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Meeting Summary

Key Takeaways from the Treasury Investment Managers’ Peer Groups Summit 2019 H1

November 07, 2019
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TIMPG and TIMPG2 members discussed their risk tolerance and the outlook for interest rates, the fact that they don't necessarily have to sacrifice returns to create an ESG-friendly portfolio, and more at the TIMPG Summit in New York. 

TIMPG 2019Attention ESG Skeptics: You Don't Have to Sacrifice Returns

Analyzing ESG factors with credit fundamentals for competitive returns. 

“How much of our cash is invested in sustainable investments?” If you’re responsible for investing your company’s cash balances and haven’t already been asked that question by a C-suite executive or board member, get ready—you will.

The skeptical response. Some NeuGroup members facing this question remain skeptical about adding environmental, social and governance (ESG) criteria to their investment policies. Some of this skepticism surfaced at the recent Treasury Investment Managers’ Peer Group summit sponsored and hosted by HSBC Global Asset Management, where more than one participant said, “I am not going to give up returns” just to have an ESG-friendly portfolio. Fair enough.

You don’t have to give up returns. The good news takeaway from HSBC’s presentation on ESG is that corporate investors don’t necessarily have to sacrifice expected returns or yield when creating more sustainable portfolios. HSBC created a hypothetical ESG portfolio with sector and industry weightings, overall credit ratings and duration comparable to an investment-grade benchmark. As the table shows, this sample ESG portfolio matched the benchmark’s yield with an ESG score that was 1.5 points higher than the benchmark. The theoretical portfolio did not have to sacrifice returns to achieve a higher ESG score (in fact, it actually picked up a few basis points) while limiting the exposure to ESG-related financial risks.

ESG analysis. The framework for creating the HSBC portfolio depends partly on scoring an industry and companies in that industry on all three ESG components (where E+S+G=ESG). As the relevance of ESG factors varies in different industries and subindustries, weightings are assigned to each component accordingly. HSBC’s overall scores for the banking industry, for example, will emphasize governance issues (55% of its ESG weighting) over environmental considerations (≈ 10%). For automotive companies, by contrast, HSBC uses a 50% weighting for the environmental factor. Company ESG scoring is evaluated in the context of its industry sector.

So who provides these ESG scores?

Many providers publish ESG ratings and scores, including Standard & Poor’s, Sustainalytics, MSCI, Bloomberg and Refinitiv. The scoring and methodologies vary across providers. A recent report from State Street Global Advisors said, “The lack of standardization and transparency in ESG reporting and scoring presents major challenges for investors.” HSBC uses multiple ESG scoring sources in addition to proprietary quantitative and qualitative data in analyzing issuers to determine HSBC’s final ESG score and investment decision.

Tail-risk benefit. Ratings agencies and credit analysts alike are paying increasing attention to issuer ESG profiles and incorporating material ESG issues in their assessment of creditworthiness. In this way, corporate cash investors can already benefit from increased awareness of the tail risks posed by ESG factors. And while some may be content to enjoy this “free lunch,” others are now considering adding ESG criteria to their investment policy menu.

Portfolio Benchmark Characteristics

Reassessing Risk as the Fed Contemplates Rate Cuts

Many—but not all—corporate cash investors remain risk-averse amid shifts in interest-rate outlook, repatriation flows.

Investing short-duration cash isn’t getting any easier. The Federal Reserve, amid an inverted Treasury yield curve, has continued to cut rates. That pivot that comes as some corporate cash investors try to put excess cash to work following post-tax reform repatriation, while others can’t achieve a steady state because a lot of their cash remains overseas. That unsettled state of affairs came to light at the recent summit meeting of NeuGroup’s Treasury Investment Managers’ Peer Groups.

