There’s a lot of mattress-stuffing in the markets these days as corporations and individual investors alike hoard cash in favor of safety. That cash is being held largely in money market funds, which some argue is only marginally better than the proverbial mattress.
It’s been estimated that corporations are currently sitting on a record $1.8 trillion in cash. That number may grow, too: a report showed that over the next six months, 30% of corporations plan to increase the cash stockpiles while 47% plan to stay where they are. Just 23% plan to decrease it, according to Treasury Strategies. The full report can be downloaded here.
The problem is this: that cash isn’t earning its keep by providing a viable return for these entities.
Behind the Hoarding
Jerome Schneider, executive vice president of PIMCO, says that these piles of cash have multiple implications for investors.
“What we see right now is that the market has been in a defensive posture, waiting to see what ‘the New Normal’ might bring.”
Until the answer to that question comes to light, investors are maintaining abundant liquidity while forsaking any yield by being invested in traditional money market funds..
Blame the economic indicators for the hiding out. The reports are confusing to even the most experienced portfolio managers. “You see a lot of cash sitting on the sidelines because conviction is lacking to make allocations to specific strategies, whether capital investment or R&D, at the moment.”
The cash-hoarding could linger as long as the economy is absent of clear signposts about how things are really going, too.
In the end, though, corporations are doing little different than individual investors these days: “People are just a little more cautious about how they’re thinking about their spending and personal finance decisions. Individuals are asking whether it’s safe or not to take on additional risks in there financial as well as everyday lives.”
The Problem
Although stockpiling cash is an understandable response to economic uncertainty, keeping it in regulated money market funds robs investors and corporations of yields. Lower interest rates combined with what money market funds can invest in (only high-quality, highly-liquid instruments) has pushed money market yields to nearly zero.
This has had an impact on portfolio returns for corporations, tax-exempt institutions and individual investors alike, says a report on the subject produced by PIMCO.
The result? Holding pure cash becomes expensive compared to holding near-cash alternatives. With yields so low, the cost of insurance to have absolute liquidity can be decisively expensive for investors.
The Solution
PIMCO says investors can create liquidity tiers in their portfolios in order to enhance yield and match asset duration to cash liabilities. Understanding the actual liquidity needs is the first step to enhancing ones returns for short-term cash allocations. The first tier is reserved for daily expenditures and other immediate needs; this cash should be kept in money market strategies.
Tier two is for strategic expenditures, such as research and development; tier three is for long-term spending needs. The PIMCO Enhanced Short Maturity Strategy Fund (NYSEArca: MINT), Schneider says, serves the needs of tiers two and three for investors with slightly higher risk tolerance.
“What MINT offers investors is a platform which is actively managed by PIMCO which will earn yields beyond the near 0% return which money market funds are paying right now,” Schneider says.
“Because it’s actively managed, it allows me and our team to think about the way the market develops, and evolve our strategy to find ways to continue providing enhanced returns over money market funds’ lower yield to our investors.”
MINT, can result in a vastly improved yield over that of money markets. In a $100 million corporate cash portfolio, 50% allocation to MINT can result in a 0.38% yield improvement.
Liquidity vs. Yield
Schneider says that there have been shifts in liquidity management in the context of yield management. Before the markets fell apart in 2007, yield was prized above all else.
In this day and age, liquidity is paramount, and MINT helps maintain it while also delivering yield.
“The blur which used to go on between corporate and individual balance sheets has been thrown out the window. Every single investor now must understand their liquidity profile and invest according to their liquidity profile,” says Schneider. “They must only pay for absolute liquidity when it is necessary, and seek other alternatives like MINT when only near-liquidity is required.”
When the Cash Comes Back
Eventually, corporate cash will be deployed back into the market. At that point, Schneider says, MINT’s strategy will become even more relevant.
“The way MINT is structured, even as rates increase and ‘the New Normal’ plays out and the world is in a better place … in our opinion there will be more of a reason to think about strategies like MINT.”
There are two reasons for this:
1. “Investing cash isn’t a back-office activity anymore,” Schneider says. For that reason, the expertise of managers such as those at PIMCO is needed now more than ever. “Going forward, the ability to access this expertise is what investors are looking for.”
2. Right now, the penalty of being invested in money markets instead of funds like MINT is tens of basis points instead of hundreds. But once interest rates return to normal levels and bond yields come back up, money market yields will still be anemically low relative to alternatives as the structural requirements which 2a7 funds face are going to inhibit returns for that sector.”
“For investors, to be thinking of different ways to invest cash in various liquidity ladders is going to become more important.”