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Nice Fit: A Matched Portfolio With a Hybrid Management Model

By October 29, 2020 No Comments

The benefits for one corporate of matching portfolio cash flows to debt payments and using internal and external managers.

Matching assets and liabilities, a staple of pension fund managers, is central to how one NeuGroup member runs his technology company’s treasury investment portfolio—or at least a big chunk of it.

  • At a recent NeuGroup meeting, the member explained the benefits of the matched portfolio strategy as well as the advantages of what the company calls a hybrid management model—using internal managers for segments of its total investments and external managers for other segments.

Playing the match game. Treasury currently uses about half of its total portfolio to create an asset-liability match for its future debt maturities, helping to reduce interest rate exposure and eliminate refinancing needs, the member said, adding that, “It’s really an ALM portfolio.” The company calls the other main segment its strategic portfolio, which has its own objectives.

  • Matching various characteristics, including duration, key rates and the mix of fixed and floating-rate debt produces a consistent stream of net income and provides “natural” maturities in advance of pending debt repayments. 
    • “We don’t need to rely on liquidating bonds to pay our debt,” the member said. “We have that steady stream of maturities providing the cash to pay it off.”
  • The matching strategy also covers interest payments. “So when interest rates were rising, our floating-rate debt payments were rising, but so was our income,” he said.  “That was very helpful in smoothing out cash flows and P&L impacts.”
    • “Some of our peers issued fixed-rate debt at what they thought were low rates, but got whipsawed when rates dropped on their cash and they suddenly had a negative net interest margin,” he added.
  • The member showed a slide indicating that both yields and durations are about equal between the assets and liabilities. But at any particular point in time, the asset duration could be equal or slightly below the debt duration.
    • “It’s impractical to find bonds that mature on the exact same day as a debt repayment, so we would typically hold bonds that might mature a few weeks or months beforehand and sit on the cash temporarily until it goes to pay off the debt,” he explained. The company excludes long-term debt, including 30-year bonds, from the matched portfolio.

When matching makes sense. The strategy works best for companies that have more cash than debt and intend to pay down the debt, the member said, drawing a comparison with pensions.

  • “Pensions that are still open and growing liabilities are going to invest differently (more growth assets) than pensions that are winding down,” he said. “The ones winding down are going to de-risk and immunize by investing in matching bonds. That’s what we’ve done thus far.” 
  • An investment manager at another corporate told NeuGroup Insights, “That approach would make sense if I expected to be paying down debt and the maturities didn’t stretch too far into the future (maybe five or six years?). Many companies (including mine) are not paying down debt.”

What’s inside. Most of the matched portfolio is invested in short and intermediate-term credit managed by external fund managers in “target maturity” term funds.

  • For example, the company might have debt maturing in late 2023 and could set up a target maturity fund to be managed externally with bonds that would mature in 2023 or leading up to that date.
  • Part of the matched portfolio is invested in US Treasuries, which the company manages internally. 
  • “I think high quality corporate bonds and treasuries are the best way to match a portfolio with a debt payment schedule,” the member said.

The hybrid model. The company splits the management of its total portfolio—matched and strategic—roughly equally between internal and external managers. The decision of who will manage which asset classes is based on:

  1. Resource intensity—Does the company need in-depth credit research and full-time traders?
  2. Trading dynamics—Can the company get price transparency and best execution with online systems?
  3. Stability of balances—The company believes outsourcing is less effective when fund balances fluctuate.
  4. Fees

Hybrid highlights. The hybrid management model, as used by the member company, may be best suited to companies that have reasonably robust internal and external management capabilities.

  • The model “creates a fluidity of knowledge, where we can learn and share best practices and get partnership value from world leading fund managers,” the member said.  
  • As for any relationship between using a hybrid model and managing a matched portfolio: “I would say matching opens up some opportunities to use your internal capabilities to fine-tune what the managers are doing in the target maturity funds.”
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Justin Jones

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