By Ted Howard
After years of an ROI drought, companies will be widening their searches for yield in the new year; not much change for MMFs.
While the global economic outlook for 2014 is looking up, the same cannot be said for the investment outlook. In this regard, 2014 looks a lot like 2013.
“It’s a very challenging time for corporate treasurers,” says Roger Merritt, Managing Director, Fund and Asset Management at Fitch Ratings. “They’re undergoing a lot of change due to market forces and the regulatory side. It’s fair to say the changes are unprecedented.”
But corporations and their continued growing cash piles are getting antsy. After years of financial crisis-induced cash conservatism, some companies, with board blessing, are intensifying their efforts to find yield. Their objective now is to have their cake and not so much eat it as nibble it too, pushing out the yield curve and making adjustments to investment mandates to allow for slightly riskier assets.
“Treasurers, as it relates to cash, are relatively risk averse when it comes to that asset class,” says Steve Rotella, CEO of StoneCastle Cash Management. “Safety and risk management seem to be the top priority over yield. But there’s clearly a desire to find a little pick up in yield and that’s causing treasurers to be more proactive in looking for alternatives.”
When the financial crisis took hold in 2008, companies basically consolidated their cash from the three-legged stool of operating cash, core cash and strategic cash into a one-legged bar stool of all cash in one safe place. But now they are looking to go back to the three-legged model and put cash in different places.
In The NeuGroup peer group universe, this means exploring alternatives for some of their longer term cash.
For many, the maximum average duration has gone from six months to two years, ratings floors have dropped from A to BBB; and new asset classes are being added, including callable bonds, ABS (auto, student, and credit card loans), floating rate notes, CMBS, emerging market debt, bank loans and high-yield debt.
New Products
At the same time big-name asset managers are coming up with products to meet yield demand. In 2013 BlackRock and Legg Mason’s Western Asset Management announced the launch of new products that will have the look and feel of a money market fund. Both companies now offer ultra-short obligation funds. The new funds sport a floating net asset value, which is the reason many MMF investors have moved to bank deposits. Nonetheless they are offered as safe, low-yielding destinations for those turned off by coming MMF regulation.
Yet another destination for cash is StoneCastle Cash Management’s Federally Insured Cash Account (FICA). FICA is a cash management program that offers weekly liquidity, a competitive yield and most importantly, a high level of FDIC insurance.
What the FICA product does is slice up a company’s single deposit into $250,000 increments or less and deposit it at hundreds of community banks around the country, thereby getting the federal insurance. Companies can now deposit up to $50mn per tax ID, which means companies with multiple operating entities—and separate tax IDs—could deposit much more.
Meanwhile, other companies are stepping up to offer MMF-like products. These include PIMCO, Payden & Rygel, Barclays and Guggenheim Investments, all of which are promoting their short-duration bond exchange-traded funds (ETFs), which are considered cheap, safe and liquid. PIMCO’s ETF, MINT or Enhanced Short Maturity Exchange-Traded Fund, has grown to be the company’s largest ETF.
Tired of Low Yields
The growth in new products may be a result of increasing comfort levels for asset classes that might have been prohibited following the credit crisis. But it is also a result of restive boards eager to stave off potential activist investors and rein in opportunity costs. One treasurer at a US consumer product company says that at a recent board meeting, one board member noted that the company’s pension fund was returning about 6-7 percent whereas corporate cash was earning just 15 basis points.
“The board member wasn’t saying ‘Go out and get 6 or 7 percent,’” the treasurer says, noting that the pension fund has a lot of assets not allowed under the company’s investment mandate. But he was implying that corporate cash could do better than 15 basis points. “The old acronym was SLY: safety, liquidity and yield. But there’s been an overwhelming focus on just the safety and the liquidity and yield has been left on the side of the road.”
But now risk is creeping back in, the treasurer says. Whereas on $100mn the company would get 15bps, it now wants to try to get 150 to 200 basis points. “That starts adding up to a few pennies per share and that gets people’s attention,” the treasurer says. However, he adds, everyone has to be aware that now the company is “bringing more risk into the equation.”
That can be done, says Asha Joshi, managing principal at investment advisor Payden & Rygel, which offers an MMF-like product called the Payden Limited Maturity Fund. Besides, Ms. Joshi says, staying short also has risk. “Treasurers are coming to the realization that shorter doesn’t automatically mean safer,” Ms. Joshi says. Treasurers are also thinking about the opportunity cost of continuing, like the aforementioned treasurer, to settle for 15 basis points when they can likely squeeze out a little more yield.
Companies “going out longer [in yield] can add value,” Ms. Joshi says. “And you don’t even need to add credit risk when you do that.” For instance, companies can go into Treasuries and “earn extra yield by going out a little bit longer.” This is something the Payden Limited Maturity Fund offers. It uses investment-grade short-term securities that are a little longer in duration than money market funds. Although they maintain a high degree of liquidity, companies must be comfortable with a floating net asset value (NAV).
Meantime, Ms. Joshi notes, money market funds, as per Rule 2a-7, are forced to stay in that very short-term space. What can be worrisome, she says, is that many funds, trapped in this two-month window, might start wandering into lower-rated paper to juice yields.
For companies unhappy with money market fund regs and not feeling safe enough in bank deposits, separately managed accounts have been a popular alternative.
In a separately managed account, companies can find those higher quality assets, and also gain more control. With separate accounts treasurers can then gain more control, Ms. Joshi says. “They get to dictate their risk tolerances and the nuances of those tolerances; they get to say how much liquidity they need and how much is left as hot money, how much is invested in BBB-rated names; whether it can invest in asset-backed securities or not. They get to decide how far on the risk spectrum they want to go. As opposed to being subjected to some fund prospectus.”
Also, if new assets come to market, companies with a separately managed account can take advantage of them. If they’re utilizing a third-party, companies and their treasurers can be educated on pros and cons and the risk profile of any new security. So there are many new avenues to explore for treasury, says Ms. Joshi.
Money fund prospects
So far, despite looming regulation, companies haven’t been abandoning MMFs and they remain, along with bank deposits, the vehicle of choice for operating cash, the so-called hot money.
But it will continue to be a challenging year for MMFs: continued diminishing investment opportunities, the same possibility of bigger and bigger redemptions as cash managers seek predictable—and perhaps better—returns in the slew of other products mentioned above; and finally, the same threat of consolidation.
Currently the Securities and Exchange Commission is considering a host of proposals for the MMF industry, all mainly aimed at preventing runs on funds. These include making current fixed net asset value (CNAV) funds to a floating or variable NAV (VNAV) (at least for prime funds, not government or treasury funds), redemptions fees and liquidity buffers.
“Predicting the future in MMFs has gotten relatively easy the last five years,” says Peter Crane, president of Crane Data. “2014 will be more of the same. Near zero yields, and pending regulatory change. At some point you’re going to reach sight of the end [of those issues] but not in 2014.”
Most observers are hopeful VNAV isn’t the final rule. Fitch’s Roger Merritt says the MMF industry will have an “easier time getting its arms around fees and gates” vs. VNAV. And HSBC, in a paper entitled “Run risk in Money Market Funds” it submitted to the SEC, said that “from an investor’s perspective, there is no meaningful economic difference between CNAV and VNAV funds, and neither fund is more prone to runs than the other.” Thus, it recommended redemptions fees as the best alternative.
“We believe that run risk is best mitigated by empowering MMFs to impose a liquidity fee on redemptions during periods of market dislocation,” HSBC wrote.