Creating Choice and Opportunity in Cash Investment
by Neil Hutchison, Executive Director, J.P. Morgan Asset Management
Corporate investors are no strangers to the complex market issues that are encumbering decisions on how to invest surplus cash. Negative interest rates are creating particular challenges, and it becomes difficult to counteract these issues using the most familiar and popular cash investment instruments. Although the past two years have witnessed an increase in M&A activity, corporate cash reserves remain at a record high. At the end of 2013, for example, the top thousand public, non-financial companies were holding $3.53tr. (source: The Cash Paradox, Deloitte LLP) with no considerable change since then. Given the scale of investment challenge experienced by many corporations, treasurers are now starting to look beyond traditional cash investment instruments and find out what choices and opportunities they have to boost returns within a controlled risk framework.
Market constraints on investment
With most corporate treasurers taking a conservative approach to portfolio risk, deposits and short-term liquidity funds such as money market funds (MMFs) remain their most common investment choices. These are straightforward to transact, allowing treasurers to diversify their risk across counterparties (particularly with MMFs) and maximise access to liquidity. Now that the overnight euro market rate has fallen to 20 or 25 basis points (bps) below zero at best, and is likely to fall further, the convenience and familiarity of deposits needs to be weighted against the negative return. Yields on euro denominated MMFs are also now slipping into negative territory as they start to reflect current market conditions.
This creates a new and unprecedented situation for corporations. While the long period of record low interest rates prompted treasurers to start thinking about the cost rather than the return on surplus cash, this is now a reality. Given the level of cash holdings in many corporations, the financial implications can be substantial.
The situation is exacerbated further by the changing regulatory environment. MMFs need to hold more cash and cash-equivalent instruments than they have done in the past, leading to a further depression in yield. Banks, typically the largest allocation in AAA-rated money market funds, are terming out their funding in response to Basel III requirements creating a mismatch between supply and demand.
One of the most commonly highlighted potential regulatory changes in MMFs is the shift towards variable net asset value (VNAV). Many investors are wary of investing in these funds, not least because they are less familiar with variable NAV than constant NAV funds that characterise many short-term MMFs in Europe. They may also need to seek a change from their current investment policy to permit investment in variable NAV funds. It is important to understand the relative risks of variable NAV funds: for example, they have the potential for a lower credit quality than constant NAV funds as well as longer duration, but given the cost of holding cash, it is likely to be worthwhile to understand and explore the opportunities for using variable NAV funds.