Discovering the value of liquidity

What should treasurers be seeking out to generate more value from their investments?

Does your investment policy help or hinder value creation?

Jason Macdonald, Head of Liquidity Product at Barclays, explores whether a rising interest rate environment and higher-quality cash forecasts provide the opportunity for treasurers to derive value (in real terms) from their available liquidity.

Jason Macdonald

Head of Liquidity Product at Barclays

Treasurers thoughts are changing in terms of priorities.

The latest AFP Liquidity Survey, which aims to understand current and emerging trends in organisations' cash and short-term investment holdings and strategies in the current economic environment, found that:

57% of respondents are managing the duration of their portfolios

19% are reviewing positive real yields among permitted investments

16% are diversifying investments/asset classes within their investment policy

Despite these survey results, anecdotal evidence suggests that even with interest rates rising by a factor of almost 10 over the last two years, many treasury teams have not reviewed their investment management policies. Instead, organisations have continued to rely largely on the same policies to prioritise security and liquidity of funds through bank deposits and money market funds – investing typically on an overnight basis for instant access. A number of organisations are only just beginning to consider yield on an equal footing with security and liquidity.

Depending on the nature of the business, the cost of maintaining such a strategy can have a significant impact in terms of potential revenues in the current high-inflationary environment. Through a combination of a revised investment policy, better use of technology, and making more of cash forecasts, treasurers may be in a position to materially improve the real returns on their available liquidity.

Driving change

While there may be clear benefits for treasurers exploring alternative investment approaches, factors within organisations may discourage changes to investment management policies. For example:

Investment Policies

Existing investment policies may be too restrictive, prioritising security and liquidity and deterring change.

Management Approach

Board and senior management may be comfortable with the existing investment policy and practice and be reluctant to adjust their approach. They want to avoid doing anything that affects the accounting treatment as “cash and cash equivalents” for their surpluses.

Risks

Treasurers may not fully appreciate the risks and opportunities of alternative investment solutions (or those associated with the status quo).

Time

Treasurers may simply be too busy or lack the bandwidth to consider reshaping investment policy and strategy and the possible additional operational implications.

So what should treasurers be doing to generate more value from their investments?

Most organisations will use either money market funds or bank deposits (both overnight and longer) for their surpluses and in some cases may use only one of them. Alternatives such as managed/mandated investment strategies and repos continue to be considered relatively niche products. However, treasurers may discover added value by building a wider portfolio of investment products rather than restricting themselves to bank deposits and money market funds (especially in the light of turbulence in the financial markets early in 2023).

Of course, all investments – including money market funds and bank deposits – present risks; when considering security, liquidity and yield there is a balancing act to find the optimum investment strategy and risk exposure with which the organisation is comfortable.

Route map

One of the first steps is to initiate conversations with bankers and asset managers to help formulate a portfolio of investment strategies. Initially, this would require treasurers to go through a qualitative and quantitative checklist to understand:

The variability of their cash positions

How much cash is available for investment

The core level of cash that can be invested for certain periods of time

Whether the investment policy needs to change

Implementation and maintenance costs in terms of technology (and headcount).

With these factors established, it should be possible to develop alternative investment strategies that incorporate a balance of liquidity and yield while preserving security, and build more diversity into the investment instruments used. These potential solutions can then be reviewed against the organisation’s governance framework to ensure that any revised investment management strategy remains consistent within it.

Technology is a key enabler, providing more flexibility, agility and transparency for investment management processes. It can be a particularly powerful tool for smaller treasury teams or those with little capacity to build change, with a wide range of software solutions and platforms available. These can enable a more dynamic investment strategy through:

Security

Continue to protect security by only enabling investments that comply with the investment policy including the management of counterparty, accounting and overall liquidity risks.

Reducing Risk

Reduce operational risk through the application of straight-through processing.

Transparency

Provide full visibility of actual and possible investment solutions and choices available.

Planning

Allow for scenario planning and stress testing.

Forward planning

Organisational buy-in for such change in policy is crucial to success. It is essential to build confidence not only within the treasury team, but also with the chief financial officer and the wider board, to make sure all are comfortable with adopting a different approach to managing surplus liquidity.

With a revised and more dynamic investment management strategy in place, treasurers can extract additional value from their existing cash forecasting processes. They can use the forecast to inform investment decisions across a range of instruments and counterparties, from a liquidity as well as a yield perspective within an overall security envelope.

The macro-economic environment makes this a good time to review investment strategies and check if you can unlock additional value from your surplus cash.