Whether you’re a grandparent or the CFO of a Fortune 500 company, for the past 40 years you have had basically four choices to manage your excess cash:
• deposit it in a bank
• invest it in a regulated money market fund
• purchase short-term government securities, such as Treasury bills
• put it under your mattress.
Choosing one or more of these options was straightforward. But chronically low nominal yields hovering near zero percent and recent regulatory changes mean investors need to reevaluate how they manage their cash in an effort to secure attractive returns while preserving capital that they will need for important outlays, such as paying quarterly taxes or payroll.
Since the 2008–’09 financial crisis, regulators have sought to make our financial system stronger and more resilient. Their efforts have most recently resulted in profound changes in short-term markets, which had proved extremely vulnerable after the failure of Lehman Brothers Holdings in 2008. These changes — the most significant since money market funds were first introduced in the 1970s — are now becoming a reality for larger institutional and smaller retail investors alike. When surveying the new landscape, investors need to consider the following points:
Banks may not want your money and may now turn away select customer deposits. In fact, JPMorgan Chase & Co. recently announced that it will look to reduce more than $100 billion of deposits from its balance sheet. Alternatively, others have suggested that they may charge clients a fee to maintain their balances because of the higher regulatory costs associated with maintaining those accounts.
Money market reform is here. Following reforms announced in July 2014, several large money market fund managers recently announced shifts to their fund lineups, including converting some prime funds, which invest in companies’ short-term debt, in favor of strategies that invest in government debt. Across the board, these changes mean that regulated money market funds may have fees for or limits on withdrawals during times of market stress. Institutional investors specifically will need to consider the risk of investing in prime money market funds in which their principal is no longer pegged to a $1 fixed net asset value.
Demand for short-term assets, such as Treasury bills, will only increase during the next few years as managers of money market funds gravitate toward government debt over corporate credit, making it difficult for yields to rise above the infinitesimal levels where they sit at present. Moreover, even after the Federal Reserve begins to raise rates, money market yields will likely continue to be depressed as managers try to recoup fees they have been forgoing in a zero-bound market. That will make these funds even less attractive on a relative basis, and even more so as rates begin to normalize.
So, is it time to buy a bigger mattress? We think not. Not only is cash really not that comfortable to sleep on, it won’t generate any returns if it’s socked away at home.
Investors will need to rethink their cash-investing paradigm. Managing cash is more than passively investing in a laddered portfolio of T-bills and bank deposits. Having a partner who understands the facets and tools of liquidity management — including credit exposure — is not the luxury it once was but is increasingly essential. Investors should seek expert advisers not only large enough to manage a variety of liquidity needs but also active and nimble enough to adapt continuously to the coming changes in cash management.
Whether one invests through diversified short-duration mutual funds, exchange-traded funds or separate accounts, now is not the time to be sleeping. The changes we have witnessed in the past several weeks should be a loud and clear wake-up call for investors big and small to reassess their cash management blueprint to strive not just for higher returns but to do so with a focus on preserving the capital in their portfolios.
Jerome Schneider is a managing director in Pacific Investment Management Co.’s Newport Beach, California, office and head of the short-term and funding desk.
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