A Bespoke Approach to Meeting Cash Investment Objectives

An Executive Interview with Beccy Milchem, Director, BlackRock

A perennial problem for treasurers of cash-rich organisations, particularly since the global financial crisis, is investing surplus cash in accordance with treasury policy, particularly as the number of highly-rated banks and assets has diminished, whilst corporate cash balances remain high. While many companies initially took a ‘flight to quality’ in the immediate aftermath of the crisis, treasurers and company boards are now looking to make their cash work harder, balancing the need to generate a return on cash with the obligation to comply with security and liquidity considerations. In this month’s Executive Interview, Helen Sanders, Editor, discusses the use of separately managed accounts to resolve this dilemma.

 Why has the issue of separately managed accounts (SMAs) become so important for corporate treasurers?

We have seen growing demand for SMAs throughout 2013-4, particularly amongst US corporations. Many of these companies with a European business that have invested in USD SMAs are now looking to set up SMAs denominated in EUR. In addition, an increasing number of European corporations are looking at alternative investment options given the low yield environment we find ourselves in. There are a variety of factors contributing to this demand, for example:

• As the use of SMAs by multinational corporations becomes more widely publicised, awareness is increasing;
• Corporations continue to hold large cash balances, with the challenge that counterparty limits and other concentration risk limits are becoming fully utilised. Consequently, treasurers are seeking new investment solutions that meet their investment policies;
• Regulatory change, such as Basel III and specific regulations applicable to money market funds (MMFs), are encouraging treasurers to consider what solutions will meet their investment requirements in the future;
• The continuing low yield environment, particularly with the challenges in EUR, has prompted many treasurers to seek more bespoke investment solutions that can be tailored to their specific investment objectives;
• By employing an external manager companies can gain access to specialist resources in credit, risk and portfolio management that can act as an extension to a treasury team.

What type of company is most attracted to SMAs?

Companies across a wide spectrum of industries that hold large cash balances and have the ability to segment cash by liquidity needs and profile are attracted to SMAs for their strategic cash. With the impact of Basel III regulations on bank funding already being felt and the low yield environment, companies are becoming far more adept in cash flow forecasting. Consequently, many treasurers now have the ability to forecast cash flow with a reasonable degree of accuracy so that they can better segment cash between balances required for working capital/liquidity and strategic cash where same-day liquidity is not required. This places them in a better position to make more effective use of their cash and fulfil their investment objectives more precisely.

What would you highlight as the key benefits of using SMAs? – is increased yield the primary driver?

In some instances, yes, treasurers use SMAs to increase yield whilst respecting their security and liquidity objectives; however, this is by no means the only reason why corporations use SMAs. There are often advantages in stepping outside of the core MMF investment universe and we have seen clients looking to do this to achieve the diversification they require. A key benefit is that in a pooled MMF there is the inherent cost of liquidity due to the same day feature of the funds. However, in a separate account this can be reduced as corporate treasurers become more savvy in segmenting and terming out their cash, and therefore reducing the need for overnight investments which naturally have a lower yield.

In addition, some companies are seeking to reduce their exposure to financial institutions in favour of non-financial corporations. By using SMAs, treasurers may be able to access a wider range of issuers and assets, achieve greater diversification, and remain within policy. Another important reason for using SMAs is to take advantage of the expertise and credit research capabilities of a respected investment manager, and leverage their market access. This is often a key consideration bearing in mind that many treasury departments have only limited resources for cash investment while the balances involved can be very large.[[[PAGE]]]

Having segmented their cash balances, how do treasurers go about structuring an SMA?

Building a partnership with a trusted investment manager is an essential first step. Some companies will be looking for a ‘buy to hold’ portfolio, but more commonly, treasurers want their investment manager to take a more active approach, leveraging their expertise and market access to target a specific benchmark. We first work with treasurers to ascertain the corporation’s investment objectives, including credit requirements, target return, liquidity, volatility and risk tolerance. Credit quality is clearly an important issue, which could include specifying minimum and average credit ratings for portfolio holdings. Many companies will also consider concentration risk within particular market segments. Having identified all the relevant investment objectives, we can then define appropriate guidelines that our expert investment and credit management teams will then use as the basis for managing the portfolio.

Building a partnership with a trusted investment manager is an essential first step.

One challenge we have come across is where investors have already established a USD SMA and often intend to mirror the guidelines for a EUR portfolio. The difficulty is that there are considerable structural differences between the US and European markets, with different issuance levels. Some instruments do not have direct parallels: for example, where US treasuries are used in a USD mandate the investor will need to define their exposure limits to sovereign debt issued by each country in Europe. This requires more in-depth analysis as there are a number of countries to assess as well as taking a view on core European sovereigns versus periphery sovereigns. This analysis is obviously not required in the US. In addition, the overall euro and sterling markets are much smaller than the US dollar market and so this must be accounted for when structuring a mandate. Treasurers need to work closely with their chosen investment manager to ensure that their investment objectives are translated appropriately for each currency.

What trends do you think we will see in the adoption of SMAs in the future?

We anticipate continued growth in the use of SMAs, particularly with the impact of potential new regulations and as awareness of SMAs improves. In the past, minimum fund size restrictions were a deterrent or barrier for some companies, but investment managers are now able to scale their SMA offerings to accommodate a far wider spectrum of companies. Whilst there is still the appeal of the traditional MMF AAA rating, the increased transparency of fund holdings and prospect of regulation in this area in Europe have already prompted the look through to underlying investments and in this way the conversation around creating a mandate that will meet a company’s own investment guidelines is now easier. We launched our first unrated MMF last year, the EUR Assets Liquidity Fund, in anticipation of challenging investing conditions in the EUR market and the need for additional flexibility within the parameters of the traditional stable NAV MMF investors are familiar with. We are encouraged by the interest we have seen from corporates in this product and the willingness to look more closely at the credit quality of the underlying assets to determine whether the fund complies with their investment policy.

What other considerations should treasurers have when setting up an SMA?

When considering an SMA, it is essential to conduct appropriate due diligence on potential investment managers. The right investment manager should be a long-term partner and will have a key impact on the success of the SMA in fulfilling the company’s investment objectives. It is important to build confidence and trust upfront and ensure that the organisation has a clear understanding of corporate investment objectives, appropriate resources for credit management and stringent controls and processes. Having then invested in an SMA, treasurers should review performance regularly, but just as importantly, consider how evolving investment policies could impact the SMA. In some cases, this may allow access to a wider range of assets and potentially even greater opportunities to diversify risk and generate improved yield.