is lower. The fund only holds 20-30 names. Unfortunately the best EUR solution at the table was the “least negative.” Deutsche Bank has a EUR Money Market Fund with a floor, but this is not a 2a-7 fund, and members expressed some reservations about it.
Best-In-Class Manager
As corporate treasuries seek to diversify their investment strategies, finding top-notch managers has become ever more important. Also key is matching portfolio managers (PMs) to a company’s portfolio needs, searching for best-in-class managers, and then perhaps the most difficult task of all: getting rid of an underperforming investment manager.
Key Takeaways
1) You’re fired! The NeuGroup’s TIMPG 2015 fall pre-meeting survey found 76 percent of responding participants have a formal RFP process for hiring investment managers. The same percentage, however, does not have a formal process for terminating them.
2) Setting the stage. One member walked the peer group through his company’s process for choosing and retaining managers that meet the company’s portfolio needs. First is determining the portfolio’s target allocation. Treasury uses Bloomberg data to look at the expected return vs. risk, using a three-year standard deviation, and then it measures the impact in terms of EPS to determine, in conjunction with the CFO and treasurer, whether a policy change is appropriate.
3) Exploring alternatives. The company’s treasury team explored several investment alternatives to its current three-way, equal split between high quality ABS and agency MBS, treasury and agency bonds, and financial and corporate bonds. The alternatives included high-yield, emerging market debt, and buying ETFs and selling options to collect the premiums. Ultimately, the board decided to liquidate the entire portfolio and repurchase shares. Repatriating all the company’s cash can be a good way to terminate managers, the treasurer said wryly.
4) Honesty is everything. The company has no hard and fast rules for firing managers, and has never done so, but striking out three quarters in a row, or no longer communicating in a timely way, could be the final straw. A second peer-group member said his company has fired 29 managers over the last five years, and they are told directly when it’s due to performance. A poor performer is discussed at the board level, when treasury may recommend giving six months to turn things around. “If you’re honest about their performance, they’re less likely to come back half a year later trying to get back on the platform,” the company’s treasurer said, adding a few compliance violations and poor communication can be overlooked if performance is strong.
5) RFP strategies. One member said she asked the rep of a prospective manager whether they used Intex models to value ABS. Using that vendor wasn’t necessary, but the question left the rep confused—bad sign, she said. Another member received applause for his advice: Ask managers for their entire RFP template, to compare what different ones emphasize. “By saying just send us everything, they have no ability to understand what we’re looking for, besides what we tell them. But we can get an idea of what their organization’s strengths are,” he said.
Outlook
Corporates’ search for alternative investments means finding new managers in sometimes unfamiliar sectors, and invariably firing the ones that don’t work out.
Conclusion
Despite their efforts to paint a rosier picture, the top BlackRock executives addressing the group, Larry Fink and Peter Fisher, ultimately described a future of slow economic growth globally, and plenty of challenges in between. Among those challenges they included China attempting to shift to a service economy, and the developed economies trying to reconcile fighting deflationary pressures with ultra-low-interest rates and the harm they can inflict. Low rates combined with regulatory reforms impacting MMFs and banks’ capital requirements add another layer of complexity, and corporates will have to rethink their investment asset allocations. Moving to alternative asset classes will require either more manpower or more technology. The changes have also resulted in liquidity challenges as market makers reduce their inventories of securities, requiring corporate asset managers to familiarize themselves with new trading arenas, such as electronic trading venues.