The Changing Landscape of Cash Management and Investment
by Travis Barker, Head of Liquidity Business Development, HSBC Asset Management
The global financial crisis highlighted the importance of a disciplined approach to cash investment, with many corporate treasurers taking a more conservative view of how they invested their cash, with a clear emphasis on capital security and liquidity. Although the crisis in the financial markets eased over the latter part of 2009, the landscape for cash management and investment had fundamentally altered, shaped by a new approach to counterparty and market risk, and a changing regulatory environment. Furthermore, the emerging crisis in Europe emphasises that treasurers need to continue to be vigilant in ensuring that cash is invested appropriately and in accordance with the needs of the business.
Using MMFs to manage investment priorities
As every financial text book will emphasise, investors consider three key priorities when making investment decisions: security of capital (credit risk); availability of cash when required (liquidity risk) and a return on capital to protect the relative value of cash (interest rate risk). These are frequently summarised as: security liquidity and yield. Treasurers increasingly recognised-long before the crisis – that while it is possible to manage these objectives in-house, such as by using a combination of deposits and repo instruments, few companies have surplus cash balances that are large enough, or sufficient treasury resources to undertake such a strategy effectively. Consequently, a simpler solution for many treasurers was to outsource their cash investment into constant net asset value (NAV) money market funds (MMFs). These initially took hold in the United States, and have since become popular in the United Kingdom, Europe and increasingly in Asia.
The emerging crisis in Europe emphasises that treasurers need to continue to be vigilant in ensuring that cash is invested appropriately and in accordance with the needs of the business.
The concept of MMFs is that they comprise the pooled assets of a number of institutions, invested in a variety of high quality assets with a short-term maturity. In addition to providing the necessary diversification on the asset side to protect investors’ capital, investors also retain immediate access to liquidity, due in part to diversification on the liability side, as investors have different financial drivers, and so withdraw money at different times.
In the years up to the crisis, adoption of MMFs continued steadily.During the crisis, the three pillars of investment: security, liquidity and yield, became just two, as investors largely discarded their pursuit of yield in favour of credit and liquidity risk management. MMFs that invested predominantly in government debt became very appealing, and we saw treasurers building up cash levels in these instruments throughout the first half of 2009. With market liquidity returning, but with ultra-low interest rates remaining, we have seen recent net outflows from MMFs across the industry of around 11.7% since June 2009, although HSBC has seen continued robust growth with a 1.9% increase in assets held in MMFs over the same period.
However, these statistics mask some interesting trends. Firstly, we have seen treasurers’ confidence in ‘prime’ MMFs (i.e., those that invest in financial institution and corporate assets) return, which reflects a more balanced view of risk than we saw during 2008 when government funds took precedence. For example, since June 2009, USD government funds have fallen by over 28% and EUR government funds by more than 26%. In contrast, ‘prime’ offshore MMFs have seen a net increase which is particularly apparent in EUR funds which have grown by over 20% over this period. Secondly, despite low interest rates, treasurers are still prioritising security and liquidity, and are not seeking to optimise yield. Although we have witnessed a net outflow from some MMFs, this is not matched by an equivalent inflow into enhanced funds. For example, in France, while there has been a drop in regulaire funds of over $39bn, dynamique or enhanced funds have grown by only $7bn. It is a positive sign that treasurers have not forgotten the lessons learnt during the crisis and have found an appropriate balance in their cash investment approach.
While the importance of MMFs was highlighted during the crisis, it also emphasised that there are changes required to ensure that MMFs are sufficiently resilient to withstand extreme market pressures. In reality, MMFs have proved amongst the most robust and reliable investment instruments; however, as Box One illustrates, it only takes one anomaly to destabilise an entire industry. The Reserve Primary Fund broke the buck as it had shifted the risk-reward balance by seeking enhanced performance through higher risk assets. To avoid contagion created by the actions of one fund manager, there is strong market support for tighter regulations to ensure that MMFs are managed according to common standards. In addition, MMF providers have refined both the way they manage their funds and how they communicate with investors to provide transparency and rigorous controls.