Investment Priorities Through a Regulatory and Market Transition

by Jason Straker, Head of Client Portfolio Management, Global Liquidity EMEA, J.P. Morgan Asset Management

Every year, J.P. Morgan Asset Management (JPMAM) produces its Global Liquidity Investment PeerView report, an in-depth study based on an extensive survey of more than 400 liquidity investors globally. The report illustrates trends and behaviours amongst investors, and provides a valuable benchmark for investors to consider how they are managing liquidity and identify potential areas of focus. In this article, Jason Straker, Head of Client Portfolio Management, EMEA for J.P. Morgan Asset Management’s Global Liquidity Group discusses some of the key findings and the action points for treasurers.

A market in transition

2015 is a particularly interesting year in which to conduct the PeerView survey, given that significant regulatory developments are under way, combined with a challenging, but potentially changing interest rate environment. Banks in North America and Europe in particular are implementing Basel III, one of the outcomes of which is a declining appetite for non-operating deposits of less than three months’ duration. At the same time, money market fund (MMF) reforms have been finalised in the United States, and will take effect over the coming months. These reforms are forming a backdrop to discussions in Europe and other regions such as China on similar reforms. From an interest rate perspective, negative interest rates in Europe create specific challenges for euro investors, while investors in USD and to an extent GBP are anticipating an increase in rates.

2015 is a particularly interesting year in which to conduct the PeerView survey

This diverse combination of market and regulatory pressures is prompting investors to reconsider and potentially revise their investment approach. However, the PeerView results indicate that they are not responding in a negative or reactionary way to these changes. For example, many commentators have predicted that investors would reject MMFs as they shift from a constant net asset value (NAV) to a variable NAV. Sixty-three per cent of investors anticipate continuing with the same allocation of MMFs once the reforms take effect, while 20% expect to increase their allocation. In the United States, 70%  of the respondents who are currently invested in a prime money market fund, expect to continue using this product once the forthcoming reforms have been implemented.

Pressure on asset allocation

While the use of MMFs looks likely to remain stable or even increase, the same cannot be said for operating deposits. Almost half of respondents noted that their banks were already encouraging them to move cash off their balance sheets, and this will become more widespread in the months ahead. The notable exception so far is in Asia, where this is not yet taking place. Banks in Asia are implementing Basel III at a slower pace than banks in North America and Europe, but banks globally will ultimately be subject to the same liquidity and capital adequacy requirements, so investors in Asia will need to consider alternatives to deposits as those in other regions are doing. In fact, the impact is likely to be greater as the use of deposits is more common in Asia: 57% of assets in Asia are held in deposits compared with 44% in Europe and 42% in the United States.[[[PAGE]]]

A catalyst for change

MMF reforms have been finalised in the US, and will take effect over the coming months

Given the current market and regulatory conditions, many investors – around 40% currently – are already reviewing their investment policy to validate their investment objectives and ensure that the range of instruments and permitted credit quality of assets and counterparties is appropriate to achieve these objectives. Those that are not already undertaking this review will need to do so shortly to avoid being caught out as new regulations are fully implemented but also to be in a position to take advantage of opportunities to increase investment returns as interest rates rise.

Amongst those that are already going through this review process, security and liquidity remain primary objectives while yield, although important, remains a tertiary priority. Even so, investors have seen returns at an unprecedented low level for an extended period, most notably in EUR. As a result, the appetite for yield is increasing both within the current investment environment and in anticipation of future interest rate increases. This is reflected in two key areas: notably, changing attitudes towards counterparty risk and the range of permitted instruments.

An evolving risk appetite

Since many banks were downgraded by credit rating agencies, investors have become more willing to invest in tier two counterparties than in the past. When this applies to banks, this appears to be a sensible strategy: banks are now far stronger and more robust than in pre-crisis days, having overhauled their balance sheets. It is perhaps worth being more cautious when investing in other tier two issuers, however, and accessing the resources of an expert external credit manager can be very valuable in understanding and determining an appropriate levels of counterparty risk.

The expansion in the range of investors' instruments, both funds and direct investments is a positive development

A positive development, however, is the expansion in the range of instruments that are authorised through the investment policy, therefore enabling investors to overcome the declining availability of short-term deposits and leverage opportunities for higher returns. In the United States, government debt, repurchase agreements (repos), bank obligations, commercial paper (CP), and corporate debt securities are already growing in popularity. There is a similar, but less pronounced trend to permit these instruments amongst European investors, and government debt is typically less attractive. However, both corporate and bank debt, whether directly or as repo collateral could offer attractive opportunities. In Asia, while overall trends are similar, there is also an emphasis on wealth management products, but this is likely to decline as investment markets deepen and institutional investors become more closely aligned with those in other regions.

A widening investment spectrum

As MMF reforms take effect in 2016 in the United States, which is likely to be followed by similar reforms in Europe, one of the likely outcomes is that investors will have a wider spectrum of funds from which to choose. Investors are already demonstrating an appetite for separately managed accounts (SMAs) while other pooled funds are also becoming more popular, and this trend is likely to continue as the range increases. For example, at JPMAM, we have significant investment into our JPM Managed Reserves Fund which is currently $5.4bn in size. The expansion in the range of investors’ permitted instruments, both funds and direct investments, is a positive development as investors can be more precise in meeting their short-, medium- and longer-term investment objectives. Increasingly, investors are becoming more adept at segmenting their cash into working capital, core and strategic cash. Liquidity has never been more expensive than it is today, so as same-day access to liquidity is less likely to be required for core and strategic cash, investors are able to explore a wider choice of investment options and seek better returns without compromising security.

Expertise and insights

As the PeerView report demonstrates, most investors perceive that moderate or significant effort will be required to revise their investment policy and implement changes but this is not necessarily the case. Leveraging advice and expertise from an expert partner such as JPMAM, not only on our own investment solutions but the wider market can offer significant advantage and streamline the process considerably. Furthermore, using resources such as PeerView 2015 can also be very helpful in identifying trends and benchmarking against comparable investors.

To download the PeerView 2015 report, please go to www.jpmgloballiquidity.com/peerview