Published: November 09, 2022
With the business world agitated by rising interest rates, inflation, threats of recession, geopolitical instability, and other uncertainties, is it time for treasurers to revisit their investment policies? TMI explores some of the options in the company of a trio of experts asking, in particular, if the search for yield is now on or off the agenda.
In the current trading and economic environment, volatility is the watchword. But as inflation rises around the world, so central bank interest rate hikes seek to hold it in check. For investors, this means that yield is no longer just a distant memory. In an unstable economic environment, does the slightly easier capture of a few more basis points have much appeal for the corporate treasurer, especially as companies have been shoring up their cash positions to ensure ample liquidity?
Yuliya Tarasava
Co-Founder and COO, CNote
The recent volatility in the market re-elevated the value of cash as a hedge but the inflation concerns bring back the yield conversation, comments Yuliya Tarasava, Co-Founder and COO of impact investment platform CNote. “Given the global forces and events shaping the current environment, plus conditions particular to a corporation’s home or regional markets, we are likely to see some changes in corporate investment strategies within policies.”
For Beccy Milchem, Head of EMEA Cash Management, BlackRock, an increasing number of client enquiries on the availability of government funds suggests some investors are looking to de-risk by a notch or two, with a number either holding more liquidity or even pausing or delaying investment decisions. “But there is no obvious wholesale push to de-risk, and we’re not seeing treasurers giving up on yield in favour of security and liquidity,” she says.
Against a backdrop of rapid upward rate movements, with more increases planned, the uncertain macro environment is playing into a very challenging cash investing space for clients, notes Milchem. “It’s why we’re now spending more time talking to treasurers about what is available and where the ‘sweet spot’ is for them.”
Mikaela Rumenius, Head of Financial Markets, Senior Treasury Manager, Spotify, believes treasurers should always focus on security and liquidity before yield, but maybe more so now than at other times. “We have a portion of our cash outsourced already, for more strategic investments, so with the funds we have left in-house we definitely focus on liquidity and think twice before we lock our cash up for too long,” she explains “Capital preservation and access to cash takes precedence over yield.”
The short-term cash and cash equivalent markets present an easy means of diversifying a portfolio, especially with options to take an outsourced approach to credit risk and access to liquidity. Indeed, this space typically provides a good spread of products including Treasury bills, commercial paper, marketable securities, MMFs, and short-term government bonds. These offer an array of risk parameters, from the relative security of government funds to those that step out a little further on the risk curve.
Beccy Milchem
Head of EMEA Cash Management, BlackRock
While treasurers don’t have to take too much duration risk to obtain yield now, it’s worth noting that the current uncertain and rapidly changing environment informs BlackRock’s own approach, which tends to favour shorter duration. With this in mind, Milchem suggests that the treasury focus should really be on liquidity. Indeed, it would seem that money funds with daily liquidity are currently a reasonably good place to be because they can quickly absorb any interest rate movements.
It’s important to stay on top of the markets, but the current volatile environment could make doing so problematic for those lacking the resources to frequently check for opportunities and threats. Whereas professional portfolio managers are able to look at and respond to the cash markets on an intraday basis, few treasurers have that luxury, especially given everything else in an unstable world that is demanding their attention.
With yields heading up and away from zero, she says a misstep might see a treasurer taking a seemingly attractive rate on a three-month bank deposit today, only to find that the yield curve has quickly surpassed that traded level.
Good trades do exist in challenging markets, but break-even analysis – finding the rate at which an investor is compensated correctly for future interest rate moves – and an understanding of where the terminal central bank rate is, is more important now, says Milchem. “With central banks still grappling with inflation, they are treading an uncertain path. An upwards trajectory of interest rates is likely in the coming months, but there is also a chance rates will overshoot and have to be reined in.”
Balancing yield with security and liquidity historically has been a constant work in progress for treasurers, and CNote’s Tarasava says a company’s unique circumstances (the amount of cash on hand, sector, size, seasonality of operations and so on) can tilt that balance. However, she cautions that today, there is another variable treasurers need to consider: the positive impact that their decisions on cash and other instruments can create—or the harm they may cause. Indeed, investors, activists and media have been paying more attention to where corporate cash is sitting and how it can be used as a tool for change.
“Typically, well-designed strategies and policies should account for abnormal environments so that treasurers can take proactive steps rather than being forced into reactive ones,” says Tarasava. “Ideally, many treasurers are taking actions called for within their current policies to deal with the conditions we see today. If that’s not the case, now is certainly the time for treasurers to review policies to make them more comprehensive,” she continues. Indeed, she believes policies that are “full-cycle-proof” will account for rapidly changing conditions and uncertainty and will bring in a wider variety of asset classes.
