Reasons to Be Cheerful: Treasury Short-Term Investments in 2023

2022 ripped up the short-term investment norms of the past decade as surging inflation and soaring interest rates took centre stage. While this caused particular challenges for treasurers, new opportunities to maximise results from excess cash have emerged for the year ahead.

The short-term investment space has witnessed both volatility and an upward momentum over the past year. Soaring inflation coupled with aggressive central bank interest rate hikes have dramatically shifted the landscape for corporate investors. Crucially, inflation has been much more resilient than many anticipated at the start of 2022.

Daniel Farrell, Director, International Short Duration, Fixed Income, Northern Trust Asset Management (NTAM), comments: “There’s been a significant rise in inflation, and not just in the US, Europe, and UK, it has been global. It has proved a lot stickier than some expected at the beginning of last year, largely due to consumer demand and the war in Ukraine.”

The Covid-19 pandemic triggered huge levels of government support through different forms of stimulus. That, in turn, helped build up consumer savings. “In some cases, the government support went too far,” reflects Farrell. “In the case of the US, it was too large and too long. This fuelled the rise in consumer demand.”

Russia’s invasion of Ukraine at the end of February 2022 also had an impact on global inflation, highlighting the significant roles that both Ukraine and Russia play in critical supply chains. The natural gas, wheat and corn produced by the region are relied upon worldwide. With the war limiting exports, some markets have experienced shortages that have driven up prices.

“As a result of these two drivers, inflation started to peak around the 10% level,” continues Farrell. “That’s why the central banks are concerned that inflation will get out of control. While they can’t change the supply chain disruption or the war, central banks are focused on ensuring that secondary impact effects don’t spiral out of control. These are the direct and indirect inflationary impacts that have been passed on to goods, resulting in a wage-price spiral. That’s why the central banks aggressively hiked rates in 2022.”

While inflation and interest rate hikes can cause many cash-management-related challenges for treasurers, rising interest rates offer some opportunities for short-term corporate investments. This is reflected in the traffic witnessed by investment portals over the past year.

Karl Adams, Senior Director, International Cash Distributors (ICD), comments: “In Q2 2022, we had three times the number of new clients come on board compared with the same period last year. That spread of early investors ranges from people coming back into MMFs since the end of lockdowns, with which the increase in interest rates has helped, and we also see much interest from new investors who have never used MMFs before.”

One region to witness a dramatic turnaround in rates is the Eurozone. Interest rates had been negative since the European Central Bank (ECB) introduced its negative interest rate policy in June 2014. That changed in July 2022, when the ECB initially raised rates by 50 basis points – its first hike since 2011 – which immediately took the deposit rate to 0%. Subsequent rises have taken the rate firmly back into positive territory, which has attracted investors.

“Investors are seeing the ECB hikes moving the interest rate into positive territory, which has generated a large increase in demand,” notes Adams. “These clients previously said that MMFs weren’t attractive to them because they were still getting 0% in traditional bank deposits. These rate increases will open the door for many investors such as treasurers. We will continue to see increases in this asset class through this year and beyond.”

Regulators soften approach

At the start of 2022, treasurers and fund providers were concerned about proposed regulatory changes to MMFs. Proposals from bodies including the US Securities and Exchange Commission and the European Commission, intended to help market stability, looked as if they would instead render some of the most popular forms of MMFs unusable. Swing pricing in the US and the effective elimination of the stable net asset value (NAV) component from the low volatility NAV (LVNAV) fund type in Europe were very much on the cards.

“Everything we saw from the communications, reports, and consultation papers were all guiding us towards the effective removal of LVNAV funds,” recalls Farrell. “However, just before the summer, the approach softened. Regulators were consulting more with investors about the impact and where investors would go as a result of such changes. We haven’t currently seen anything that is firm.”

Regulators should consider the fallout if corporate investors cannot invest in an LVNAV fund with a price of one. Attention needs to be paid to not only where treasurers might go with their investments, but also what the resulting impact on the short-term investment ecosystem might be. What effect would this have on the real economy and in the securities that global fund managers buy?

“There’s more of an awareness from the regulators that it’s not simply clear-cut decision to remove the benefits of an LVNAV fund” adds Farrell. “They are now considering the knock-on impact of any actions. We are more comfortable that we would see not a hard removal, but maybe some form of a negotiated solution.”

Further reassurance around MMFs, particularly of the LVNAV variety, comes from Adams, who notes that trends from investors on ICD Portal showed a good performance from that fund type during the pandemic. “During that time, we didn’t see the outflows or the need for a massive review of LVNAV MMFs,” Adams recalls. “We saw more outflows from VNAV [variable NAV] products. So, our evidence would back up the point that LVNAV funds do not need to be changed that much. We also held a survey where 71% of respondents said they would be more likely to redeem out of VNAV products. So, if the regulators do listen to the investors, then moving to a VNAV-only model isn’t going to be optimal.”

