The high cost of cash is ushering in the next generation of liquidity management.
Institutional investors are looking for more control over investments, including higher-yielding ways of putting cash to work by extending duration and taking more credit risk in segregated accounts, according to managers.
In a new development reflecting the post-Lehman environment, additional returns are also gained by increasingly lending fixed-income securities within the liquidity portfolio.
Historically, cash was “a bit of an afterthought,” said Kathleen Hughes, managing director and head of global liquidity management at Goldman Sachs Asset Management in London. “In the past few years, investors such as sovereign wealth funds, insurance companies, hedge funds and commercial banks (among others) have been taking a more active approach to cash.
“Now some pension funds are starting to realize the benefit of managing cash more strategically,” Ms. Hughes added. She declined to name the funds.
While most pension funds have not yet made significant changes to cash management, some of the world's largest funds are thinking differently.
Among them is the 470 billion Danish kroner ($87 billion) ATP, Hilleroed, Denmark.
“It has become more important to consider "what is the price of cash,' ” said Anders H. Svennesen, vice president and beta portfolio manager for ATP. “Before the financial crisis, everything in the short end (of the yield curve) pretty much traded at the same level. Today there is a difference.”
ATP considers a broad range of cash instruments to find “the best place for cash, or where we are best paid for our cash,” Mr. Svennesen said. “We're trying to find the investments that give an adequate payment on cash given the underlying risk, illiquidity, etc.”
The recent decision by the Federal Reserve to keep U.S. interest rates at the current low levels at least through the middle of 2013 delivered a blow to money market funds. Furthermore, regulatory changes have resulted in less risk — but also less yield, sources said.
“With rates approaching zero in money market funds, more (institutions) are taking a step back and looking at cash as an asset class,” said John T. Donohue, managing director and chief investment officer of global liquidity at J.P. Morgan Asset Management (JPM) in New York.
No statistics are available for the total assets under management in strategic, segregated cash mandates. However, some of the world's largest cash managers say they are increasingly being appointed for separate account liquidity management mandates. At JPMAM, for example, assets in separate accounts for ultrashort cash equivalent strategies have risen by about 30% in the past year, totaling about $25 billion. The firm has about $450 billion in money market assets under management.
Strategic cash management will continue to grow, Mr. Donohue said. “There are a lot of regulations coming down the pipeline that will structurally change the front end of the yield curve, making it steeper,” he added. “Because of that, there are more opportunities to gain a significant advantage over money market funds by taking only slightly more credit and duration risk.”
Segregated liquidity accounts also allow institutions “to really tailor the investment guidelines to their own particular needs and add a degree of control,” said Richard Lacaille, global CIO at State Street Global Advisors in London. SSgA manages about $440 billion in cash assets. “They know exactly what's in the portfolios.”
The evolution of cash as an asset class began with corporate treasurers, many of whom faced record levels of corporate cash since the financial crisis of 2008-2009, sources said. In the U.S., corporate cash broke through the $2 trillion ceiling for the first time, totaling about $2.05 trillion as of Sept. 16, according to a quarterly report published by Treasury Strategies Inc., Chicago, a treasury management consultant. Eurozone and U.K. corporate cash also remains near all-time highs with about e1.95 trillion ($2.7 trillion) and �780 billion ($1.2 trillion), respectively, according to Treasury Strategies.
Some investors who previously managed all cash under one set of guidelines are more recently bucketing cash differently, using cash flow forecasting, Ms. Hughes of GSAM said. For example, pension fund executives might base cash flow forecasts on future liabilities. For the part that clients don't need to touch for six or 12 months, they might think about other risks they're willing to take.
Joe Sarbinowski, New York-based managing director and head of institutional liquidity management at DB Advisors, New York, said many clients are seeking “to take advantage of the yield curve since there's so much cash on the short end chasing fewer and fewer quality securities.”
“They're willing to invest in very high quality securities,” such as quality sovereign debt and non-financial corporate bonds “but with slightly longer duration, and get rewarded.”
“Moving liquidity from one week to 90 days can deliver up to 20 basis points or more in yield, depending on the credit,” Mr. Sarbinowski said. In the past two years, assets under management in segregated cash mandates in which clients have more control over the portfolio composition has increased by between 30% and 40%, according to Mr. Sarbinowski.
Compared to the enhanced cash portfolios that were popular before the financial crisis — but generally blew up following the September 2008 bankruptcy of Lehman Brothers Holdings Inc. — “the next generation version is much more watered down, less risky,” JPMAM's Mr. Donohue said.
For example, J.P. Morgan Asset Management (JPM)'s own ultrashort liquidity strategies do not invest in mortgage-backed securities. However, managers do invest in assets such as credit cards and auto loans, which have no extension risk. “We don't use futures or derivatives to hedge down duration,” Mr. Donohue added.
In addition to lengthening duration and marginally increasing risk, some investors are using repurchase agreements to add yield to their liquidity portfolios, sources said. In what's known as a repo and reverse repo, securities including U.S. Treasuries or other government bonds are "loaned' in return for a fee and collateral, which could include high-quality credit or other securities.
While this is similar to stock lending that institutions have done for years, pension funds have only begun lending their fixed-income securities since the financial crisis as a opportunistic way of helping banks gain liquidity, said Chris DeMarco, senior consultant at Aon Hewitt, who has advised pension funds on repos with durations generally of between two to five years.
“A lot of pension funds hold (nominal and inflation-linked government) bonds because they need them to match liabilities,” Mr. DeMarco said. “More pension trustees are seeing that these liquid assets — generally with very high credit quality — are a source of value.”
Mr. Lacaille of SSgA added that the three most important factors to consider in a repo transaction are the underlying borrower, the maturity, and the type and quality of the collateral. “Of that, the most important is the relationship between the borrower and the collateral; transaction counterparty exposure is the first line of defense from a risk mitigation perspective,” he added.