Money market obstacles trigger search for alternative yield
0by Dan Willson, head of Sector Treasury Services’ credit team
As we step forward in the new financial year, the constant search for a reasonable level of yield knows no bounds. While official interest rates have been at the record low 0.5% since March 2009, money market yields have remained somewhat elevated in recent years. This has afforded local authorities the ability to maintain a relatively defensive stance, but still generate a yield considerably in excess of a short-dated cash benchmark. There is a strong likelihood that this scenario will not extend into 2013-14.
While market risks have abated through the second half of 2012-13, they are by no means dormant. Recent issues in Cyprus and Italian politics have provided investors with clear reminders that risks remain, even if markets are now more resilient than they have been.
The general reduction in market concerns has lessened risk premia in money market yields. However, there have been several specific issues which have had a material impact on lowering sterling market rates over the last 6-12 months. These have included the provision of extraordinary liquidity provision by UK authorities. On this front we have had the Bank of England providing a regular monthly auction of six month monies via its Extended Collateral Term Repo Facility (ECTR) which commenced in June 2012. The second operation was the Funding for Lending Scheme. To date this may not have provided the desired impact of increasing the supply of credit into the “real” economy. However, it has provided institutions with a further glut of funding thus reducing their appetite for wholesale market deposits.
To this should be added the impact of increased regulatory oversight, with particular emphasis on institutions becoming less reliant on shorter-dated wholesale market funding.
With the Funding for Lending Scheme recently being extended for a further year and regulation hardly likely to return to “light touch”, these influences are likely to remain in place for the foreseeable future. It is also a given amongst forecasters that Bank Rate is unlikely to be raised for a number of years. As such, the only “hope” for higher money market yields in the near term would come from a fresh resumption of market stress – most likely from an “event” in the Eurozone – hardly a desired scenario.
What, then, can be done to address the deteriorating (or realistic) outlook for investment returns in coming years?
1. The importance of a clear understanding of your cash flow requirements. A complete picture is always an utopian dream, but do try to ensure that your investments are based on as accurate and reliable forecasts that allow you to make best use of your position, both in the present and also for the known future.
2. The second consideration is whether your overall level of cash investments is appropriate. Are there policy decisions that could be considered in terms of “invest to save” schemes which may not necessarily provide a “quick fix” solution, but could make better use of your resources over the medium term?
3. Is your current investment strategy appropriate? Are time and money limits reflective of your needs and also your individual risk appetite? Are you finding it increasingly difficult to operate a practical investment process without being “forced” into making investments they would not necessarily want to do?
4. Have you considered alternative investment instruments to run alongside or in place of more traditional money market transactions?
There are varying degrees of risks associated with a wider range of asset classes and these need comprehensive appreciation. It is not just credit risk that needs to be understood, but liquidity and interest rate / market risk as well, although these can often be intertwined. Any option in which an investor hopes to generate an elevated rate of return will almost always introduce a greater level of risk. By carefully considering and understanding the nature of these risks, an informed decision can be taken. Sometimes it will be to introduce new operations, but in many circumstances it may simply be that the risk/return balance is not suited or appropriate to local authority treasury management.
There are very few “quick fixes” available to investors in current market conditions. It is therefore important that not only are a range of options considered, but also expectations of senior personnel and Members are managed effectively.