Following the last major MMF regulatory reforms of 2019, the biggest challenge investment portals faced was technology-related. They had to ensure that they had the development and the structure in place for new VNAV products and changes to accumulating products.

“Most of our investors at the time invested only in CNAV [constant NAV] products,” remarks Adams. “There was some build-out and changes we had to do, such as increase our reporting capabilities. The technology needed to be ready to adapt to any new issues that future reforms would throw at us. However, as we have the technology in place since the previous reform, we don’t see a huge amount of development required, if anything, for this next round of updates.”

Opportunities for yield

The good news for treasury short-term investment portfolios is that interest rates continued to rise in the first round of monetary policy meetings in 2023, leading to some increased yields. However, the level of 75 basis points hikes that had been made by the Fed, BoE and ECB slowed to 50 basis points in their January meetings.

“Central bankers will remain focused on taming inflationary pressures at upcoming meetings, however they are now recognising the risks of overtightening and negative impact on the economy,” cautions Farrell.

With their rate-hiking cycle so far, central banks have demonstrated they have not been as concerned about what forward-looking economic growth data. Instead, they have been very much looking backwards at the inflation data and been keen to get that under control. However, this is starting to shift to a more balanced approach.

“Market participants should pay particular attention to this balancing act,” comments Farrell. “This was the rationale for our view that we expected central banks to reduce the size of the hikes we had seen, which came to pass in January.”

With that in mind, having a view of the potential peak of rates will be vital for corporate treasurers in their short-term investment planning.

“We believe that, in the coming months, the Fed will take the Fed funds rate up to 5%,” reveals Farrell. “For the ECB, we believe they will go up to 2.25% over the same time period.”

For the UK, analysis is more complex following September’s mini-budget and subsequent extreme market volatility and political uncertainty.

“There’s more information we need to hear before we can analyse what the UK data will look like,” says Farrell. “We believe there will be more hikes by the Bank of England, but we don’t think they’re going to deliver the number of hikes that the markets have priced in. As of October 2022, the forward market has 5.3% priced in for this time next year – but we don’t anticipate they’ll be able to deliver that many hikes as the economic impact would be too great.”

While central bank rate hikes continue, the subject of economic growth is increasingly likely to be in the spotlight. In an environment of ever-higher rates and a cost-of-living crisis, the spectre of recession looms large.

“The UK and Europe are highly likely to be in a recession this year, and there’s an increasing risk the US may also enter into a recession, although how deep these will be is still uncertain,” predicts Farrell. “This is why the central banks are trying to get their rate hikes done in the coming meetings, as they will likely have to pause as growth data looks to become more impactful. Inflation has started to deteriorate and will continue to drop in the coming months.”

With the strong likelihood of further rate hikes, MMFs still represent the best option for day-to-day liquidity for treasurers. But if a treasurer has portions of their liquidity portfolio that they can afford to put aside for a more extended time period – such as a three-month or six-month window – then instruments such as ultra-short bond funds become more attractive.

“Our view is the central banks are going to continue hiking rates, but that will end in the coming months when they will finally reach their terminal rate,” underlines Farrell. “If you agree with that view, then now is the right time to be thinking about potentially redeploying a portion of excess cash into ultra-short-style strategies.”

On top of that, credit spreads have been widening, making ultra-short bond funds extremely attractive to corporate investors, particularly in the UK and Europe. “Looking at the spread that we currently get in a comparable treasury or UK gilt, it is possible to obtain about 242 basis points in one- to three-year securities in sterling and 175 basis points in euros,” highlights Farrell. “That’s a significant spread, which comes in at a fund yield of around 6.2% in sterling and 3.75% in euros. Ultra-short bond funds are still attractive in dollars, but the spread is tighter, at about 80 basis points. If treasurers do have the opportunity to segregate some of their excess cash, I would suggest looking into that now.”

Enhancing investment visibility and control

In a turbulent economic environment, treasurers must have the ability to track market data, the performance of the funds they are invested in, and to move cash in and out of different instruments as and when required. Investment portals can increase data visibility and access, particularly on MMFs, enabling treasurers to screen and analyse fund performance and associated information. Exposure analytics and compliance monitoring also support risk management.

“For fund performance, we support investors by allowing them to view a wide range of datasets all in one place,” says Adams. “Treasurers can see all MMFs on the portal, even those they may not currently use. This is a huge benefit to corporate investors, particularly with the rising rates, allowing them to view and screen the funds they might want to invest in as well as historical data.”

