New realities of investing cash and liquidity: “What to do now?”

by Guest
in Blogs · Treasury
— 13 Jan, 2021

Image by Nattanan Kanchanaprat from Pixabay

Sponsored article: Brian Buck from Morgan Stanley Investment Management Global Liquidity looks at the “unique challenge” for cash management strategies.

As investors assess the ongoing impact of the pandemic on their business, levels of cash and liquid assets remain elevated. This combination of high levels of cash and very low and negative interest rates presents a unique challenge. At the foundation of cash management is balancing the desire for capital preservation and liquidity while still achieving attractive levels of income.

Best practice for cash allocations

When investing cash, the same basic principles should be followed, whether you are an individual investor or a listed company. A liquidity forecast likely shapes the risk appetite and investment objectives of your investment program. The ability to forecast cash with a reasonable degree of success has long-term benefits and may provide opportunities to adopt certain strategies while also mitigating funding and liquidity risks. As investors adapt their investment strategy to the new market paradigm, we believe an important aspect will be the ability to stratify liquidity.

Investors who can reasonably forecast their cash flows are better equipped to segment their liquidity into distinct pools, each with its own purpose and investment opportunity set.

More specifically, investors will likely need to segment their liquidity into balances that are needed immediately and those that are more stable. From there, the dispersion expands, as some have multiple longer-term cash tiers and others do not. These longer-term tiers can be tied to specific needs, construction projects, bond maturities or other purposes. Some have definitive end dates, while others are open-ended.

Hypothetical portfolio allocations

After considering your investment objectives and liquidity needs, portfolio allocation decisions can be made. As mentioned earlier, tying investment strategies to your cash flows is an efficient allocation plan, as it allows you to effectively manage the need for liquidity while improving diversification and obtaining potentially higher yields on longer-duration assets.

Below are three different liquidity portfolio options that address different risk, return and liquidity concerns.

Option 1: Most Conservative Model

All investments have daily liquidity and a stable price;
Lowest potential return, highest liquidity;
Ideal for investors with a strict focus on capital preservation and liquidity.

Option 2: Conservative Model

This introduces some credit risk and investments with floating net asset values;
Enhanced potential return, high liquidity;
A good balance across the key objectives of capital preservation, liquidity and yield.

Option 3: Least Conservative Model

This allows for customisation across investments and liquidity;
Risk/return characteristics can vary greatly by mandate as durations can range from one month to two years;
This is for investors who would like to own their own securities and have customisation over their investment account.

Selecting the Best Strategy for you?

Portfolio allocation decisions can be assisted by answering the following questions that touch on some key investors’ concerns:

How do you emphasize the different objectives of capital preservation, liquidity and yield?
How much daily liquidity is needed?
Do you have liquidity balances that are more stable and are not needed to fund daily operations?
Are there any accounting concerns?

Answering these questions will help identify the starting point for cash allocation and the key areas of focus for each investor. For example, those investors who need stable value investments and daily liquidity likely will need to use option 1 (above), while investors with more flexibility and risk tolerance can potentially move toward portfolio options 2 and 3.