An enhanced cash layer helps one cash investment manager fund M&A deals while earning better returns than MMFs.
A so-called enhanced cash category whose size can expand or contract like an accordion depending on anticipated outflows—including spending to finance M&A deals—is one of three layers of liquidity with differing durations described recently by a member of NeuGroup for Cash Investments at the group’s fall meeting in New York. The other two layers are operating cash and strategic cash.
- “We need to have different layers of liquidity to support these targeted outflows; almost think of it as a short-term LDI,” the member said, referring to a liability-driven investment strategy of investing in assets to meet specific financial obligations.
- The presentation included a grid to illustrate the company’s strategy for setting the durations for enhanced and strategic cash investments. Treasury uses mandates for separately managed account (SMA) managers who invest strategic cash, broken into four tiers with lengthening durations.
Not a hedge fund manager. The member made clear that while the context of the presentation was how his team factors in interest rates and invests along the yield curve, capital preservation and liquidity are his North Star when it comes to investing cash.
- “I’m not paid to take big risks,” he said. “I’m paid to make sure the cash stays safe and we don’t lose money—not to be a hedge fund wizard.”
- That point was underscored by his list of treasury’s capital allocation priorities, with cash investments placed last, following these top three objectives:
- Supporting the company’s business through organic growth (funding R&D, for example) or inorganic growth like M&A.
- Supporting the company’s capital structure by helping maintain a higher credit rating that will minimize interest expense, helping achieve metrics for operating cash flow and free cash flow.
- Capital return to shareholders.
Target duration for cash. The member seeks to maintain a target duration for the blended portfolio of cash investments of approximately one year with limited credit risk.
- “Our thought process behind one year was that a FP&A cycle is generally one year,” he said. Another factor is that large M&A deals generally take about a year to close, he added.
- The need to finance M&A deals affects the duration of the blended portfolio, the member noted. Knowing a large transaction will close by the end of this year, for example, would require keeping current durations shorter, limiting investments farther out the yield curve.
Enhanced cash. As the graphic above shows, the enhanced cash layer of liquidity holds assets that are also held by the operating and strategic cash layers: Money market funds (MMFs) and time deposits overlap with operating cash; and Treasury bills and commercial paper (CP) with strategic cash. Here’s how the member described enhanced cash:
- “We have money we know we’re going to use in eight, nine, 10 months that we don’t necessarily want to put out the curve and have rates go the wrong way on us; so we will use this enhanced cash in order to beat money market funds, beat time deposits, but also diversify a little bit out of banks and bank exposure.”
- The percentage of the overall cash portfolio held in the enhanced bucket fluctuates as M&A and other outflows ebb and flow, with more held in enhanced cash when, say, deals are expected to close relatively soon. The target duration for enhanced cash is three months.
- “We’re obviously concerned with performance, but we’re not necessarily having strong views on duration with this enhanced cash layer,” the member said. “We’re really targeting large dividends, large tax, M&A, those types of big outflows.”
A tiered duration strategy. The four tiers of strategic cash invested by external asset managers range in duration from six months to 2.5 years. One advantage of this tiered approach to target duration, he said, is that managers are not buying the same securities.
- The SMA managers are allowed to adjust duration up or down by three months relative to their benchmark. “That gives them the flexibility to outperform,” the member said. Each mandate has an average credit rating it must maintain.
- The mandates also have their own guidelines that must meet the company’s global investment guidelines. “As long as we give the managers mandates that are in line with that global guideline, we can write the mandates as needed, which is super helpful because then you can be a lot more flexible with your managers as market opportunities happen,” he said.
No market timing necessary. The member concluded his presentation by equating the tiered duration structure to a “dollar cost averaging” approach to reinvestment. “Obviously, when you put new money to work, you should have some view on rates,” he said. “But always having this tiered structure allows constant buying of each part of the curve you’re targeting.
- “So if you’re letting this money kind of sit with these managers, you’re kind of getting the benefit of always being in the market at these different durations as opposed to being some sort of hedge fund guru and calling rates.”
