How do you measure liquidity risk, perhaps one of the biggest investment risks lately, and how do you manage what you cannot measure? At a May meeting of The NeuGroup’s Treasury Investment Managers’ Peer Group (TIMPG), members discussed how liquidity will be impacted by recent regulations and how to start to evaluate this risk.
One of several takeaways from the liquidity risk session was the investment managers should have a clear outline of what they want to measure. One member began the discussion by outlining how his company measures risk and it manages it. They measure three components: liquidity, interest rate, and credit risk. This company is focused on science and patients and as a result focused on liquidity needs; it has also experienced tremendous growth.
This company also uses a top-down approach to cash forecasting, which can be used to manage liquidity risk. Cash forecasting is used to see how much liquidity is needed. The company’s business is R&D-intensive, so it reviews near-term liquidity requirements as well as a cash-flow forecast out ten years.
As for the company’s investment policy, like at most companies, it determines what kind of risk the company is willing to take. Outlined in this particular investment policy are the minimum issue size, maturity, and credit. The company breaks the investment portfolio into four tiers and each pool of cash is managed with different liquidity needs, duration and risk. To measure compliance with investment policy, the company relies heavily on external investment managers for producing risk metrics on their accounts. They also compare risk among the managers.
Understanding your cash flow is critical. What with new regs and the absence of viable alternatives to money market funds, liquidity will get more expensive to keep and as a result, several members said they going to have to think about their needs harder than they have in the past. Although it is still too early to understand what the future of short-term cash investing will bring, one thing is for sure: liquidity risk is becoming an increasing risk concern.