Managing Cash in Challenging Times
by Britta Hion, Managing Director, BlackRock
With the short-term investment landscape rapidly changing due to a number of factors, attitudes around cash investment strategies are also evolving. Money Market Funds (MMFs) are, and will continue to be, important cash investment vehicles for a wide range of investors; however, the low yield environment and the changes brought on by regulatory debate have shifted the money market fund landscape. Investors need to embrace and understand these changes but also be aware of alternative options that are available and may be better solutions for some or all of their cash management needs.
In this article we aim to address the solutions that are available to investors in the short-term fixed income space and clarify how they can be used effectively to manage every individual investor’s unique requirements in these challenging times.
Navigating the new world of cash investing: Beyond money market funds
A. Acceptance of share reduction mechanisms
As has been the case for some time now, trading conditions in money markets remain challenging and recently money market instrument yields have traded negatively. In these highly unusual circumstances, fund providers, recognising that investors accrue considerable value from the availability of share classes with a stable NAV, have determined that it is in the best interests of shareholders to implement a form of a share-reduction mechanism which enables a stable NAV to be maintained on days when the net yield on the fund is negative.
The mechanism works as follows: On days where there is a positive net yield, dividends will be accrued normally; however, on days where the net yield is negative a number of shares with a NAV which equals the amount required to maintain a stable NAV per share may be redeemed. The redeemed shares will be cancelled and the value attributable to those shares will be retained by the fund provider to offset the net negative yield. This will enable the NAV per share to remain stable. Therefore, shareholders would incur a reduction in the number of shares they hold.
B. Unrated money market funds
Unrated MMFs provide an investor with the option to invest in a portfolio of the same high quality assets that are held in an externally rated MMF just without the constraints of credit rating agency guidelines. For example, the same high quality names that cash investors are used to seeing may be invested in but with slightly longer durations or in slightly high concentrations. This provides the client with the potential for a yield pick-up over funds that have an external rating.
Credit analysis and review is not absent in unrated funds: unrated refers to the rating applied at the fund level, which analyses the adherence to specific guidelines established for rated MMFs. At BlackRock we consider external ratings as a preliminary screen in our own independent credit review; that is, we use the ratings as a ‘starting point’ in our assessment of an investment, formulating our own independent ‘credit opinion’ about an issuer or a specific investment instrument. Our assessment does not end when we purchase a security. Just as each rating agency may upgrade or downgrade issues, our credit analysts apply an independent assessment of each security throughout the period that we hold the security in a portfolio which includes monitoring rating agency changes.
Over 45 credit analysts oversee BlackRock’s money market approved lists and all investments considered for our rated and unrated funds must be on these lists. Over the past ten years the BlackRock credit team has anticipated ratings downgrades, and withdrawn securities from the approved list or restricted the maturities of these issuers, an average of eight months ahead of the rating agencies.
C. Short bond fund alternatives
As part of the European Securities and Markets Authority (ESMA) guidelines there are ‘short-term’ money market funds that are the most commonly known but they have also defined a set of guidelines for money market funds with a slightly longer duration.
Features of these funds typically include:
- Longer investment horizon than short-term money market funds (6-12 months)
- Fluctuating NAV
- Maturity limits (fixed): 397 days
- Maturity limits (floating): 2 years
These funds also have the potential for a yield uplift compared to short-term MMFs and often have a total return objective.
When considering longer-duration funds, the concept of cash segmentation is making a reappearance as these funds are ideal for cash considered ‘strategic’ that can be invested for a longer period of time. It is important for cash investors to conduct a thorough evaluation of their cash needs and pinpoint their risk profile. Effective forecasting of liquidity needs and assessment of risk tolerance allows for the best opportunity to achieve excess returns within a cash portfolio and to quantify how much cash is available for strategic investment in these types of funds.