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The results of recent surveys of institutional investors suggest that a range of issues – including improvements in cash forecasting, changes to investment guidelines, the “bucketing” of short-term cash investments, and persistent concerns over certain provisions in U.S. money-market-fund regulations – may be inclining institutional investors to consider alternative investments in addition to money-market funds for the management of their short-term cash.
While many respondents to the June J.P. Morgan Global Liquidity PeerView Survey affirmed the importance of money-market funds for managing short-term cash, they also acknowledged “grappling” with regulatory changes applied to domestic money funds. Only 37 percent of U.S. respondents to the survey reported that they are invested in money funds – down from 63 percent in 2015. Most significantly, liquidity investors reported that a combination of regulatory pressures and a rising-rate environment are forcing them “to consider new investment solutions,” such as “customized portfolios” and cash-segmentation approaches that balance the need for highly-liquid investments with longer-maturity instruments in order to take advantage of an upward-sloping rate curve.
A still-heavy reliance on bank deposits suggests “a general feeling of apprehension” about overall economic conditions, the Association for Financial Professionals noted in its 2017 Liquidity Survey, released in July. Some 41 percent of pre-reform money-fund investors reported that they have abandoned money funds altogether, and only one-third of pre-reform prime-fund investors would be inclined to return to prime funds even if the prime-to-government yield spread reached or exceeded 50 basis points. Many indicated they have revised investment policies, nearly half now “separate out” operational cash from core and strategic cash, and 20 percent will introduce segmentation strategies to take advantage of higher yields on longer-term instruments.
The Executive Guide to Investment Strategy and Policy, also released in July by the AFP and underwritten by J.P. Morgan Asset Management, put particular emphasis on the importance of revising investment policies to include investments with maturities longer than those of registered 2a-7 money-market funds. The guide similarly advised liquidity investors to leverage cash-management technology in order to improve cash forecasting and to create and implement segmentation strategies that maximize rising rates.
A New Emphasis on Strategic Investing
Despite an uptick in overall economic activity and interest rates that have finally begun to rise, corporate treasurers remain “in a very conservative place right now,” Andrew Linton, managing director and head of Corporate Sales, Global Liquidity at J.P. Morgan Asset Management, and Paula Stibbe, managing director, head of Global Sales, Global Liquidity at J.P. Morgan Asset Management, explained recently to Money Market Insight™.
“Think what those folks have been through: a great recession, the Fed taking rates to near zero, yields of short-term cash products at just a few basis points, and major reforms to money-market funds,” Stibbe said. Because of all that, she noted, “treasurers retreated to the safety of bank deposits, which rewarded them with modest earnings credits, and to money-market funds, which provided a small yield and, importantly, daily liquidity.”
However, Linton observed, things have now changed. “With the likelihood that some treasury department staffs have turned over entirely since the financial crisis, treasury professionals have had to become more sophisticated and strategic in the way they manage cash holdings. The recent surveys all mention cash segmentation, and as a cash-management strategy, segmentation certainly isn’t new, but in a post-reform, rising-rate environment it has changed significantly, and the surveys – particularly the AFP Executive Summary underwritten by J.P. Morgan – demonstrate that change.”
Formerly, he continued, the first of three typical segmentation “buckets” would be a prime money-market fund; a separate account or a managed account would be the second bucket; and some kind of short or intermediate bond fund the third. For many treasurers currently, though, the first and most liquid bucket will be a bank deposit or government fund that offers T+0 settlement, the second would be a prime money fund, and the third a separate or managed account.
Linton stressed that money-market-fund reform has reinforced the role that government funds have played historically – providing “near-absolute liquidity.” In the new environment, he said they are likely to continue playing that role alongside bank deposits, though he envisions a somewhat different role for prime funds. “Even though prime funds will be very liquid and in most cases provide same-day, or T+0 settlement, most treasurers won’t consider them for their first liquidity bucket anymore, although the 30+-basis point pick-up over government funds – which is a very meaningful gain and one that is likely over time to increase – will make them attractive to treasurers.”
The prime-over-treasury spread advantage is not likely to precipitate a sudden return of cash to prime funds, however, Linton maintained. “As institutional clients get more comfortable with the floating NAV and as they see that funds will be managed in ways that will avoid the imposition of redemption gates or fees, some money will move back into prime funds, but that will happen slowly.”
Uncertainties in the post-reform economic environment and perceptions of the different risks presented by all investment products, among other variables, help explain the interest among treasurers in revising investment policies to include previously-impermissible instruments, which each of the three recent surveys reported. “The revision of investment policies is an evolving and ongoing process,” Linton pointed out. “Many policies were written well before the financial crisis and therefore restrict some of the new products, including those with floating NAVs.”
Stibbe added that while policy revisions typically expand the range of permissible investments and provide needed flexibility, new policies are crafted carefully “to ensure they have the appropriate risk framework and that investments will be diversified across asset classes.” Many revised policies “institute strict concentration limits on the percentage of investments allowed to certain asset classes and industry segments, such as financials,” she noted, and for money-market funds “a majority of investment policies set counterparty limits as a percentage of the fund’s total assets as well as requiring minimum fund sizes.”
Some investors, Linton and Stibbe acknowledged, will remain uncomfortable with the reform-related restrictions on prime money funds, and their investment strategies for very short-term as well as for medium- and longer-term cash investments may rely more heavily on a mix of alternative instruments – including separate accounts, direct investments, and new bank products that may be able to compete on liquidity and yield with money-market funds.
“Our view is that no single investment instrument will be right for everyone, but to cite one example, we’re seeing demand for separately-managed accounts, although they can be difficult to set up and include some restrictions. So while they’re unlikely to replace money funds, they might supplement them. Short-term bond funds offer opportunities but come with some additional volatility, don’t settle on a T+0 basis, and are typically less liquid than some other instruments. Even direct investing may not be feasible for some treasury departments.” Complicating the investment decisions for treasurers, the utility of all potential investment products, including bank deposits, can change significantly depending on economic conditions and cycles, they said.
Both J.P. Morgan executives expressed confidence that, in the current environment, money funds are likely to remain reliable products for the investment of short-term corporate cash. They noted, however, that even if a treasury department isn’t quite ready to use new investment products, changes in investment policies that permit their use will position institutional investors to implement them when, or if, they think the time is right.
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