Not hungry for risk. The lack of interest among most members in raising risk in their cash portfolios is clear in results from the pre-meeting survey:

  • 59% characterized their appetite for riskier assets as low, with 35% saying it was moderate.
  • 37% reduced or plan to reduce duration in their domestic cash portfolios, the most common of any portfolio change (and matching the percentage who said they plan no changes).
  • 32% had tightened credit risk or planned to; no one said they planned to increase it.

What's Your Appetite for Riskier Assets Sleep tight. Explaining the risk-averse stance, one member said that “back in the day,” before the financial crisis, he and other cash investors embraced riskier assets and said, “Let’s go for the return.” He says at a former company, he invested “in all that stuff,” including mortgage-backed securities and collateralized mortgage obligations. Not now, though. “I’d like to be able to sleep at night,” the member said. “We’re rewarded to make sure the money is there when you need it.”

Interest in re-risking. Another member—an outlier—is interested in adding more risk to his company’s portfolio and asked, “What opportunities does this group see outside of cash? Is anyone putting on risk?” He said he likes “low-vol structured products,” including high-grade, asset-backed autos. And he said, “ABS shouldn’t be a four-letter word.”

The duration equation. One member of the group said that with corporate credit interest-rate curves essentially flat out to three years, there is “minimal incentive” to own longer maturities. “We have been shortening the duration of our corporate cash program for more than two years. I would expect that to continue until the curve steepens,” he said. He is sticking with his belief that rates are heading higher—admitting “we’ve been consistently wrong’’—meaning he doesn’t want to own, say, long bonds. In the meantime, he likes non-investment-grade floating-rate bank loans, held in separate accounts run by external managers.

A steeper curve? Another participant is betting the curve will in fact steepen “because we think the Fed will be forced to cut rates in 2019 because data will deteriorate from Q1 onwards.” As a result, the company’s interest-rate portfolio is “trading long vs. benchmark duration” and he’s “doing due diligence on adding risk back into the portfolio in various ways, but in order to do that we would have to revisit our benchmark, because that is our guiding star.”

One member captured the difficulty of forecasting in the present moment, saying, “I am very mixed on the view of a steepening yield curve. The only way I can see the yield curve steepening is if the Fed cuts rates significantly and the mid/long end stays where it’s at. What we have seen so far is the entire curve shifting down, with the long end moving much lower, more than the short end.”

Repatriation complications. Risk questions raised by the rate environment are made more complicated by the lingering effects of US tax reform. Leading up to reform, many corporates shortened duration so positions could roll off, or mature, before they repatriated cash to onshore entities; some are still waiting for the roll-off and others are leaving cash in better-yielding dollar funds offshore. Those that have repatriated cash are expecting that to be allocated out of the strategic cash portfolio, so short and liquid is the mandate. All this made even more sense when short-term rates were climbing; now that they’re not, cash investors are subjecting themselves to second-guessing.

One member who said “we have too much money to run our business” now that cash is back onshore is trying to figure out “what do to with excess cash” that senior management ultimately wants to spend on acquisitions or give back to shareholders. “We’re going to spend it,” the member said. “It’s a question of when or where.” But this much is sure, he said: “We need more liquidity in order to support the business needs/changes. That means less risky investments, more short-term liquidity and more internal management of that cash.”

Offshore-to-onshore dividends. Another member whose company’s offshore cash balances have largely been repatriated is now focused on repatriating ongoing and future cash flows as part of a quarterly offshore-to-onshore dividend strategy that “requires a greater level of liquidity.” To offset the lower yield on the offshore liquidity balances, the company is using a diversified pool of liquidity investments that include prime funds (offshore only), interest-bearing bank deposits and A2/P2 commercial paper.

Repatriation: Unfinished business. In a live poll, nearly one-third (30%) of meeting participants said their companies had repatriated less than a quarter of the cash they hold offshore. And 45% of attendees have yet to repatriate as much as half the cash held overseas, one reason many corporate cash investors are in a holding pattern when it comes to achieving a steady state. One member whose company has brought back billions in overseas cash says the question now is “how much should we hold,” adding, “At some point we have to have a strategy.” But until more companies have brought back more overseas cash—and while the yield curve remains flat—many cash investors are unlikely to add much, if any, credit or duration risk to short-term portfolios.

