Beyond Bank Deposits and Money Market Funds
Ever since reforms inspired by the financial crisis required prime money market funds to float their net asset values, institutional cash investors have been searching for alternatives that will provide the same type of dollar-in, dollar-out liquidity, safety of principal and yield that the old prime funds offered. And now that the Fed’s interest-rate hikes are setting expectations for higher returns from corporate cash investments, treasury professionals are under growing pressure to consider entirely new portfolio strategies to achieve desired balances of liquidity, risk and yield.
This month’s Capital Advisors Group white paper, Comprehensive Cash Investment Strategies: Comparing Three Major Types of Investment Vehicles, provides a useful framework for crafting cash investment strategies in this new environment. Our report provides an overview of the recent changes in the two most popular traditional cash investment vehicles: bank deposits and pooled assets, such as money market funds. It also describes how a third investment vehicle—directly purchased short-term portfolios—is coming back into fashion and helping corporate cash managers meet their objectives.
The reforms to prime money market funds in 2014 and 2015 drastically reduced their usefulness for treasury professionals, prompting the biggest reshuffling of cash management vehicles we’ve seen in decades. By 2016, more than $1 trillion had flowed out of institutional prime funds while government money market funds increased by about the same amount. In the meantime, cash managers increasingly turned back to an old standby, bank deposits. At the end of 2017, cash deposit balances of nonfinancial corporate businesses had ballooned to $1.5 trillion, more than three times the $472 billion that remained in prime money market funds.
But bank deposit yields have lagged as the Fed has raised rates (see our June white paper, Deposit Betas Rising but Still Falling Short) and, while pooled-asset government funds provide liquidity and safety, the returns they deliver are often nothing to write home about. That’s why many managers are going back to the future by assembling portfolios of directly purchased assets, which were far more common before the creation of prime money market funds in the 1990s. Direct purchases require management and expertise—which can be developed in-house or supplied through separate accounts managed by a registered investment advisor – but they also provide control along with of higher return potential. A managed portfolio of directly purchased assets can help provide targeted liquidity and return through laddered maturity dates, and can help provide safety of principal through careful vetting of assets following a well-crafted investment policy.
The financial crisis, money market fund reforms, and the long-awaited return to a rising interest rate environment have presented new challenges for cash investment professionals. But they also offer new opportunities for those who think outside the box by considering new investment strategies that can help position their organizations for success in the new cash management landscape.