Following the US lead
The euro will bring a whole new portfolio of cash products based on the new currency, says Tim Keaney of Deutsche Bank Global Institutional Services. “We will have a series of very specific cash vehicles that will run the whole risk spectrum.”
But, assuming international bankers know about cash products, the thinking seems to be that it will not be that removed from what has happened in the US. Keaney is a veteran in this area and now straddles the Atlantic, running this part of the bank’s securities services business.
Keaney is certain we are seeing the same trends in Europe as occurred in the US some years ago, where the larger corporates led the way in driving the market to reduce costs in cash transactions and maximise returns on cash balances.
He says: “We are seeing an intense desire to focus on these aspects both in the UK and on the continent.” The consolidation of providers in the banking market – now becoming apparent in Europe – reflects or is anticipating where customers are headed, which is towards a concentration of businesses and fewer bank partners. The growing interest in cash pooling, where one bank has control of overall cash positions, products by major companies is confirmation of this trend, he believes.
Keaney adds: “You will need to be able to offer your customers a series of products generally categorised as cash, but having different risk profiles.” This can mean products that are using derivatives and other instruments to achieve their objectives, though Keaney acknowledges: “This has not affected Europe in a major way yet.”
Keaney points out that many US investors who managed their cash in-house now direct it into money market funds or other instruments, or into repos, have decided to outsource that function to an outside manager, giving them their risk parameters and the type of instruments they are able to use.
He points to the tremendous sea-change that has affected the US pension fund scene, where plans 20 years ago might have had 20 to 25% in cash as a matter of policy. “Now plan sponsors with a top-down strategy take quite a different approach as they have a predetermined return that has to be achieved to meet their accumulated pensions benefits. So if the investment managers hold too much cash they cannot reach these targeted return rates. As a result, the pensions manager is continuously challenging them.” Mandates will not let managers hold much cash, unless this has been agreed with the plan sponsor, so they have to be fully invested with the minimal sums for the transactions necessary to run the portfolio. “We now see this model or characteristics of this model taking shape around the world.”
A tantalising snapshot of where Europe is at comes from the findings of a survey by US group JP Morgan Investment Management of European attitudes to that recent import from the US, rated money market funds. Some 71% of 200 large corporates and banks say they like the look of these but, so far, nearly three quarters still invest primarily in bank deposits.
The investment group concludes that it is just a matter of time before the penny drops and these funds start to become popular. In the US some $500bn of institutional money lodges in money market funds, compared with some $30 to $40bn in such vehicles in Europe. “There is a lot of business out there,” says Peter Knight at JPMIM in London. It is not just corporate investors, but banks are seeing their benefits as a means of generating commission income without putting deposits on their balance sheets.
UK asset manager Gartmore believes UK pension funds trustees are anxious than ever to make the cash portion portfolios work as hard as the other elements. Its triple-A-rated money market fund with £900m in assets is where it would like to see this cash being put to work by UK funds. Pension fund legislation on investment security and prudence has put cash management into the spotlight.
Now it is close to launching a euro money market fund, which it wants to offer in different continental countries. Gartmore’s David Hynes says: “We are seeing some growth in euro money market funds, although not colossal because European pension funds can equitise cash more quickly than before due the single currency. The cash can then be swept into one bank account.”
The part electronic platforms will play in the world of cash as a separate asset class is highlighted by State Street. Its ‘Quadrant platform’ provides the communications route between the custodian and the investment manager on a ‘custodian neutral basis’. In particular, the bank’s Fund Connect on-line trading mechanism allows the execution of cash strategies through a range of investments and triple-A-rated money market funds. “Trade viewing can be carried out any time with execution possible one daily and notification given on-line,” says State Street vice-president Caroline Hutchings. She adds that it is possible to run the system through an optimiser to determine optimal currency and cash allocations, for a portfolio taking into account risk and tracking error.
Back at Deutsche Bank, John Burgess, who has recently transferred to London from New York to develop cash products for Europe, believes developments will be very much in hand with the custody operations, but by no means exclusively. “The first vehicle we will be offering in Europe will be a triple-A-rated money market fund. It will have euro and sterling denominated funds, and we expect huge growth in the euro fund.”
The question then is how soon the European market will be ready for the other strategies that have been developed in the US,such as leveraged cash products, which are being used to enhance returns on cash. “These are run on a protected basis or a full mark-to-market, where we run hedge fund overlays on top of the cash portions,” says Burgess. The principal protection strategy will uses zero coupon bonds to provided the guarantees. “Then we will take the interest that is going to be earned, leverage this using futures and options and trade it very actively, in almost a hedge fund scenario, but where the principal is guaranteed.”
But Burgess emphasises that it is the “traditional” money market fund that is still the most popular vehicle in the US. “ I think this will be the most popular here too, and we think it will happen very quickly. We hope in the next year or two.”