More Than Zero
Battered by volatile markets and burned by flaws in structured debt, companies face hard choices about where to invest cash. They commonly have three priorities now, say experts: liquidity, capital preservation, and transparency. “If an investment has the hint of structure, treasurers will pass on it,” says Karl D’Cunha, a senior managing director at Houlihan Smith & Co.
But if the only investments that meet newly conservative investment policies aren’t returning anything above the 25 basis points that Treasuries paid in late February, does the finance department dare start thinking about yield? It’s a tough call.
“Monetary policy is begging you to take more risk. There’s no yield left for anything that is devoid of risk,” says Tom Luster, a co–portfolio manager of the Eaton Vance Institutional Short-Term Income Fund.
If a company simply wants a guarantee that its cash will be safe and believes that the U.S. government is a reliable guarantor, then by all means it should stash the funds in Treasuries. But if it wants to earn more than a bare minimum of yield and can live without an ironclad guarantee, there are a number of relatively safe, liquid alternatives — some with a degree of government protection.
One of the safest plays for corporate treasurers these days is putting money in demand deposit accounts to get the earnings credits that banks pay business customers. Such credits offset bank service charges. Also, because of the Federal Deposit Insurance Corp.’s new guarantees on these accounts, “companies get a commercial banking rate at a government risk level,” says Barry Barretta, a principal at Treasury Strategies.
Here are some other government-backed options that offer a risk premium:
Government-sponsored enterprise (GSE) debt. The discount-note programs of mortgage investors Fannie Mae and Freddie Mac, as well as the Federal Home Loan Banks, can be feasible substitutes for T-bills, says Lance Pan, director of investment research at Capital Advisors Group, an institutional-investment firm. The giant mortgage investors are under conservatorship through 2009. Although their debt doesn’t carry the explicit backing of Washington, experts say they are more than comfortable owning these notes in the short part of the yield curve. The New York Federal Reserve Bank is buying back GSE debt on a weekly basis, points out Brad Airing, managing director in short-term fixed income at Banc of America Securities. The notes, ranging from overnight to three-month maturity, carry slightly higher yields than Treasuries and are more liquid than many corporate names, Pan says.
Government money-market funds. These funds consist of debt issued by GSEs and government agencies. They earn higher yields than Treasuries. But government money funds also require more due diligence, Pan says. Some invest in government securities longer than one year, which can pose risks if shareholder redemptions rise or interest rates spike. In addition, because government money funds use repurchase agreements, investors need to be aware of the types of collateral involved (Treasury bills or something riskier) and what the fund’s policy is on overcollateralization, Pan says.
TLGP-guaranteed debt. By early February, banks had issued $121 billion of debt backed by the FDIC’s Temporary Liquidity Guarantee Program (TLGP), according to Moody’s Investors Service. While boards of directors might recoil at some of the financial names that have issued debt, the TLGP guarantee insulates investors from principal losses. The guarantee applies to debt issued prior to June 30. Many of the notes carry a two- or three-year maturity, a drawback for those concentrating on shorter maturities.
Institutional investors are returning to general-purpose, prime money-market funds, as money managers meet the market demand for greater liquidity. At Fidelity Investments, portfolio manager Kim Miller now has 40 percent of the assets in his funds in very short positions — within seven days, he says. “That’s sufficient liquidity for any outflow I could imagine,” says Miller.
Luster has shifted his Eaton Vance prime money-market fund to a greater weighting of Treasury bills and agency discount notes. They now make up close to half of fund assets. But he is also investing in time deposits of financial institutions that have the ability to issue FDIC-backed debt and buying commercial paper from select industrial corporations. “If Alcoa can’t roll its paper with investors, it can sell it to the Commercial Paper Funding Facility [CPFF],” Luster says. “That’s kind of a liquidity backstop for the money markets.” The Fed’s CPFF, another one of its programs to oil the gears of the financial markets, is buying three-month paper rated A-1 or above.
If treasurers do invest in prime money-market funds, though, they have to perform much more due diligence than previously, say experts. A typical money-market fund may hold a substantial amount of financial-institution debt, says Pan. “A good number of these banks will be survivors, but the margin of safety is very thin.”
Airing of Banc of America Securities says investors should assess five key aspects of a fund: the quality of the manager’s research capabilities, compliance with risk-management strategies, liquidity and shareholder concentrations, portfolio management in down cycles, and the strength of the sponsor. “Get an asset listing and monitor it,” adds Barretta of Treasury Strategies.
Sophisticated corporate treasury departments looking for greater yield and diversification are eyeing sovereign debt. That could work if other nations’ economies recover faster than the United States’s. But if you go this route, “be prepared to explain to the board why you bought Canadian or European debt rather than just sticking to U.S. Treasury bonds,” cautions Brian Weber, a senior associate at Houlihan Smith.
Investing in triple-A industrialized nations is far safer than investing in triple-A corporate debt, Pan says. “Do I trust the government of Ireland more than I trust corporations? Yes,” he says. “Because the sovereign entities have several ways to satisfy their obligations, like raising taxes and deflating currency, actions that corporations can’t take.” No one is suggesting, however, that all sovereign debts carry the same amount of risk.
Lastly, corporate bond spreads may tempt treasurers because their yield differential with Treasuries is near historic highs. But don’t forget the economic context, says Luster. A bond may be cheap and high yielding because the issuer’s business fundamentals are weak, he says, and “the value opportunity might actually be a value trap.”
Vincent Ryan is a senior editor at CFO.
By Vincent Ryan