« Lower for longer »

Persistent negative interest rates (in EUR) force asset managers to reinvent their business model to focus on a "more dynamic" cash management model to avoid value destruction that a (too) prudent short-term placement would imply. Taking an assured dry loss or preferring an investment with relative positive returns and limited volatility is a real strategic choice to consider. It is not simple or neutral and difficult to sell to an Audit Committee or CFO. Beyond standing idly by...

It's just a catchphrase...

This could be the title or chorus of a pop song from the charts. A heady chorus and a rhyme, a refrain repeated to excess ... Yet we must get used to this risk and the idea that rates are not ready to rise immediately and even if they go up again, they would do so smoothly and at a pachyderm pace. So, we need to demonstrate patience, who is the mother of virtues, but not the one cultivated by the treasurers... How to do better or his/her best with sub-zero rates? This is the impossible equation that we are being offered. The Japanese have known this for well over 20 years. The ZIRP or "Zero Interest Rate Policies" have shown their limits. The ECB went even lower than the ground floor in terms of interest rates. What would be the reasons to believe in rising rates as populations age, the economy is still slowing down, the cost of living is already very expensive, and States are over-indebted.

This is indeed a Cornelius dilemma to be solved. How can inflation be avoided while boosting the economy and employment? Central banks are desperately trying to stimulate their economies without really getting there and after using an incredible and unprecedented fighting arsenal. The policies of NIRP and ZIRP have shown their limits, I fear. An instrument that is supposed to be temporary, such as quantitative easing (i.e. QE), becomes permanent. It is the central banking world that is upside down. I don't think we should expect much from that side. So, what do we do?

The challenge of corporate investors "long" in cash

Corporates face a huge challenge: how can we explain that managing prudently excess liquidities destroys value? They desperately hunt for value and yield without getting there. Worse, they lose money by doing "well" (at least they believe they do well). So, what could we do to change this? Putting a little more risk in your wallet? Increasing durations? Lowering credit rating limits of our counterparties? Some have already invested in long-term bonds and Govies. However, with a good counterparty risk the return is hardly better, and even often, still negative with, as a bonus on top, an intermediate volatility for those who report in IFRS (because of quarterly mark-to-market valuations). This interim volatility arises even if they keep the bonds until their redemption. The classic dilemma between more returns at the expense of increasing risk is always the same. Does the additional risk justify the higher marginal return? That’s the key question!

The solution if you want to avoid destroying value (caused by negative rates) would be to slightly change your strategy. Investment in longer bonds has been tested and became now unproductive. Corporate bonds could help extracting more yield providing rating tolerance is low(er). Its investment policy must therefore be reviewed if it is to free up and extract yield and obtain a minimum return or at least a result above EUR zero.

"Corporates face a huge challenge: how can we explain that managing prudently excess liquidities destroys value?"

It's time, it's the moment!

 

Isn't it time to completely revisit your investment policy? The problem has only lasted too long and it will continue. To do nothing or propose nothing to a CFO and Board would be pure folly. Timing and motivation come together to finally allow new investment strategies to be more aggressive without being messy or reckless. It is high time to try to put in place more dynamic strategies with “positive return” potential, at the risk of perhaps not winning at the end. But it's better to try than to lose for sure, isn't it? The treasurers seem to me to be ripe and the right time to try to change its short-term investment strategy gradually and to test new solutions and different strategies.

 

Volatility, when you hold us!

Volatility in financial terms, the Greek letter sigma, means the degree of variation in a series of prices processed over a defined period, measured by the standard deviation of income. It measures the price change of an asset over a defined period. The wider the price range, the greater the volatility. When short-term rates are at minus 0.55%, it is no longer volatility but proven and realized losses, accumulated/accrued over time. If you are willing to accept a firm 0.55% loss, why not accept a contained volatility of say 0.55% (over the entire portfolio) by accepting other asset classes with more volatility than deposits or MMF’s to in total reach an acceptable portfolio volatility? And let's apply (greater) volatility to longer-term products on more "strategic" tranches. Isn't that common sense? Yet it is so far from the spirit of the treasurers...  In total, the average volatility could be less than the insured loss percentage (i.e. ESTR rate)? Let’s be "disruptive" too in our liquidity management to avoid the risk of simply seeing the damage. A doctor is not there to keep the patient alive but to cure him/her, right? The treasurer is the doctor who keeps the patient alive without seeking to cure him/her. The comparison is certainly strong but illustrates the spite of some peers in the face of an inescapable and lasting situation, alas.

Segregation of available assets

I really like the theoretical and academic idea of cash segmentation. If the company and its CFO can determine within the total liquidities and excess cash what is daily needs (very short term), operational needs (short-term), cyclical needs (medium-term) and strategic needs (long-term), its funds can be better managed. If you see your bank as private investor, it will ask you for your savings what is your time horizon? We don't ask the same questions to treasurer. CFO’s would certainly answer that “everything is to be kept very short-term” (just in case) and hyper-liquid. A nonsense to be corrected in the first place. If you define an investment pool and segregate in tranches according to the length of availability, you can already invest better. A perfect cash-flow forecasting, and an optimization of flows concentration is a first step. Technology allows us now to better optimize our flow concentration. There are also FinTech's offering innovative products or platforms to broaden the spectrum of cash investment products (e.g. Treasury Spring). Let's use them. Having to explain lost money is already complicated. Explaining to the CFO that your good management cost let’s say 5 million, for example, out of an average of 950 million cash placed at ESTR (constant rate hypothesis). The energy spent explaining losses, while management of liquidities is sound, could be more judiciously allocated to selling more "dynamic" products. The stakes are worth it. The context has changed and the risk of a bank deposit or long-term bond (if rates go up) seems to me worse than more diversified and segregated management. Why not investing in corporate debt funds, for example?

 

The alpha and the omega

The alpha in finance measures the performance of an investment portfolio against a reference value, for example the ESTR/EONIA for short term investments. This is the degree to which the investor has successfully outperformed the benchmark, or not. It can therefore be positive or negative. Beta tells us whether the underlying is more volatile (or less volatile) than the market. So, amplifying your alpha is a goal of any asset manager (up to a certain predefined risk tolerance/appetite). It can only be achieved by a (partly) differentiated strategy and a combination of money market funds and longer-term underlying assets or funds, including maybe corporate debt too. Unfortunately, the miracle recipe and the universal panacea do not exist. You will need to be patient and gradually try to infuse a more dynamic management portion to convince your management of the relevance of such a dissociated and new strategy. We cannot stay motionless and simply tolerate losses caused by negative rates. It is the only parade I see without taking reckless risks that no one would want to take.

François Masquelier, CEO, Simply TREASURY