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Increasingly, pension funds in Europe are seeking better ways of managing their cash. Peter Eerdmans, senior investment consultant at Watson Wyatt in London, sees two main reasons for this focus.
Cash is carried within the fund, for instance by an equities manager who has not invested it, and this may tend to be simply held overnight with the custodian. “People are seeing that they can do it more smartly,” he says. “They can sweep all that cash into a money market fund.”
The other reason why cash management needs are growing is that an increasing number of pension funds are now using derivative structures within their investment strategies.
“More and more pension funds are using derivative structures to meet their goals,” he says. These goals may be liability matching, but funds may also have derivatives in place for the sake of returns, for example, currency overlay structures.
“The money underlying is cash,” he says, which means that the pension fund then has a liability on a swap to pay Libor, for example. So it has then to invest the cash in order to generate this return.
These structures, says Kevin Frisby, investment consultancy director at HSBC Actuaries, give the pension fund more investment freedom. “It’s easier to achieve Libor plus three than beat a long-dated gilt by 3-4%. That’s impossible to do, there aren’t enough opportunities to do that,” he says.
So pension funds are holding more cash than has generally been the case in the past. “Historically, there never was much_cash because cash is not interesting to pension funds, because it is very low down the duration scale, whereas pension_fund liabilities are long-term,” says Eerdmans.
Although the derivative structures can involve exposure to any type of asset, the derivatives most commonly used by pension funds are duration swaps – interest rate swaps or inflation linked swaps.
There are many options available to pension funds looking to invest cash more cleverly, but the first point is for the funds to consider how available their cash is. “Pension funds need to think about what their requirements are,” says Eerdmans. “How liquid their requirements are – do they need it the next day or is it longer term?”
If the liquidity requirement is very short term, then the best choice is probably to sweep the cash account into a high liquidity AAA-rated money market fund. “If it’s longer term, clients typically go for enhanced cash funds. These generally attempt to outperform Libor by 20 basis points, rather than match 7-day Libid, as is the case with AAA funds.
“What we also see is clients moving into the more active space; active cash management where the aim is to beat Libor by 100 or 200 basis points,” he says. It is all on the spectrum of risk and return, he says.
Cash equitisation also happens if funds use the more active structures, such as currency overlays or tactical asset allocation portfolios. They might still want to retain exposure to the equities markets, in which case they would equitise their cash, he says.
Frisby gives another example of a situation where, in the normal course of business, pension funds might hold cash on a long-term or short-term basis.
For example, if a fund is offering a transfer for members. In a bulk transfer, all of a sudden, values for a long-term member become fixed in stone for a period. In this situation a pension fund would be mismatched if it remained invested in equities. The necessary holdings in cash could stay in place for six months during the offer period, says Frisby.

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