‘Chasing yield’ not the best strategy as negative rates loom

Bank of England. Photo: Robert Bye, Unsplash

Recent speculation that the UK may be heading toward negative interest rates prompts questions at LATIF for treasury officers managing local authority funds.

Speculation is rife that the UK may be about to see negative interest rates. This week, local treasury officers are warned to maintain their focus on “security, diversity and liquidity” and avoid the “chase for yield” amid dwindling prospects for a return on investments.

With the official Bank of England rate at 0.1% and concerns that it may see further cuts, treasury officers are under pressure to ensure local authority money is working as hard as it can. But discussion this week at  Room151’s Local Authority Treasurers Investment Forum (LATIF) suggests that a return may not be the most important consideration.

According to Dennis Gepp, managing director and chief investment officer at Federated Investors, treasurers may want to put aside their concern for returns. Speaking on the subject of money market funds, he told the conference that he does not expect rates to rise for the “foreseeable future” and added that he had “given up” on a rate rise in 2021. With hopes of a return on short-term cash dashed, he says there are other issues to weigh.

“If investors will not receive meaningful returns from short-term cash, they need to ensure that they are still getting security, diversity and liquidity.”

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Pessimism about the prospect of returns on cash deposits has increased as speculation has intensified that the Bank of England may be heading toward negatives interest rates.

Just days ago Silvano Tenreyro, a member of the Bank’s monetary policy committee, gave a speech  in which she said negative rates could boost the UK economy prompting a slew of follow-up article from economic commentators.

“My overall assessment is that, while we can never have complete certainty, negative interest rates should with high likelihood boost UK growth and inflation,” Tenreyo said.

She added the current low rates have “helped loosen lending conditions” and said: “I believe further cuts would continue to provide stimulus.”

The subject has been well rehearsed elsewhere as the Bank considers the pros and cons of going negative. Victoria Worsfold, 151 officer at Guildford council, says one of the key topics of discussion for the Bank of England’s money market committee, on which she serves,  “is what the potential impacts of negative rates may be.”

Chasing yield

Undoutedly, low rates pose councils with hard choices when it comes to placing short-term cash. Gepp warns against pursuing yield without considering the risks which, given the current economic landscape, may exceed the potential return.

“I appreciate it is very tempting to look for yield, especially when interest rates are near zero. However, the risks of chasing yield are higher than they would normally be,” said Gepp. “The problem is that when interest rates come so low the margins between the greater risk and the lower risk get minimised.

“So, you do not get the additional return for the additional risk that you’re taking The risk of losing cash is greater than losing one or two basis point on the return of your cash.”

And looming over the whole discussion for treasurers is what happens to local government cash if rate go negative.

Some have already thought the problem through and are less concerned. According to Tim Seagrave, group finance lead at Manchester City Council, his authority has developed a “strong understanding of its own approach”.

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“We’re not in there to chase yield,” says Seagrave. “We know we’re using it to manage short-term cash flow. For us it is a relatively easy choice; the challenge of negative rates is difficult but relatively minor compare to the other treasury risks that we face.”

However, he worries that some local authorities are vulnerable because they rely on investment yield to “balance their books”.

There are also concerns that money market funds might start producing negative returns. Many, including Victoria Worsfold, may be wondering how the returns might be kept positive or how long returns would be close to zero.

Gepp says the answer lies in MMF’s not being entirely invested in overnight transactions—instantly vulnerable to any interest rate moving—but spread against assets which produce a weighted average life of around 50 days. Only between 20 and 40% of portfolios are maintained in instant or weekly liquidity to be available for investors.

In common with other money market funds, Gepp also says in the event of return entering negative territory because of a fall in gross yield plus the cost fees, Federated has put in place fee “waivers” to ensure investors receive at least one basis point return.

If official rates go negative, he added, there is a process in place to ensure the money market fund “can continue to remain available to all our clients, even at negative yield.”

The prospect of negative rates is unlikely to diminish any time soon. While it remains, councils will continue to explore ways of protecting their cash.