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Risk Management

Reassessing Risk as Fed Contemplates Rate Cuts

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July 03, 2019

By Antony Michels

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, looks poised to cut rates, a 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 cash remains overseas. That unsettled state of affairs came to light at the recent summit meeting of NeuGroup's Treasury Investment Mangers' Peer Groups, sponsored by HSBC Global Asset Management.

What is Your Appetite for Riskier AssetsNot hungry for risk. The lack of interest among most members in raising risk in their cash portfolios is clear in the 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 answering no changes).
  • 32% had tightened credit risk or plan to, but no one said they planned to increase it.

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 said that at a former company, he invested "in all that stuff," including mortgage-backed securities and collateralized mortgage obligations. Not now, though. He said, "I'd like to be able to sleep at night. 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 rate 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 subject 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 certain, 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.

How Much of Your Offshore Cash Have You Repatriated

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.

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