How Much of Your Offshore Cash Have You Repatriated?A Guide to Managing Investment Portfolios In-House

Corporate cash investors grapple with how to balance in-house investing with external managers.

US tax reform enacted at the end of 2017 led to a reduction of cash balances at many companies that repatriated and put to use cash once trapped overseas. In anticipation of repatriation and because of a flattening yield curve, many companies also shortened the duration of their cash portfolios. All this has prompted some corporate cash investors to reduce their use of external asset managers.

How much to manage in-house? There’s no one-size-fits-all answer to the question of what percentage of cash a multinational corporation should manage in-house and what to leave to professional asset managers. But at the TIMPG summit, the host and sponsor, HSBC Global Asset Management, offered some guidelines to frame a discussion on how companies might approach the question and strike the right balance.

Seven key components. HSBC identified typical asset manager roles, responsibilities and resources that form an operational structure with the aim of delivering investment outcomes that can be highly specialized and that are transparent and minimize risk:

  1.   Credit analysts
  2.   Portfolio managers
  3.   Traders
  4.   Operations
  5.   Performance measurement
  6.   Compliance
  7.   Risk

HSBC said that some of these resources could be combined when creating a framework for in-house portfolio management—depending on the complexity of the investment objectives and the risks. For example, portfolio managers could place trades, and the operations and settlement roles could partner with monitoring/compliance and performance and reporting roles. Along with credit research and risk oversight, this leaves four key teams.

Calculate the costs. HSBC breaks down the costs of a “start-up” investment team into these categories:

  • Direct/operating. This includes head count (PM, credit analyst, operations lead), a Bloomberg terminal, benchmark data, a portfolio management system and credit rating agency research.
  • Indirect. Trading and settlement errors fall under this heading.
  • Opportunity. This cost includes any underperformance vs. the benchmark or the comparable external manager, and the loss of an external manager’s market knowledge and thought leadership.

Rule-of-thumb estimate. To break even, according to HSBC’s estimates and assumptions, corporates should have a good $1.5 billion of investable assets to make managing cash in-house worthwhile. The formula may be calculated roughly as: break-even assets under management (x) = $1.5 million (annual direct costs of in-house operation)/10 basis points cost of external manager.

Soft factors. But it’s not just math that dictates why corporates may want to manage some portion of their cash in-house. There are also soft issues, like the opportunity to develop investing skills and market knowledge among treasury team members to prepare employees for career growth down the line.

How to build a short-term portfolio. In a separate session, an HSBC portfolio manager walked through some of the building blocks for an effective short-duration portfolio. Among the questions to consider:

  1.   Can it deliver cash when needed?
  2.   What index will it be measured against?
  3.   What is an acceptable level of volatility?

The presenter observed that:

  • While longer-duration portfolios almost always outperform, the portfolio has to meet the investor’s risk management (tolerance) levels, as well as its liquidity needs.
  • In an inverted curve environment, floating-rate notes can be helpful as they have a good yield, but low duration.
  • Not buying financial institutions can have negative consequences: Missing higher-yielding opportunities and overweighting other sectors.

Bottom line. During breakout sessions, groups of members constructed hypothetical portfolios, most taking a tiered approach to risk and using a range of products including commercial paper, CDs, time deposits, government securities, agency debt and investment-grade corporate debt. But answers to the question of how much cash should be managed in-house vs. externally remained elusive. However, this general rule may be reasonable: The shorter and safer your investments, the more you can afford to manage them internally; if you are looking a little further along the risk spectrum, the in-house management options decrease in value and the benefits of multiple outside managers increase.

Weak Appetite for Prime Money Market Funds

Many corporate cash investors say that in their book, it’s still not prime time for prime funds. 

