Lower rates put squeeze on short-term investments

There aren't many profitable places for short-term investors to put their money these days.

Short-term rates already are at 41-year lows, and the Fed is looking to lower them even further. All institutional cash and short-term money managers can do is wait for interest rates to rise or take on more risk in search of higher yields, according to industry experts.

Short-term bond investments have never been a get-rich-quick asset class; cash managers and pension funds seek safety and liquidity over returns. But the decline in interest rates has pushed the yield on money market investments to well below 1% this year, and it appears likely that short-term rates will stay low for some time to come.

That's not a major problem for pension funds, which normally don't have allocations to cash. But for companies and non-profit institutions with naturally conservative investment guidelines, cash management is close to a zero-sum undertaking.

According to iMoneyNet, a firm in Westborough, Mass., that tracks money market funds, prime institutional money market funds had an average yield 0.89% in mid-June. Institutional money market funds contain just more than $1 trillion, according to iMoneyNet.

The meager yield on institutional money fund accounts is even more anemic given the average 30-basis-point fee, said Peter Crane, vice president and managing editor at iMoneyNet. That's half the average retail money market fee.

Short-term money managers have been scratching for yield by adding more asset-backed securities to their allocations. According to a survey of the 15 largest domestic institutional money funds by Moody's Investors Services, New York, holdings of asset-backed commercial paper jumped to nearly 25% during the six months ended Dec. 31, up from 20.6% as of June 30, 2002. The Moody's study, released June 10, said money fund managers were buying more asset-backed securities and asset-backed commercial paper "in an effort to capture yield."

While the use of asset-backed commercial paper might have helped boost yields slightly, the yield on money market investments has slipped steadily from 6.25% in July 2000 to 1.05% in January of this year and down to the current institutional yield of 0.89%, according to iMoneyNet.

Most cash assets are locked in to conservative investment policies and are limited to high-quality, low-yielding money market instruments. Portfolios allowed to extend further on the yield curve or to include more risky short-term corporate bonds might be able to pick up incremental yield, said investment professionals. But, they warn that also carries additional risks.

"The market is a very powerful thing," said Richard Bort, president of Bort & Associates, a Sherman Oaks, Calif., corporate cash management consultant. "If you want to do better than the market offers, there are only two things you can do: Take greater credit risk or take greater market risk. There are no silver bullets. There are no such things as home runs in the short end of the market, just a lot of singles," he said.

"If you are a corporate treasurer and you have a conservative investment policy, you can enhance your yield, but that means taking on corporate obligations and that means more credit risk. And most don't think it's worth it to go further out on the yield curve just to pick up an extra 75 basis points. With a company's liquidity pool you can't fool around too much."

Moving further out on the yield curve is difficult to choose, said Ray Ruzek, president of Ruzek Management Co., a Newtown, Conn. cash management consultant. "You are always going to need that liquidity but you just aren't making as much, that's all there is to it," said Mr. Ruzek.

That's the case for Craig Ehrnst, treasurer at NCCI Holdings, Boca Raton, Fla. Mr. Ehrnst said he has evaluated methods of enhancing yield but "it wasn't worth it. Because at the end of the day, although we aren't getting the extra returns, it is still a cash position. We don't want to assume the extra risk and it would take away some of the flexibility. You have to look longer term," he said. "Will rates stay down? It's an anomaly that they are this low now."

"We are by nature risk averse with our corporate cash," he said, adding credit policy was tightened to reduce or eliminate the use of lower rated P2 rated commercial paper and to "stick with P1 paper." He said NCCI has an average daily cash position of between $50 million and $60 million, which is invested in a Bank of America short-term investment fund.

"There's a lot of searching going on for value in the short end of the market," said Bill Daniels, first vice president at Mellon Financial Markets, Pittsburgh.

Mr. Daniels said investors allowed to pursue "opportunistic" investments can boost returns slightly. For example, he said, three-month General Electric Corp. commercial paper was yielding 95 basis points while a two-year GE floating rate note was providing LIBOR plus five basis points, or about 1.11%. Also, he said, treasurers may sometimes acquire corporate paper with three to six months remaining to maturity to boost yields.

Terry Bilkey, principal at Pittsburgh-based BilkeyKatz Investment Consultants, said his firm recently placed $125 million in corporate cash with two short-term managers for a corporate client. He said the deal involved placing about 60% of the assets or about $75 million in a "core" portfolio in traditional money market account he expects to yield about 0.80% after fees. He said the manager "has some latitude" on maturities, but can invest in nothing beyond two years and may invest in some asset-backed and collateralized mortgage obligations "within narrow limits."

The remaining assets were placed with a separate account manager in a "specialized mortgage portfolio using CMOs," or shorter collateralized mortgages. He said the combined portfolio should yield as much as a money market "plus 50 or 100 basis points," while maintaining liquidity and low risk.