Pension funds are losing out on millions of dollars by not managing more aggressively their more than $82 billion in cash, according to some consultants and managers.
Most pension cash is being swept into low-interest bank short-term investment funds, they say, when it could be placed in more profitable short-term investments with little additional risk.
According to Pensions & Investments' annual survey of the nation's 1,000 largest pension plans, the average defined benefit fund has about 4% in cash. In many instances, some investment managers and consultants point out, cash is overlooked in meeting investment goals of the plan.
Traditionally excess pension cash has been swept into the master trustee bank's short-term investment fund, or STIF, as part of the custodial relationship. But, some STIF portfolios and money market mutual funds have come under scrutiny because of their use of derivative instruments - especially those funds that invest cash collateral for securities lending activities.
According to the Donoghue Money Fund Report, more than a dozen money market funds had to be rescued by parent companies in 1994 for derivatives losses.
Some pension plan sponsors have started to hire short-term asset managers to run enhanced cash management portfolios, which typically use slightly longer-term securities - rather than the 30- to 90-day government securities usually used in STIFs - to improve yields while adding little risk.
Chicago Board of Education Treasurer Mike Gurgone said he has revised the investment strategy for the system's operating cash investment program to include an enhanced cash portfolio.
He said he will recommend the hiring of four enhanced cash management managers to oversee $100 million of the board's approximately $700 million in cash. The balance will continue to be managed internally, he said, and the externally managed assets could be increased to $200 million eventually.
He said the enhanced portfolio could be up to 30% of total assets at any one time and the maximum duration will be about 30 months compared with the shorter maturities of the operating cash portfolio.
He said he expects the enhanced portfolio to earn several basis points of incremental returns over the board's short-term operating cash assets while remaining liquid.
The $3 billion Oklahoma Teachers' Retirement System usually has an average 5% to 10% in cash, currently about $200 million, said Randy Kopsa, secretary. While the system does not make use of outside cash managers, Mr. Kopsa said cash is managed actively by internal staff to improve returns. The investment strategy involves extending maturities on the yield curve beyond the traditional 30- to 90-day maturities. He said the average maturity now is about 24 days to account for the interest rate environment, but 15 months ago the average maturity was as much as 400 days on a portion of the portfolio.
"Historically, we have added between 60 and 125 basis points over STIF account returns," he said, while earning $1 million to $1.5 million income annually over what would have been earned in a STIF portfolio.
The idea behind the use of enhanced cash management is that while some cash is needed for normal pension or corporate operations, other liquid assets may be actively managed and invested for slightly longer maturities at a higher return.
Enhanced cash portfolios involve adjusting maturities depending upon interest rate expectations and moving out further on the yield curve, up to the two-year range.
"The problem with (pension) cash is that you usually have more of it than you expected," said Ron Peyton, president of Callan Associates, San Francisco. "Some funds have been building liquidity and carry a significant amount of cash balances over a long period of time."
Plan sponsors "are paying too much for the liquidity if cash is kept in 0- to 30-day paper" as in some STIF accounts, he said. "A pension fund with a long-term time horizon shouldn't have any allocation to cash, but they all seem to have it. But the markets have been so good in recent years that no one has paid much attention to cash. Now that you have stopped getting (large) returns on major asset classes, cash is getting more attention."
Enhanced cash managers performed well in 1994 compared with domestic fixed-income managers, according to the YanniBilkey CA$H universe, which tracks 240 institutional short-term managers with more than $200 million in assets. Enhanced cash managers returned between 1% and 4% for the year, compared with negative returns for most fixed-income managers.
"Clearly, as pension assets grow and cash grows there is a need to get every nickel out of the (pension) program," said Terry Bilkey, principal at YanniBilkey Investment Consulting, Pittsburgh.
That is one reason for avoiding STIFs, he said, because STIF portfolios "are expensive for what you are getting. You can get active cash management for half the price and the structure of the portfolio fits with what you are trying to do," he said.
According to Advisers Capital Management Inc., New York, a $50 million enhanced cash portfolio in January 1985 would have grown to $96.8 million at the end of 1994, compared with $92.8 million in a typical STIF account, an incremental earnings increase of $4 million.
Advisers Capital President Patricia Klink said pension cash as well as corporate cash probably would benefit from enhanced cash management over traditional STIF accounts.
"A certain amount of this cash should be considered for active management with the following assumptions: that capital preservation and liquidity are the primary objectives, and whenever possible you will take advantage of the opportunities in the short-term markets and add value when appropriate. You must recognize there is a need for expertise to know when it is appropriate. With enhanced management you still can have low volatility, but with an incremental return over what you would have in a STIF. There is an added component of volatility with active management, and the only question is how much volatility can you accept in return for incremental value.
"If you stay in a STIF you are assured of capital preservation and liquidity, but there is no opportunity for added incremental value. There is the choice," said Ms. Klink.
Cash, she said, "is the one asset category where you can add incremental returns on a very low risk basis compared with the rest of the (pension) plan."
According to David Blanchard, head of Blanchard Asset Services, a New York financial consultant, pension funds should design an investment plan for cash in conjunction with other pension assets so all investments contribute to meeting the fund's earnings assumptions.
"The actuarial earnings assumptions of some pension plans is becoming harder to meet, and cash .*.*. should be working to help meet those needs along with equities, bonds, real estate and other assets in the fund," Mr. Blanchard said.
"Many pension funds are looking for that 8% to 9% return. Last year most indexes were off, so if you can squeeze an extra 50 to 75 basis points out of one-year paper through enhanced cash strategies, it would be a positive move."
Ironically, said Mr. Blanchard, pension funds may find that, by investing in STIF accounts, they may be investing in complex derivatives and other investments their own investment guidelines would not permit.
"The problem with STIF funds is that many use derivatives, options, futures and other securities that your own investment guidelines wouldn't allow you to do," said Mr. Blanchard.