For many, going a little shorter may be the most appropriate path, both for investors with immediate liquidity needs and for those with a mix of daily access cash and cash that can take a little more duration risk. Defining that mix is possible through cash segmentation, which is now key, says Milchem, because there may be more mark-to-market risk in portfolios that take more duration risk.
However, she does not necessarily advocate revising investment strategy and policy if liquidity has been assessed and allocated appropriately. “Some trades will naturally go underwater in a rising rate environment and that is fine as long as treasurers don’t need to liquidate them. If they are holding something that has secondary market liquidity, they can sell it, but they probably don’t want to realise that loss,” she explains. “If they have bucketed their cash in a way that they still have enough available in immediate liquidity, they can continue holding that trade. But if they haven’t implemented a segmentation strategy in an appropriate way that leaves them with sufficient liquidity, you could be a forced seller in that market.”
Ideally, the investment strategy and policy in place should work in both recessionary times as well as in times of growth, comments Rumenius. She explains that Spotify’s set-up, with a portion of the cash outsourced, was always made with the intention of working in an either-or scenario.
“An externally managed fixed income portfolio is not something that can be liquidated or changed back any day. It was important that when we took the decision to outsource, it had to be on terms and an amount invested that worked for us long term, regardless of volatile environment, but still leaving us with a substantial balance that caters for liquidity needs and any unforeseen events, and that portion should be in risk-free, liquid investments.” However, she feels the policy should always be evolving, so annual revisions are key to ensure a policy that suits the organisation’s needs best.
Making an appropriate response to market changes may take on further complexity for the international treasury operation. “Treasurers should definitely be open to tailor for local needs,” advises Rumenius. “There are going to be instruments that are less common in the US – for example, covered bonds – so that’s brought up in our policy as a specific item. That being said, I think the policy as a whole should cover global needs, but with certain tweaks as deemed necessary.”
Mikaela Rumenius
Head of Financial Markets, Senior Treasury Manager, Spotify
For Tarasava, investment strategies and policies absolutely should take local conditions into consideration. “While we live and operate in a global economy, the multiple differentiating factors across national boundaries – regulations, market tools, cash products, inflation cycles, rate environments – call for a tailored corporate investment strategy.”
Of course, it will depend on operating currency as to whether differing central bank interest rate rises will be an issue or not for investments. Typically, a treasury will have a main operating currency and will look to get assets back to that currency before applying cash segmentation. But larger global firms may have regional functions where different investment mandates are applied based on two or more operational currencies.
“In most cases segmentation is more effective when treasury has a large cash allocation that it wants to work a little harder,” notes Milchem. “This is why it’s essential to consider local conditions: treasury may be considering segmenting immediate liquidity in different currencies, but these pools might not be at a scale that would justify the cost and effort of a bespoke mandate.”
That said, in some circumstances, Milchem says that the effort may well pay off on smaller pools. As the European Central Bank (ECB) continues to deliver its move into positive rate territory, she believes euro investments are becoming more interesting. “Even treasuries dealing with smaller allocations in euro should be reconsidering their money fund investment policies because some products are designed to quickly absorb whatever action the ECB takes.”
In October 2022, the ECB raised rates by a further 75 basis points, to 1.5%, the highest level since 2009. Based on its assessment at that time, its Governing Council said it was expecting to raise interest rates further.
If segmentation is one of the most effective processes to achieve a better grasp on cash positions from an investment perspective, then the typically small treasury department will benefit from supporting technologies.
For the decentralised international group in particular, one of the main goals of technology deployment is achieving enterprise-wide cash visibility and a better understanding of its risk exposures. Enhanced visibility enables improved cash flow forecasting, which in turn lays the foundations for effective cash segmentation which, as we have seen, facilitates better informed investment decisions.
With portfolio diversification a common element of the corporate treasury investment model, even a cash portfolio can benefit from effective cash segmentation, enabling movement beyond simple overnight bank deposits. Execution of strategy in the short-term space may require in-house assessment of risk and reward. However, given common resource constraints in treasury, both in terms of personnel and technology budget, this stage is often outsourced to specialist cash investment managers.
These firms typically employ their own dedicated risk teams, armed with proprietary technologies (such as BlackRock’s centralised data solution, Aladdin) that can create benchmarks and a range of different tactical approaches, according to criteria such as jurisdiction or cash segment.
Key treasury investment objectives may still be liquidity and capital preservation, but a segmentation strategy may reveal a ‘step-out’ strategy as feasible.
When considering this approach, the key question for every investor (not just treasury) is: are you being paid for the risk you are taking? While locking in to a slightly longer duration may be enough for some investors – with the noted caveat that rates are rising quickly – others may have more of an appetite for alternative asset classes.
As mentioned in the main article, Spotify already has a step-out element in its portfolio in the shape of outsourced fixed income portfolio with longer duration. “This was a decision we took early in our investment journey as a way of stepping out and creating additional yield when we were in a start-up phase and needed to spend our time on other more value-adding issues,” explains Rumenius.
