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Reputation, Security, Liquidity & Yield

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  • by Editor
  • in Blogs
  • — 10 Jan, 2012

I was reminded recently of the hedge fund manager who was asked at a conference how he thought local authority treasurers should manage their reserves in the wake of Iceland. He was speaking on a panel of distinguished economists and investment experts all of whom, when asked the same question, were unified in their response: diversify, diversify, diversify.

Taking the only free lunch in investing, as diversification is often referred to, was the one piece of advice the panel felt able to give. Until that is, the hedge fund manager had his say. Now hedge fund managers aren’t well known for turning down free lunches and it is, of course, by virtue of holding diversified investments that they manage (sometimes) to ‘hedge’ away certain risks.

But this hedge fund manager was not being asked how he would manage a large portfolio of cash but how he thought local authorities should. And his answer was revealing. To paraphrase, he said: if you, the local authority treasurer, construct a really clever, well diversified cash portfolio that yields a respectable return then nobody is going to thank you for it and you won’t get paid any more than you would have done anyway. If you lose money – particularly any money with a foreign bank – then you’re in big trouble.

Organisational and reputation risk are very real problems if you are responsible for investing public money and anyone who experienced the BCCI and Icelandic episodes will remember the reaction from the press and public and will probably tell you that it wasn’t much fun. Some will even tell you it affected them personally and professionally. So, quite naturally, managing the exposure to those risks has tacitly entered the decision making process in local authority cash management.

There’s a theory doing the rounds at the moment that if you lose money with a UK high-street bank that goes belly-up, assuming one would ever be allowed to go belly-up, then the fallout is going to be so colossal and widespread throughout the UK that local authorities will not be singled out. So from a reputation standpoint, UK high-street banks are a pretty safe place to be.

The questions though is, are they any more secure than, say, Australian banks, Canadian banks or even U.S. banks? Well, it seems highly unlikely that the UK Government would let UK local authorities lose money in UK banks. But, arguably, a more internationally diversified portfolio of cash may be more secure than one concentrated in a single currency. If that’s the case then ‘security’, the most important of the DCLG’s watchwords for treasury managers is perhaps playing second fiddle to an expedient investment strategy that seeks to limit the professional damage that comes with losses, such as those to Icelandic banks.

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