Yesterday, Room151 held a workshop for local authority cash investors which focused on changes to this year’s treasury management strategies. Afterwards, we caught up with session moderator Dom Piper, global liquidity executive director at JP Morgan Asset Management.
How are council treasury management strategies evolving?
What we are seeing – not just from a local authority perspective but across the board – is a greater drive toward segmenting cash investments. By that I mean taking a close look at the percentage of cash that has to be kept same day liquid vs. cash that can be put to work further out on the curve. This can be achieved by looking beyond AAA money market funds (MMFs) into enhanced type cash products or via separately managed accounts that can be tailored to a specific treasury team’s risk, return and liquidity requirements.
Economic pressures have kept yields low but as that eases there will be continued yield compression across financials driven by Basel III reform. Banks are effectively penalised for any short-term financing and this is already being reflected in both yield and supply. This is most acute when investing three months and in.
Diversification continues to be key, and I do not see a return to the days where a treasurer is content with simply splitting risk across a handful of relationship banks.
How are proposed EU regulations on money market funds affecting your investment advice?
During the workshop, a couple of councils raised concerns around MMFs no longer being an option available to them given impending regulatory change. This certainly is not an outcome we foresee, and any regulatory change that does come into play would take some time to be brought into force. MMFs may look a little different in construct 2 or 3 years from now, but investor demand for a pooled vehicle which instantly diversifies risk and provides an ongoing credit review process will not go away.
One potential outcome of regulatory change that was highlighted was a move away from stable net asset value to variable. This is a potential outcome and over the next year or so it would be wise for treasury managers to ensure that their investment guidelines support both fund types.
What alternative funds are available for local authorities?
In addition to AAA MMFs, we have an additional product which looks to increase duration while also taking on a little more credit risk. Additional return never comes without a corresponding level of increased risk, but with full transparency and understanding there is definitely a place for such product where same day liquidity and absolute day-to-day preservation of capital may not be required.
Should authorities look at deriving higher yields from investment in corporates?
There is limited supply of A1/P1 rated corporate names and as such they do not factor highly in the buy-list for our AAA Money Market Funds. We do look at BBB rated corporate names for our managed reserve strategy and this can provide a good diversifier to financials. Unlike financials, many corporations are happy to be BBB rated and are very capable of being able to service their debt on the short end.
Should the expectation of a rise in interest rates affect councils’ investment strategies
There was a poll in the room around expectations for a rise on sterling rates – I think there was a mixed view on when it will happen. JP Morgan’s view is aligned to the market – we believe a rise is likely in the first quarter of next year. If treasurers have a view that rates could rise more quickly than the market anticipates then the use of floating rate notes is a good way of managing interest rate risk, assuming they are able to get supply.
Have the bail-in regulations altered the treatment of systematically important banks?
Even if not compulsory, bail-ins impact perceived confidence in any implied government guarantee of bail-out and further underlines the need for a rigorous credit process. Bail-in may ease political messaging for the government vs. a bail-out, but would not be without other consequences across the financial markets.
How should local authorities be trying to maximise their investment yield?
While everyone has an eye on yield, it should not be the primary driver of an investment decision. A good starting point is to identify what an investor’s tolerance to loss is on a marked to market basis and over what period of time. If tolerance to loss is zero then an investor should not really be looking any further than a AAA government or credit fund style investment. If however they can withstand marked to market losses over a three to six month period then there are definitely options available to increase yield.
How can authorities hedge against headline risk?
The use of an asset manager effectively outsources a treasurer’s credit process and should look to reduce the potential occurrence of headline risk. It’s also useful to ladder maturities into the investments that are made. If a credit starts to deteriorate it’s useful to be able to reduce exposure by allowing maturities to naturally roll off as opposed to having to sell a security into the market facing a potential capital loss.
How are local authority treasurers changing in their approach?
All our investors, including local authorities, are more savvy now in terms of the investments they are exposing themselves to. If there is anything positive to come out of the financial crisis it is that treasurers now demand complete transparency from asset managers so they can take a proper view of what the underlying risk return dynamics are. This creates more work for a manger, but it does provide the opportunity to differentiate ourselves – not all money funds are created equal.