The Return of Returns: Cash is Back
By Eleanor Hill, Editor
Central banks across the globe have varying approaches to monetary policy, but the general direction of travel, until recently, had been the same: one of tightening. When the shape of the yield curve changes, treasurers must be prepared to respond. Jim Fuell, Head of Global Liquidity Sales, International, J.P. Morgan Asset Management, explains how treasurers can position themselves to take advantage of ‘cash is back’.
Eleanor Hill, Editor, TMI (EH): First and foremost, is cash really back?
Jim Fuell (JF): Generally speaking, yes, cash is back. Despite the dovishness expressed by the Fed at its recent March meeting, the last two years have delivered a progressive tightening of USD rates. Cash is certainly back from a US perspective: three-month Treasury yields have pushed through the 2% mark , while dollar money market yields have risen above the yield available from many broader, fixed-income benchmarks making cash an attractive asset class. Across the rest of the major currencies this theme is less present and there are a number of potential disruptors.
Brexit is causing uncertainty around the next sterling rate move. The same is true in the Eurozone, where expectations for rate movements are possibly further out than we had anticipated a year ago. And with Mario Draghi coming to the end of his term as President of the European Central Bank (ECB) later this year, the market is not expecting any change prior to his departure in October 2019, with euro rates pegged to the ECB deposit rate of -40 basis points .
Beyond 2020, we may see sterling and euro rate rises, but to a degree, that will depend on what the US looks like at that juncture; the tightening path may still be closed.
EH: What is the impact of this for investors? How can they react to changing rates – or is it a case of ‘wait and see’?
JF: Investors not only have to be paying attention to macro events, they also have to be thinking in terms of the agility of their investment policies. With interest rates globally in play, subject to the caveats I mentioned, it’s important for cash investors to be positioned for changes to the shape of the interest rate curve – and, crucially, to be prepared in the event that the central bank actions are contrary to what the market has expected. The reason is simple: it can be very painful for investors who are unable to respond quickly when the yield curve changes. Therefore, treasurers need to build flexibility into those policies to enable them to use different solutions – these are not ‘normal’ times we are operating in.
In my view, deploying an enhanced strategy that steps outside of traditional cash instruments is a good option for investors in this environment. ‘Step-out’ strategies, such as our Managed Reserves (see box 1), have played well to investor needs where they are looking to cut or at least not extend their duration too far – since they are still waiting to see precisely where rates will head. Such a strategy enables them to generate an incremental level of performance in a solution that has the in-built flexibility to look like a liquidity strategy when necessary, and to step-out a little further when appropriate.
Our Managed Reserves strategy can be delivered via a pooled vehicle or Separately Managed Account (SMA). We have also recently deployed this strategy via an Exchange Traded Fund (ETF) wrapped vehicle, catering more to the retail end of the spectrum.
Elsewhere, another key consideration for investors in this environment has to be credit quality. Since 2007/2008, credit has yet to be seriously tested, and as such, I’d argue that investors should not be thinking about extending duration to generate incremental return without keeping a close eye on credit quality, certainly outside the more intensely regulated banking market.
EH: You mentioned about ensuring investment policies are flexible. What new instruments might treasurers want to include in those? And are there any other new cash strategies they should be considering too?
JF: The completion of European Money Market Fund (MMF) Reform on 21 January 2019 has been widely discussed, but it’s important to note that some of the constraints placed on MMFs by regulation does impact their underlying performance. Treasurers may therefore want to take a second look at other options – from short- and ultra-short duration bond funds, through to ETFs and SMAs.
While treasurers are considering alternatives to MMFs, this is also a great opportunity to think about asset allocation. When weighing up their options, sometimes investors will consider a particular solution or asset class in isolation; they may fail to take into account the impact of the addition of that investment on their existing portfolio. It’s essential, for example, to assess whether that investment will add or reduce portfolio volatility or whether it will have a positive or negative impact on any real/unrealised gains.
As such, it’s my belief that the new investment landscape may merit a more sophisticated look at asset allocation, beyond simple segmentation. This is where our concept of Strategic Asset Allocation (SAA) may be beneficial. This is a completely customised way of meeting individual investment objectives and constraints, which typically evolve as investor needs change. Indeed, when investors truly understand the risks and returns, it can open up the use of new asset classes within a broader, well-diversified portfolio.
The SAA process involves listening to each client’s objectives and combining their priorities with input from our portfolio managers to ensure the solution is implementable and consistent. To help determine SAA frontiers, we have developed a portfolio optimisation engine that can be designed around bespoke criteria across a wide range of specific requirements. It’s critical that we then test potential SAA portfolio resiliency through historical and forward-looking stress scenarios.
As part of the Managed Reserves process, we suggest that clients adopt a flexible investment policy to allow for both broad asset allocation shifts as well as alpha generation from investment managers. And each investment is continuously monitored for performance and overall portfolio fit in an effort to enhance returns while protecting against downside risk – hopefully giving investors the best of both worlds.
Box 1 - Managed Reserves Strategy
For liquidity investors looking to move beyond money market funds (MMFs) in search of higher yields/returns and for those investors positioning their portfolios for a rising rate environment, J.P. Morgan Asset Management’s Managed Reserves provides a compelling cash management strategy.
Source: J.P. Morgan Asset Management, as at 29 March 2019. Past performance is not a reliable indicator of current and future returns.
 Source: Bloomberg, as at 29 March 2019.
 Source: Bloomberg, as at 29 March 2019. Forecasts are not a reliable indicator of current and future results.