Here are some options:
ETFs
For some treasurers, ETFs may be on the radar. ETFs are open-ended mutual funds that trade on an exchange and typically aim to track the performance of an index. Today they cover every part of the fixed-income market including short-duration strategies across credit and rates. In the case of short-duration ETFs, they offer a step out from same-day access MMFs and invest in the underlying bonds.
The wrapper for ETFs can be a difficult one to cross from an operating and reporting perspective, notes Milchem, but she adds that some clients are comfortable looking through the equity-like wrapper to use ETFs as a tool to access underlying short-duration fixed income risk.
ESG
Many treasurers are also now seeking ways of incorporating sustainability into their portfolios. “ESG is something we always try to take into consideration when investing, so it’s not considered a step-out investment for us,” explains Rumenius. However, for some, it may fall to impact investing – where a specific, often localised goal is targeted – to deliver an appropriate risk–return trade-off.
While arguably impact investing goes beyond the realms of what a short-term cash policy is designed for in terms of liquidity and capital preservation, some steps can be taken and tactical strategies that involve ESG screens and tilts towards best-in-class issuers have been launched across the MMF and ETF short-duration space.
Impact investing
Tarasava says impact-oriented alternative investment options can meet two significant current needs: the portfolio diversification – and attendant risk mitigation – needed to address market volatility and uncertainty, and the progress on ESG metrics needed to meet corporate goals and stakeholder expectations.
“Investors and others are looking as hard as ever at corporations’ DEI policies, climate change and community actions. If anything, focus on these issues is growing as people everywhere are affected by inflation, the ongoing pandemic and climate disruptions,” she comments. “Because many ESG and DEI initiatives are directly tied to money movement, whether it’s cash or investment, corporate treasurers are positioned to be an essential driver of impact within their organisations.”
In the US, treasurers can diversify with cash deposits across community development financial institutions (CDFIs), low-income designated (LID) credit unions and minority depository institutions (MDIs). “These deposits are both secure and meaningful,” says Tarasava.
They add to the deposit base at community depository institutions, enabling them to increase lending activity and deploy additional financial resources. For example: CDFIs fund women- and minority-led small businesses, affordable housing, and economic development. LID credit unions serve communities where most people have household incomes well below the national median. MDIs are financial lifelines for communities of colour.
“For cash allocations, US treasury teams can use a special programme that spreads deposits out nationally to multiple FDIC- and NCUA-insured institutions,” explains Tarasava. “This kind of alternative cash management strategy can meaningfully reduce risk compared with keeping all holdings in one or two major banks, as some treasury departments might choose for operational simplicity.”
She continues: “Not only does it diversify holdings but it can reduce risk if it increases the proportion of fully insured deposits. These institutions must comply with the same regulatory standards as traditional banks in terms of capitalisation, liquidity, asset ratios, and other parameters. And while private equity, venture capital, and private credit funds require deep due diligence, allocation of cash deposits to these institutions can be an easier entry point into impact investing for treasurers.”
And the impact isn’t only due to investments flowing into communities. Corporations can also diversify their supply chain by choosing to invest in Black-led banks and other community finance institutions led by people of colour and women.
“Treasury is emerging as a really exciting way for corporations to deepen their work in impact areas they care about, be it supporting native communities, fighting racial bias, or combating climate change,” enthuses Tarasava. “Treasury has always been in support of company goals, and in today’s circumstances, where shareholders are looking for more visibility into how the company is achieving those goals, the treasury function can become a driving force by revising investment strategies to include social impact as one of the variables for which to optimise .”
Crypto
Crypto assets may be also part of a step-out approach, but their suitability is still a moot point for many. “It might not be something a treasury team should be focusing on,” comments Rumenius, “but we’re watching the space to ensure we’re up to speed in the different investment alternatives crypto can bring, as well as the complexities around it.”
While there are no hard and fast rules as to how to approach treasury investments, there is a guiding principle that steers Rumenius’ actions at Spotify: “Liquidity, liquidity, liquidity.” Indeed, it’s her main consideration when investing, especially in times such as these.
“It’s a great comfort for us, and senior management, to know that we have a strong balance sheet that can cater for unforeseen events, so I definitely don’t want to lock up the funds for too long in order to create a few extra bps.”
On balance of evidence here, options are available to explore, and those options are widening, but treasurers are still reserving the right to remain cautious in the face of increasing volatility.
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A perfect storm of low interest rates, the pandemic, and potential regulation has put pressure on the short-term investment instruments that treasurers rely on for cash management. Add in trending topics such as environmental, social, and governance (ESG) and the role of technology in business, and it is clear there is plenty for treasurers to […]
