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Investors’ needs have cash managers trying new strategy tweaks

Neil Hutchison said segmentation has led to major growth for J.P. Morgan’s reserve cash business.

Cash managers are developing more revenue streams by implementing cash segmentation strategies at a time when investors are seeking enhanced cash portfolios.

As interest rates go higher globally, cash managers say they are seeing an uptick in interest in their services. With the average U.S. money market fund 7-day yield at 1.69% and a number of money market funds already offering 2% 7-day yield, according to data provider Crane Data, compared to S&P 500 dividend yield of 1.9%, investors are getting better returns from cash allocations. Asset owners also are increasingly looking for different segments of cash management.

Catering to these emerging needs is transforming the business for cash managers.

While in the recent past, cash managers would park their investors' cash allocations in low-yielding liquidity management strategies, they now are splitting their short-term cash business into two categories: overnight and reserve cash, which is invested from three months to a year, to help investors with tactical objectives.

Sources said the need to segment cash has become much more pronounced given persistent low-yield market conditions. As a result of central banks' quantitative easing, investors sought short-term cash strategies like overnight cash instruments to avoid low or negative bond yields. And "as a result of banks complying with Basel III regulations, clients holding cash have had to bear the cost of carrying that liquidity," said Beccy Milchem, head of international corporate treasury cash sales team at BlackRock (BLK) Investment Management U.K. in London. "Now they are looking for that cash to work harder for them."

"Investors realized that they had too much allocation to liquidity cash (overnight cash) and that they were paying too much for same-day liquidity," added Neil Hutchison, lead portfolio manager within J.P. Morgan Asset Management (JPM)'s global liquidity group in London, in a telephone interview. "Managed reserve cash could earn you between 20 to 40 basis points more than an overnight liquidity cash fund."

J.P. Morgan has tripled its reserve cash business to $60 billion in assets under management globally, from $20 billion five years ago, thanks to the segmentation approach, Mr. Hutchison said.

Peter Yi, director of short-duration fixed income at Northern Trust Asset Management in Chicago, said cash has become a real asset class and is no longer considered insurance for a portfolio.

"We have seen growth of (our) business on the institutional side due to the increasing value of liquidity management in a volatile market environment, especially considering the uptick in the VIX (CBOE Volatility index) relative to last year. Investors went to risk-controlled assets and they are looking for an overall stability in their asset allocation," Mr. Yi said. Northern Trust declined to provide the size of its cash management business.

"Investors are looking to separately manage reserve cash because of a pickup in special situations. As you are aware of a merger or acquisition coming up, you are building cash for a particular point in time," J.P. Morgan's Mr. Hutchison added.

Others using it, too

Other cash managers said they also are using a cash segmentation approach to win business as asset owners are looking to boost return on their cash by locking it with managers for periods anywhere from three months to one year.

Ms. Milchem said that in the past 18 months, pension funds started to look into this ultra-short-duration bond fund space where they can get more return. BlackRock (BLK)'s reserve cash funds quadrupled to $5 billion from $1.3 billion in the past 18 months. The firm's total cash business stands at $450 billion.

"And these products appeal to short-term cash investors who are willing to take more risk," said Kathleen Hughes, global head of liquidity solutions sales at Goldman Sachs Asset Management in London, compared to the AAA-rated money market funds.

Goldman Sachs declined to provide details of its cash management business.

Cash managers said the emergence of cash segmentation strategies have allowed investors to allocate portions of their cash into "strategic buckets" and have prompted investors to move into ultra-short bond mandates with inflows into six-month duration products, Mr. Yi said, adding cash necessary for daily liquidity continues to be allocated to 35-day money market funds.

Ms. Hughes agreed "investors are paying more attention to cash in their investment ecosystem, adding that the need for ultrashort bond funds — those with durations of less than one year — have emerged because money market funds were too prescriptive in terms of duration."

The Investment Company Institute estimates investors' cash holdings are at their highest levels since the global financial crisis, sitting at $2.9 trillion. Much of the recent changes to the cash business have been catalyzed by the 2016 U.S. money market reform, and the European money market reform that started this month, sources said.

The U.S. reform required floating net asset values on institutional prime money market funds, and the boards of money market funds are now allowed to impose fees and restrictions on investors that want to withdraw from funds in times of financial crisis. That sparked an exodus into government money market funds from prime funds and had investors turning to cash managers for assistance in rethinking cash allocations.

In Europe, a similar reform will allow a new category of money market funds — low volatility money market funds — that will have a floating net asset value but could convert into constant NAV funds under certain circumstances.

Mr. Hutchison said that with the European reform underway, inflows into ultrashort strategies may benefit as investors have to get comfortable with a variable net asset value.