In my February 2021 blog post, Anchors aweigh at the short end?, co-authored with my colleague Caroline Casavant, we shared our outlook for short-end interest rates and short-duration credit assets, along with an idea on how to diversify liquidity sources through exposure to short-hedged non-USD government bills.
By way of follow-up here, here’s an actionable implementation strategy for investors to consider: “Tier” cash-management buckets and select investment components for each tier to enhance yield on excess cash balances.
An actionable strategy
Given today’s historically low interest rates, many clients wish to boost the yield on their operating cash, but without compromising the important role of cash as a source of portfolio liquidity. We believe the answer may lie in “tiering” one’s cash investments to ensure the continued availability of desired liquidity, while also prudently taking more risk (as appropriate) with excess cash balances in seeking to earn a higher rate of yield.
Institutional clients typically maintain a highly liquid, ultralow-risk bucket of “cash on hand” — their tier one — in some combination of bank deposits and/or government funds. As many of these clients know all too well, the trade-off is that most tier-one cash generates little to no yield in the current low-yield environment. For more on that, see Thoughts on cash management with rates near zero, authored by my colleague Jeff Saul, Manager, Investment Treasury & Investment Implementation, EMEA.
However, if clients are willing to assume a higher risk tolerance with their excess cash balances, they might consider reallocating a portion of that excess cash from tier-one to tier-two (“reserves”) and tier-three (“surplus”) buckets, where they can potentially increase their level of income by adding more duration or credit risk. Of course, this approach comes with a trade-off as well: Higher income (yield) means greater risk and less certainty around availability of cash funds during periods of heightened stress in the markets.
To balance and mitigate the risk, we believe it makes sense for many clients to dynamically adjust their cash buckets over time as the yield environment and their individual circumstances change. For example, this could take the form of: 1) engaging with their asset manager to allow liquidity to naturally build as the cash portfolios roll down; or 2) actively beginning to liquidate tiers two and three and moving back to tier one as their cash needs evolve.
No one size fits all
We are sure of one thing — there is no “one-size-fits-all” solution in the cash-management space. The proper allocation of assets among different cash tiers will depend on a number of factors, including: confidence in (and potential variability of) one’s cash needs, operating-entity risk tolerance, investment time horizon, and macro headline risk, to name a few.
Figure 1 provides some potential solutions for clients to think about as they develop a cash-tiering strategy. However, clients should work with their asset managers and consultants to create a strategy that is customized to their own needs.