Are You Mature Enough?
The
portfolios of money-market funds may now be too liquid to suit all of a
company's cash-investing goals.
For many
treasurers and their bosses, prime money-market funds have provided enough
yield on investable cash during the past year and a half — enough while
interest rates have been so low, that is. But as a result of new Securities
and Exchange Commission rules for these funds, companies may now be paying an
unnecessary liquidity premium, says Capital Advisors Group, an
institutional-investment firm. That's because the changed compositions of
prime money funds due to the new rules could reduce the yield the funds earn.
After the height of the financial
crisis and the blowup of the Primary Reserve Fund, money managers moved into
shorter-term, more-conservative investments such as Treasury bills and time
deposits of financial institutions. They had to ensure that in a crisis they
could meet the same-day funds availability that money-market funds promise
investors.
The SEC's
new 2a-7 rules, taking effect this year, make money funds even more liquid.
Funds now have to hold 10% of their portfolios in instruments maturing
overnight and 30% in investments maturing within 7 days. Their weighted
average maturity (WAM) has to be 60 days or less, down from 90 days. All that
may help prevent fund meltdowns in the next crisis, but what if a treasurer
could construct a similar portfolio that was less liquid? Would the gain in
return be meaningful?
Back in
May, Capital Advisors estimated that U.S. prime money funds would
"relinquish" about 8 basis points due to the SEC rule changes,
based on historical money-market performance. The firm tested that hypothesis
in June, taking into account the current low-yield environment. It found that
extending the WAM of two hypothetical portfolios to 60 days and 120 days
resulted in 11 basis points and 31 basis points of added yield, respectively,
over a base-case portfolio with a 30-day WAM. (The base-case portfolio earned
a 0.24% average yield.) The portfolios were modeled on 15 AAA-rated prime
money funds and used the performance of publicly available bond indices in
the month of June.
The
message is simple: if a company doesn't need overnight liquidity, it can
increase returns by taking some funds out of money markets and putting them
in a managed or self-directed account. In the models, "we're not taking
on a lesser-rated security to get a higher yield," stresses Lance Pan,
director of research for Capital Advisors. "Just extending the maturity
gets you there." For example, the only difference between the 30-day and
60-day model portfolios was the replacement of all overnight repurchase-agreement
positions in the financial debt category with things like six-month
certificates of deposit issued by AA-rated U.S. banks.
Still,
there are caveats. The 120-day model portfolio, for example, leaves no
liquidity buffer for unplanned needs, Capital Advisors says. It is a
"supplemental yield-enhancing portfolio over and above a liquidity
vehicle such as a money market fund," says the report on the test.
Still, the report continues, "interest rate risk remains modest in this
portfolio, given the 180-day final maturities in securities and the market
expectations of no Fed tightening in 2010."
Pan stresses that "liquidity
budgeting" in this manner is merely a complement to money-market funds,
not a replacement. "This is a planned liquidity vehicle," he says.
"If you have a project [expenditure] coming due in 90 days, you buy
something that matures in 90 days." The downside is that if a company
needs funds in an emergency, it may be forced to sell part of its portfolio
before the maturity date — and it may have to do so at unfavorable prices.
"You're exposed to market fluctuations — that's the main drawback of
this strategy," says Pan.
Article was earlier
published in one of the reputed business magazine.
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