The market’s recent turbulence signals
the need to revisit short-term cash
investments. Not long ago, investors were flocking to high-yield instruments. Now
the pendulum has swung back in favor of less
risky strategies. Successful liquidity management involves striking a balance between
retaining accessibility to cash and earning
predictable income from excess funds.
“Organizations need to understand what
their cash needs are to determine how active
or passive they want to be with their investments,” says Scott Horan, Vice President and
Group Product Manager for Treasury
Management at PNC Bank.
Smart Business spoke with Horan about
the different types of liquidity, how the investment approach varies for each type and how
to best strike a balance between risk and
return when making short-term investments.
How has recent market turmoil affected how
organizations manage their short-term cash?
When you look at what clients were investing in six months to a year ago, there was a
lot of talk about higher yielding instruments,
such as enhanced cash funds, cash plus
funds and auction rate securities. However,
auction rate securities had problems in that
they were no longer considered cash equivalents. And enhanced cash funds and cash
plus funds have had their liquidity problems.
In response, clients that were the most
aggressive have generally backed up one
level on the risk scale.
The other thing that we’ve seen clients do is
reorder their short-term cash investment criteria. It used to be that No. 1 was return, liquidity was a distant second and safety a very
distant third. Now the order has been completely reversed: No. 1 is safety, No. 2 is liquidity and No. 3 is return. People are more
concerned about the return of their money
than the return on their money.
What are the different types of liquidity, and
how does each investment approach vary?
There are primarily three different types of
short-term cash: operating cash, reserve cash
and strategic cash. Operating cash is not very
predictable and tends to be what a client has
in his or her checking account or in very
short-term investments. Usually, with this type of cash, investments are pretty conservative and somewhat passive. Reserve cash
is the amount of cash — outside of operating
cash — that a client always wants to have on
hand. For example, clients may know they
need $1 million on hand in cash from an operating perspective, but they never want to be
below $5 million because they want a little bit
of cushion, or reserve. Typically, reserve cash
is kept close to hand but may be directed to
short, liquid investments like a money market mutual fund. Strategic cash tends to be
longer term but not normally out past a year.
Perhaps you have a certain amount of cash
that you know you’re going to use to buy a
building or equipment. You don’t want that
cash to sit idle, so in this kind of situation you
might be willing to lock up the cash in order
to get a better rate of return.
What are some typical investment options for
short-term cash?
There are three broad categories to choose
from when investing short-term cash. The
first category is individual-type securities,
such as Treasuries, U.S. Government agency
bonds, variable-rate demand notes, auction
rate securities and commercial paper. The
second type is a pooled investment, such as a money market mutual fund. With this option,
the risk is diversified and you receive a blended return. The third type of category is bank
liabilities. This includes bank repurchase
agreements, bank time deposits, including
certificates of deposits, and bank money
market deposit accounts.
How can a business strike a balance between
risk and return with short-term investments?
It is important to document your investment guidelines and policies. We talked earlier about return, liquidity and safety. An organization needs to determine what is most
important to it. By understanding how to
manage these three criteria and understanding the investments themselves, a company
can effectively balance risk and return.
In the current environment, what steps
should a company take to re-evaluate its
short-term cash position?
If a company has already established its
investment guidelines and policies, it should
revisit them. If this information isn’t documented yet, it is important to start the process. This includes defining desired maturities, comparing current investments, understanding the ratings of the investments and
examining diversification within the portfolio. These steps help to ensure that an organization’s investments are appropriate. <<
This article was prepared for general
information purposes only. The information set forth herein does not constitute legal,
tax or accounting advice. You should obtain
such advice from your own counsel or
accountant. Under no circumstances should
any information contained herein be used
or considered as an offer or a solicitation of
an offer to participate in any particular
transaction or strategy. Opinions expressed
herein are subject to change without notice.
Bank deposit accounts are provided by PNC
Bank, National Association and PNC Bank,
Delaware, which are Member FDIC.
Certain non-deposit investments are not
insured or guaranteed by the FDIC or other
government agency, are not deposits or
other obligations of, or guaranteed or
endorsed by, any bank and may lose value.
© 2008 The PNC Financial Services Group,
Inc. All rights reserved.
SCOTT HORAN is Vice President and Group Product Manager for Treasury Management at PNC. Reach him at (412) 768-9910 or
[email protected].