Don’t let the so far empty threats of a rate rise lead to portfolio complacency.
Although the threat of rising rates has so far proved hollow, companies haven’t been lulled into complacency. Many have been diligently adjusting their portfolios to be ready for any eventuality. If your company has been lulled, however, here are a few ideas from the The NeuGroup’s Tech20 Treasurers’ Peer Group meeting, whose members were presented with strategies on how some of their corporate cash manager peers are investing and preparing their portfolios.
One key takeaway was to extend duration; that is, move out the curve 2 or 3 years. This strategy was suggested to those who felt that a rate rise will not happen before then. But members were told to weigh the risks and determine if the yield pick-up is worth it. Some in the group felt rates would rise sooner, with several indicating they were shortening now.
If rates do rise, treasurers should determine whether it’s because the economy is growing. That’s because if rates rise higher than 3 percent due to Fed tightening, and ahead of economic improvement, then the US, and possibly the global economy may suffer.
Another takeaway was to reconsider higher-rated bank along with the lower rated industrials. This is because bank recapitalization, capital regulation and stress-testing in the US have meant that banks have not been this well capitalized in a long time. They now are much less of a credit risk than they were in the aftermath of the crisis when the “BBB industrial beats a bank” thinking crystallized. Also going down the credit spectrum in industrials has the potential to expose companies to a lot of bond unfriendly actions, like LBOs. But even before that, companies may be subject to top-line growth stalling and ever increasing buybacks, which are not bond friendly.
Finally, the BBB-industrials trade is largely gone and you are just not getting compensated for the risk relative to higher-rated banks at this point.
Tech20 members were also urged to avoid treasuries. That’s because there just are not enough natural buyers to make up for the tapered Fed purchases. And balance sheet optimization by banks could make treasuries cheaper relative to credit than currently, but companies could find it difficult to get a bid when they want to sell.
As noted, the key for members looking to position their cash portfolios for rising rates is to set expectations for the first Fed rate hike and then determine the company’s risk appetite for being wrong. Of course, if the company has no risk appetite, the answer is easy: shorten up your portfolio now. But in setting one’s risk appetite, consider these scenarios: If you are wrong and rates rise sooner because the economy is doing better, you can consider that cash portfolio losses could well be offset by better top-line growth in the underlying business. If you are wrong and rates rise sooner than the economy should dictate, you may be in for worse problems than losses on your cash investments.