The landscape of short-term investments has undergone significant transformation, propelled by a dynamic shift in interest rates brought on by a period of spiraling inflation. In the summer of 2023 Northern Trust Asset Management (NTAM) partnered with Treasury Management International (TMI) for their 2023 Liquidity Survey, where corporate treasurers, globally, voiced their challenges, opportunities and strategies for navigating these changes. This report delves into the insights provided by treasurers and provides updated comments on the current interest rate outlook from the subject matter experts at NTAM, particularly the Federal Reserve’s determination to tackle inflation and the benefit of different perspectives on cash management approaches.
Corporate Treasurers’ Perspectives on The Fed and Interest Rates
In a year marked by historic rate hikes and still-elevated inflation, 41% of respondents to NTAM’s mid-2023 survey considered rising interest rates as their primary concern, while 15% were focused on inflation. So, not surprisingly, 42% of respondents indicated that, given their interest rate views, they would likely reduce the duration or interest rate risk in their portfolios, with only 17% of respondents thinking at the time that they would take on more interest rate risk.
Applying the findings of the 2023 survey to the conditions we now face in early 2024, the picture has changed significantly with central banks at the summit of their rate hiking cycles, the question is leaning towards when, not if, rates cuts will begin. Given this sentiment, it is not surprising to see corporate treasurers and other money market investors adding duration to their portfolios in the early part of 2024. But the pendulum may have swung too far. Antulio Bomfim, head of global macro with NTAM, says “the market jumped too quickly into the rate-cutting bandwagon. For instance, while we agree that the Fed and the ECB are very likely done raising rates, the transition to rate cuts will likely be longer than currently priced in.”
The January 2024 Fed meeting again left rates unchanged suggesting that the federal funds rate had reached its summit, with Fed chair Jerome Powell saying the historic tightening of monetary policy is likely over. In an interview at the beginning of this month, Powell stated that the Federal Reserve was on track to cut interest rates three times in 2024, with a possibility of the first cut in May but no concrete path yet.
These policymakers’ forecasts are subject to considerable uncertainty, as no definitive direction has been indicated, placing corporate treasurers in a position where diversification and agility in cash strategies has become even more significant.
Powell has said the Fed’s most recent outcome of unchanged rates is a result of slower growth and a resilient labor market. Powell added that the Fed’s outlook for the economy is strong, but that there is not enough confidence as it currently stands to decisively take action further emphasizing the need for strategic liquidity management.
Diversifying Cash Management Beyond Bank Deposits
Amid concerns about counterparty risks associated with concentrated bank deposits and uncertain rate movements, treasurers are in greater need to explore diversified investments to further protect their portfolios. It was surprising to see that the ’23 survey revealed 18% of treasury teams have 80-100% of their short-term portfolio in bank deposits, suggesting the need to consider a broader approach to cash management, in other words, diversify.
“I wonder why the allocation to bank deposits investment is still so high, especially given recent counterparty concerns in the wake of Silicon Valley Bank (SVB), Signature, and Credit Suisse. What’s holding treasurers back from investment diversification? Is it simply a locked mindset? Or is it something else?,” posits Bomfim.
Daniel Farrell, director of international short duration, fixed income at NTAM offers “I think it’s more about the idea that investors simply lean towards what they’re more comfortable with. Some investors are less accustomed to money market funds and the different types of regulatory concerns that come with them and in many instances, it may not be approved within their own investment policies.” Farrell highlights the tendency of many treasurers to default to bank deposits instead of considering money markets funds (MMFs) which can often provide a greater range of diversification compared to traditional deposits.
MMFs invest in a diversified portfolio of short-term, high-quality market-market instruments which can include Treasury bills, commercial paper, CDs, and repurchase agreements. This diverse set of assets provides exposure to different sectors and issuers, while maintaining positions in liquid investments and access to cash if needed.
“I think we need to think about more education around diversified investments in cash management. What is worrying is, with the lack of diversification and the automatic default to bank deposits, corporate treasurers could end up creating more unintended risk,” says Farrell.
Embracing Varied Credit Quality, Defining Risks and Crafting Solutions for Treasurers
As treasury teams face challenges in portfolio diversification, varied credit quality becomes pivotal. The survey notes treasurer concerns about concentration risks, with 47 respondents highlighting rising credit/default risk as their main concern in 2023.
The market has witnessed a flight to quality, especially following the events tied to the SVB crisis last year. Investors are scrutinizing their cash investments, leading to significant inflows into MMFs. While bank deposits remain common, the emergent trend of treasurers exploring other cash management investments is noteworthy.
An intriguing outcome stemming from the banking crisis was the influx of funds into Money Market Mutual Funds.