With investment portals receiving their data directly from the fund providers, investors can see all their investment data, complete with the underlying exposures, in one place. Automated reporting gives treasurers transparency on their portfolio exposure, whether looking at counterparties, security types, or by country. This functionality is useful when a newsworthy market event results in senior management asking treasury about the company’s exposure.

“Data visibility and compliance reporting on the underlying exposure of MMFs is key for our clients at times of market stress,” notes Adams. “Corporates can gain instant reporting for their investments, covering compliance thresholds and underlying exposures, with all that fund data in one place. With the Russian invasion of Ukraine, clients were keen to identify where their country exposures were. Working with the fund providers to make sure we have the most up-to-date and complete data is key.”

Integration can play a critical role in ensuring that the data the treasurer is seeing is timely and correct. This is a factor that fund portals are increasingly finding among their users. “Around 80% of our clients now have some level of integration with the ICD Portal,” reveals Adams. “These vary from SFTP [Secure File Transfer Protocol] connections to APIs or single sign-on, all of which drive efficiencies for treasury teams and introduce more security.”

Creating an end-to-end workflow with treasury systems enables greater visibility into the corporate’s investment needs and creates efficiencies for the day-to-day treasury workflow.

“Most of our integrated clients start their day on their treasury workstation, looking at their cash balances and determining what can be invested,” continues Adams. “They use single sign-on into their trading platform and place their trades, which are executed through the portal. This information is instantly transferred to the TMS, which triggers payments and automatically settles the trade with the fund company, which then update their cash position worksheets, completing the full cycle. This is all triggered through the single input of a trade, which is a great example of the fully integrated treasury investment ecosystem.”

And it is not just the portal providers that are testing new technology to enhance the investment experience. NTAM is working in partnership with Rabobank, which has created a technology solution that is based on using blockchain to settle the underlying investments that NTAM makes in MMFs.

“The advantage of utilising blockchain is it enables us to work towards a real-time settlement solution, moving away from the traditional T+2 and T+1 settlement model,” states Farrell. “That’s the starting point for us when we think about how we can evolve our products and what we can then pass on to investors – perhaps we can have more data cut-off times or reduce our reliance on banks taking deposits and repo [repurchase agreement]. It might mean we can utilise other forms of investments and manage our portfolios more efficiently. Our plan is to understand how we can pass on these benefits to investors.”

Gaining clarity on ESG credentials

Elsewhere, action on ESG KPIs is a key corporate priority today and treasurers are increasingly used to evaluating ESG-linked financial solutions. With short-term investments, this can be easier said than done. It is hard to examine the underlying investments made by funds that purport to offer ESG benefits without having a detailed conversation and investigation.

“ESG is absolutely top of mind of every investor conversation we have,” notes Farrell. “Investor demand and regulation are the two main drivers, both of which are evolving at a phenomenal rate. Fund providers and the industry as a whole need to evolve at the same pace.”

In whichever ways elements of ESG are embedded in or linked to funds, it is crucial that the core principles of MMFs – capital preservation and liquidity management – remain at the heart of the funds, alongside an impactful ESG integration. This is one reason for caution from responsible fund managers when it comes to adding ESG to the mix.

“We don’t want to introduce ESG solutions and then have an event occur that we can’t foresee, such as the pandemic or the recent UK market volatility, which means we can’t maintain the fund liquidity or preservation of capital,” highlights Farrell. “That would become a real challenge.”

Driven by regulatory advances, investment portals are trying to bridge the gap between investors and funds to provide clear and relevant information in a timely manner.

“ICD introduced ESG data into the portal when the Sustainable Finance Disclosure Regulation [SFDR] came into being,” explains Adams. “We use that to show the classification against every fund, for example, whether they are Article 6 or Article 8 or 9, so investors can see that very clearly at a glance. Funds have also provided a brief introduction to their approach to ESG, giving investors further information.”

Be ready for ‘unknown unknowns’

Last year presented severe challenges and a few opportunities at corporate treasurers and their short-term investment portfolios. Regulatory and market changes are two vital areas to pay attention to in the current investment landscape.

“Treasurers should stay close to their fund providers on regulatory changes and interrogate their investment policies to see what impact any changes may have on this,” Farrell advises. “This also enables treasurers to look at other investment opportunities in strategies outside of MMFs, as we think the market environment will start to change. Once the central banks have finished their rate-hike cycle, there could be other opportunities for treasurers to earn additional yield on the liquidity portion of their portfolio.”

Some of these trends will continue in the months ahead, others will fade, and no doubt there will be at least a couple of ‘unknown unknowns’ thrown into the mix in the year ahead. “Keep calm and invest in MMFs,” jokes Adams. “If the past few years are anything to go by, then this year could throw anything at us. But there’s also plenty of positivity emanating from MMF reform, which we didn’t see previously. That should maintain some stability for corporate liquidity management while rising rates should provide some yield for treasurers to enjoy.”