Despite the search for yield in almost all sectors of the fixed-income markets, demand for prime money market funds seems quite tepid among corporate cash investors. That was the takeaway, at least, from comments made this spring at the Treasury Investment Managers’ Peer Group (TIMPG) summit meeting.

Prime, but not necessarily stable. Just as a refresher, significant money market reform after the financial crisis pushed many corporates out of prime funds, which invest in corporate debt, and into government funds. That exodus began in 2015 after the Securities and Exchange Commission announced it would implement money market fund regulations in 2016 that included liquidity fees and gates for prime funds, along with floating net asset values (NAVs). That meant that while US government money market funds maintain a stable $1 per share value, prime money market funds can occasionally “break the buck.”

Not prime time. While some managers returned to prime funds as rates rose in 2018, others don’t see the value. “Liquidity is so unpredictable,” said one summit participant. “In the event of a shock, I may have to take a realized gain or loss; I don’t think it’s worth the risk.” Another member said if he decides to take more liquidity risk, he’ll do it with something that yields far more than prime funds. A third cash manager seemed to speak for several in saying, “It’s still too early.” That suggests that some investors want to see more data on how the NAV of prime funds moves in different markets, including when credit spreads are under significant pressure because of fears of a recession.

What’s next? Treasury investment managers’ search for yield will likely continue, but the rise in short-term rates from above 0% has most likely reduced the need to reach for the extra yield prime funds might deliver. Also, some investors want to avoid being first movers back into prime funds. That’s understandable, as the consequences of a decline in the fund’s price is probably higher than the rewards of earning a few extra basis points in yield, especially for companies where liquidity is an institutional imperative. It may also simply be that the treasury investment managers remember the lessons learned from the financial crisis and are not about forget them.

Weighing Opportunities and Risks in Chinese Money Market Funds

Rates that beat bank deposits attract corporate cash managers, while a bank seizure raises broader questions.

Corporate cash investors at multinational corporations with operations in Asia are one reason the country’s money market fund industry is now the world’s third largest, with $1.2 trillion in assets, behind the US and Europe. In a live poll at the TIMPG spring summit meeting in New York, 70% of participants said they invest excess cash in both China and India, the world’s fastest-growing major economies.

Higher yield, lower tax. In a session on cash investing outside of primary markets, HSBC presented some of the advantages of investing in Chinese money market funds. They include yields that beat bank deposits:

  • Money market fund: 2.59%. That’s an average yield, as of March 31, based on three triple-A RMB money market funds: HSBC’s Jintrust; CIFM, through JP Morgan; and Harvest Prime Liquidity, through Deutsche Bank.
  • Bank deposit: 1.59%. That’s a one-year rate based on the People’s Bank of China (PBOC) guidelines.
  • Dividend income from money market funds is tax-free for corporations. There is a 25% income tax on bank deposits and other liquidity instruments.

Money market disruption. About a month after the TIMPG summit, Chinese regulators took over a small, struggling bank called Baoshang, creating shock waves across the financial sector. The event sent rates in China’s bond repurchase-agreement (repo) market spiking in mid-June, although they fell back late in the month. Like their US counterparts, Chinese money market funds invest in repos along with other assets.

According to the Wall Street Journal, “Some market participants say the recent funding stress briefly triggered memories of a severe liquidity crunch about six years ago. Back then, a funding squeeze caused by banks hoarding cash pushed repo rates above 10%, forcing the central bank to inject large amounts of liquidity into the markets.”

Limited impact. For its part, HSBC has not seen volatility from outflows from its Chinese money market fund, but managing interest rates has been more challenging. The bank had no exposure to Baoshang. More broadly, Caixin Global reported that mutual funds’ exposure to Baoshang is likely limited, noting, “Money market funds have also been constrained by regulations restricting their holding of assets from institutions rated below AAA—Baoshang Bank was rated AA+.”