“Something that definitely caught my attention was that money market mutual funds were actually benefiting from the cash flows that were fleeing deposits. It was interesting that during a time of stress, the market was voting with its feet. This feeling that money market mutual funds were safe enough, and that investors were taking money out of deposits and shifting those deposits to mutual funds was like watching a live-action vote of confidence,” says Bomfim. According to the Investment Company Institute, this trend seems to have gained momentum, as the amount of money invested in money market mutual funds steadily increased in 2023 - a trend that has yet to reverse. Just in the week ending February 8, 2024, assets of institutional money market funds increased by $3.07 billion to $3.66 trillion and assets of retail money market funds increased by $13.62 billion to $2.36 trillion.
Whilst fixed deposits remain an important staple of any treasury investment strategy, MMFs do offer certain advantages, particularly in a dynamic market. Their ability to capture and relay rate rises efficiently, coupled with active management to navigate falling rates makes them a resilient and appealing option for investors seeking both safety whilst optimizing returns.
However, while MMFs present opportunities, treasurers must consider regulatory updates. The recent softening of regulatory stances in the EU and the U.S. reflects the commitment to ensuring MMFs’ resilience. Treasurers should stay informed about regulatory changes and, if required, support lobbying efforts through treasury associations. The survey sheds light on the challenges faced by treasury teams and their resistance to invest in MMFs to people and staff issues, emphasizing the strain on treasury departments. Of course, hiring additional lobbyists or staff focused on regulatory issues would put further strains on treasury teams. Increased red tape and regulatory oversight means treasury teams and their human resources personnel will need to spend extra money, effort, and resources to support new rules. Indeed, approximately 9% of the survey respondents attributed their reluctance to invest in MMFs to considerations around tight human resource constraints.
MMFs, while a tactful strategy in diversifying cash portfolios are not the only strategy for a corporate treasurer looking to expand their portfolio exposures.
Understanding the Flexibility and Benefits of Separately Managed Accounts
Another effective, albeit lesser known, tool in the treasurer’s toolbox are separately managed accounts.
Separately managed accounts (SMAs) offer treasurers a customizable and flexible approach to managing short-term investments. With tailored investment strategies, SMAs provide an avenue for treasurers to align investments with their specific risk tolerance, liquidity needs, and return objectives. While there are unique benefits to these accounts, they typically require a large ticket size which may deter certain investors. For the right institutional investor however that can commit to a large enough amount, SMAs offer additional new flexibility.
“SMAs simply give the investor the ability to write their own guidelines. For example, if a MMF has a 10% overnight liquidity amount and an investor wants much higher, they have the ability to write that within their guidelines. The same applies with the credit ratings and max maturities. They may want to go out further on the curve and not be constrained to 12 month securities and are happy to extend to 24 months. It gives investors more flexibility in their own risk and return requirements,” Farrell explains.
Effective utilization of SMAs requires treasurers to educate stakeholders, such as investment committees, on the benefits. The survey found that 58% of respondents had no plans to invest in SMAs, suggesting a potential misunderstanding of their benefits. Some of these benefits include customization options, risk management capabilities, and potential for enhanced returns compared to traditional investment vehicles.
To encourage wider adoption of SMAs, treasurers must address any misconceptions or resistance among stakeholders. Clear communication about the advantages, transparency, and control offered by SMAs can contribute to overcoming barriers to adoption.
Solutions for Overstretched Treasurers
To overcome these challenges, treasurers can leverage technology and partner with experienced asset managers. Investment portals, despite being underutilized by 45% of respondents, offer an expanded view of funds and underlying exposures, helping treasurers make informed decisions. Platforms that provide holistic views of asset holdings, exposures, and counterparty risks give treasurers a more intricate view into their positions. Additionally, 13% cite resource limitations as a barrier to utilizing investment portals, indicating a broader capacity issue.
Asset managers also emerge as a surprising partner to the corporate treasurer. Bomfim says the specialization and active market participation asset managers bring to the table simply cannot be beat.
“You really cannot overstate the benefits of specialization and having people who are not just reading about the market, or just watching what’s going on in the market, but are actually active participants. We can’t underestimate the value of that. Treasurers with no allocation to MMFs are, in effect, missing a partner who is an active market participant,” says Bomfim on the benefits of utilizing specialized asset managers in liquidity management.
Encouraging Boldness in Corporate Treasurers
Encouraging treasurers to embrace bolder investment strategies within prudent risk frameworks would be advantageous. While safety and liquidity remain paramount, treasurers should feel empowered to explore diversified options to optimize short-term investment portfolios as the investment backdrop has significantly evolved since the lower for longer environment brought about by the Global Financial Crises. Strategic partnerships with specialized asset managers with expertise around inflation and interest rates can be a pivotal move for corporate treasurers who are navigating the delicate balance between diversification and liquidity needs.
Overcoming challenges related to diversification and policy restrictions requires collaboration between treasurers, senior management, and relevant stakeholders. Regular reviews and updates to investment policies, coupled with education on evolving market trends, contribute to a more dynamic and resilient treasury function.
