Investing in a Low Interest Rate Environment
by Kathleen Hughes, Head of Global Liquidity Management Sales, and Jason Granet, Head of International Cash Portfolio Management for Global Liquidity Management, Goldman Sachs Asset Management
Investing primary cash
Money market funds (MMFs) are well-established in markets such as the US and UK as repositories of short-term or primary cash, and their use is increasing across Europe and Asia. Should market conditions continue to strengthen in the future, these products will remain extremely valuable in order to hold cash needed for working capital and other short-term requirements. MMFs have the potential to provide excellent security, where they offer AAA-rating, diversified assets, a high quality investment process, and same day access to liquidity.
There are a variety of situations, however, where treasurers do not necessarily need immediate access to cash. For example, companies that have achieved a reasonable degree of accuracy in their cash flow forecasting process may be able to structure the maturity of investments into the future to take advantage of improved returns further out on the yield curve. For example, cash being held in a ‘war chest’ for known outflows, mergers and acquisitions and/or future contingency could be held in longer-term investments; similarly pension funds and insurance companies may also have tranches of cash not required in the short term. In these situations, the first priority must remain the return of principal, but treasurers may be able to take advantage of the liquidity premium available by using a wider range of investment types.
Using secured instruments for secondary (medium-term) and tertiary (lond-term) cash brings a range of advantages over unsecured instruments in supporting treasurers' risk management strategies.
Leveraging secured instruments
Investment expertise amongst corporate treasuries is growing, particularly since many treasurers went through a process of re-evaluating their risk budgets and investment decision-making process subsequent to the financial crisis. This results in the opportunity for sophisticated corporates to take advantage of the premium available through certain types of investment, particularly secured investments that should provide greater security than unsecured instruments.
It is often surprising that investors are willing to invest in unsecured instruments, particularly over the longer term, which would seem to contradict many companies’ appetite for risk. Secured instruments, logically, are designed to offer greater security for investors, as long as the collateral is of high quality. For example, while asset-backed commercial paper (ABCP) fell into disrepute in the run-up to the crisis, these instruments should not be disregarded simply because the collateral underpinning some issues in the past has been of low quality. Today, with greater financial rigour in the way that these instruments are constructed, ABCP may prove attractive prospects to corporate investors.
Another secured way to invest is in a tri-party repurchase agreement (repo). This is a mature and deep market in the US in particular, with over $2.6bn repurchase agreements as per the Federal Reserve(1) data. While repos have been less common in Europe historically, the market is growing as more sovereign debt has been issued, which is increasingly being used as collateral for repos. One of the advantages of a repo is the ability to select a maturity date linked to a company’s cash requirement, in a similar way to a deposit, whilst benefiting from the security offered by the underlying collateral.
The market in covered bonds is also developing rapidly, with a total market size of around $3trn2. These have a long-standing track record in Europe and North American investors are now able to take advantage of a similar offering. A considerable increase in covered bond issuance is being experienced by the market, with a 30% increase in the past year, and a 45% increase in four to six year maturities. As these instruments approach maturity, they may become particularly attractive to corporate treasurers in the secondary market for the investment of medium-term cash.