Stable Returns in a Volatile Investment Landscape

by Neil Hutchison, Executive Director, J.P. Morgan Asset Management

2016 will be remembered for many reasons, but from a corporate perspective one of this year’s headlines is that corporate cash holdings have increased once again. Moody’s reported in May 2016 that cash holdings amongst US corporations alone had reached $1.7tr, $1.2tr of which is held outside the United States. However, this is a global phenomenon, affecting treasurers of companies headquartered around the world. Higher cash levels make it more difficult for treasurers to find appropriate repositories for cash that meet the company’s investment criteria, on top of the ongoing challenges of low or negative interest rates and significant regulatory change. In this environment, an investment choice that is growing in popularity is step-out investment strategies, allowing treasurers to seek greater returns and diversification on portions of their cash.

Challenging investment conditions

It is not only unprecedented corporate cash levels that should be prompting a re-evaluation of cash investment strategy. Most investors have become accustomed to low and negative interest rates in G10 currencies such as the euro, so sterling was a ‘safe haven’ for many. However, the result of the Brexit referendum has also seen sterling rates pushed down from 0.5 to 0.25%. While we are less likely to see sterling hit negative territory compared with the euro, it is now expected that rates could fall further to 0.15 or 0.1%. For investors in money market funds, this means that once returns on cash are calculated net of fees, they will effectively reach zero. Another consideration is the impact of regulatory change. For example, changes to rules on money market funds in the United States are already resulting in an exodus of cash from prime to government money market funds, but one of the outcomes of this is that credit spreads are widening, creating opportunities for investors.

The treasurer’s response

Treasurers need to consider their response to the changing investment environment carefully. Security of principal remains a key priority, which underpins every investment decision. Similarly, the company needs to maintain same-day or short-term access to liquidity for a certain portion of cash for working capital purposes. For this operating cash, security and liquidity considerations dominates investment decisions, while generating a return on this cash is a secondary priority. 

However, for many corporations, there is a portion of ‘strategic’ cash that is not required for immediate use that can be used to work harder for the company. This is not a new concept: ‘cash plus’ investment solutions have existed for many years, but segmenting cash to achieve a better yield was less of a priority when a treasurer could generate 0.65% when investing in a AAA-rated money market fund. As this is no longer the case, treasurers need to be more proactive. First, they should focus on improving their cash flow forecasting process to allow them to segment their cash appropriately. Second, they need to consider their risk appetite and investment objectives when investing cash over a longer time horizon. Typically, treasurers’ main objective is not solely to maximise return, but to minimise volatility of returns. This is the premise behind JPMorgan Asset Management’s range of Managed Reserves Funds, which have already seen considerable interest amongst corporate investors, particularly US corporations, but increasingly European and Asian corporations too. The most recent addition to our Managed Reserves range is our JPMorgan Sterling Managed Reserves Fund, which was launched in August 2016. Like our other Managed Reserves Funds, this is aimed at investors with longer-term investment horizons who are looking for additional returns above AAA-rated money market funds while carefully managing risk.

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Managed Reserves to manage risk

Like an AAA-rated money market fund, the JPMorgan Sterling Managed Reserves Fund invests in short-term debt securities, but there is greater flexibility in both the tenor and range of securities in which it invests. A money market fund can invest in securities of up to 397 days maturity, for example, while our Managed Reserves funds can invest in maturities of up to three years. This provides a crucial benefit by allowing treasurers to access the steepest part of the yield curve, and therefore the greatest return for that level of interest rate risk. 

In addition, the ability to invest in high-quality corporate names is a significant benefit, with low risk, strong supply and competitive returns. With the Bank of England investing in corporate bonds through a £10bn asset purchase programme over 18 months, we are also likely to see this supply increase further. Although money market funds can hold some corporate paper, there is limited scope for this given that 45% of investment grade credit indices such as the Bank of America Merrill Lynch 1 – 3 year Sterling Corporate Index is rated at BBB, below the A-rated minimum. In contrast, our Managed Reserves Funds invest selectively in high quality corporate debt, providing better diversification and stable returns. According to our analysis, the return volatility profile of a BBB-rated risk compared with an A-rated risk over a five  to ten  year time horizon is very similar, but the investment return is far greater. We go through a rigorous credit analysis process to go behind the rating, and understand the company’s strategy, industry and risk profile in detail and purchase high quality paper from stable organisations in industries such as telecoms, although at very modest levels.

Security and diversification 

JPMorgan’s Managed Reserves Funds invest only in investment grade debt, and due to the quality of its assets, and the rigorous credit analysis process that underpins investment decisions, S&P have awarded the fund an AAf fund rating. This is higher than many of the banks with which corporate treasurers typically place deposits, but has the benefit of diversification and a more competitive return. This is estimated at 20-40 basis points above the 3-month government bill index over a cycle, but is likely to be at the higher end of this. As a result, the fund has been welcomed by institutional investors, both those for whom sterling is their ‘home’ currency and multinational corporations that are looking to diversify their currency holdings. Typically, these are corporations who can invest a portion of their cash over a 6- to 12-month time horizon, and are seeking to boost returns, whilst limiting their income volatility and risk.