Navigating through market trends, embracing innovative instruments like MMFs and SMAs, and addressing capacity challenges are necessary for crafting effective short-term investment portfolios. The next economic cycle promises to usher in an intriguing phase for corporate treasurers. As they traverse the challenges and opportunities presented by shifting interest rates and adapt to economic dynamics, treasurers are at the forefront of shaping resilient and agile financial frameworks for the future.
Download the 2023 Global Treasury Survey
IMPORTANT INFORMATION
The information contained herein is intended for use with current or prospective clients of Northern Trust Investments, Inc. The information is not intended for distribution or use by any person in any jurisdiction where such distribution would be contrary to local law or regulation. Northern Trust and its affiliates may have positions in and may effect transactions in the markets, contracts and related investments different than described in this information. This information is obtained from sources believed to be reliable, and its accuracy and completeness are not guaranteed. Information does not constitute a recommendation of any investment strategy, is not intended as investment advice and does not take into account all the circumstances of each investor. Opinions and forecasts discussed are those of the author, do not necessarily reflect the views of Northern Trust and are subject to change without notice.
This report is provided for informational purposes only and is not intended to be, and should not be construed as, an offer, solicitation or recommendation with respect to any transaction and should not be treated as legal advice, investment advice or tax advice. Recipients should not rely upon this information as a substitute for obtaining specific legal or tax advice from their own professional legal or tax advisors. References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities. Indices and trademarks are the property of their respective owners. Information is subject to change based on market or other conditions.
All securities investing and trading activities risk the loss of capital. Each portfolio is subject to substantial risks including market risks, strategy risks, adviser risk and risks with respect to its investment in other structures. There can be no assurance that any portfolio investment objectives will be achieved, or that any investment will achieve profits or avoid incurring substantial losses. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Risk controls and models do not promise any level of performance or guarantee against loss of principal. Any discussion of risk management is intended to describe Northern Trust’s efforts to monitor and manage risk but does not imply low risk.
Past performance is no guarantee of future results. Performance returns and the principal value of an investment will fluctuate. Performance returns contained herein are subject to revision by Northern Trust. Comparative indices shown are provided as an indication of the performance of a particular segment of the capital markets and/or alternative strategies in general. Index performance returns do not reflect any management fees, transaction costs or expenses. It is not possible to invest directly in any index. Net performance returns are reduced by investment management fees and other expenses relating to the management of the account. Gross performance returns contained herein include reinvestment of dividends and other earnings, transaction costs, and all fees and expenses other than investment management fees, unless indicated otherwise. For additional information on fees, please refer to Part 2a of the Form ADV or consult a Northern Trust representative.
Forward-looking statements and assumptions are Northern Trust’s current estimates or expectations of future events or future results based upon proprietary research and should not be construed as an estimate or promise of results that a portfolio may achieve. Actual results could differ materially from the results indicated by this information.
If presented, hypothetical portfolio information provided does not represent results of an actual investment portfolio but reflects representative historical performance of the strategies, funds or accounts listed herein, which were selected with the benefit of hindsight. Hypothetical performance results do not reflect actual trading. No representation is being made that any portfolio will achieve a performance record similar to that shown. A hypothetical investment does not necessarily take into account the fees, risks, economic or market factors/conditions an investor might experience in actual trading. Hypothetical results may have under- or over- compensation for the impact, if any, of certain market factors such as lack of liquidity, economic or market factors/conditions. The investment returns of other clients may differ materially from the portfolio portrayed. There are numerous other factors related to the markets in general or to the implementation of any specific program that cannot be fully accounted for in the preparation of hypothetical performance results. The information is confidential and may not be duplicated in any form or disseminated without the prior consent of Northern Trust.
This information is intended for purposes of Northern Trust marketing of itself as a provider of the products and services described herein and not to provide any fiduciary investment advice within the meaning of Section 3(21) of the Employee Retirement Income Security Act of 1974, as amended (“ERISA”). Northern Trust is not undertaking to provide impartial investment advice or give advice in a fiduciary capacity to the recipient of these materials, which are for marketing purposes and are not intended to serve as a primary basis for investment decisions. Northern Trust and its affiliates receive fees and other compensation in connection with the products and services described herein as well as for custody, fund administration, transfer agent, investment operations outsourcing and other services rendered to various proprietary and third party investment products and firms that may be the subject of or become associated with the services described herein.
Northern Trust Asset Management is composed of Northern Trust Investments, Inc., Northern Trust Global Investments Limited, Northern Trust Fund Managers (Ireland) Limited, Northern Trust Global Investments Japan, K.K., NT Global Advisors, Inc., 50 South Capital Advisors, LLC, Northern Trust Asset Management Australia Pty Ltd, and investment personnel of The Northern Trust Company of Hong Kong Limited and The Northern Trust Company.
Issued in the United Kingdom by Northern Trust Global Investments Limited. Issued in the EEA by Northern Trust Fund Managers (Ireland) Limited.
© 2024 Northern Trust Corporation. Head Office: 50 South La Salle Street, Chicago, Illinois 60603 U.S.A.
The views and opinions expressed here are those of the author and may not represent the views of the company.