Liquid views on cash assets
While some investment managers are suggesting that in the light of low European interest rates, cash could make the transition in pension funds from third class asset to third asset class, the tale is not being borne out on the ground yet.
Santiago Fernandez, chief executive at the e3.2bn Madrid-based Fonditel pension scheme for telecommunications workers, says that the defined contribution plan follows the investment policy established by the board of trustees. This comes out at 35% in equities and 65% in bonds, with a tactical dial that can vary the duration in bonds. In equities the fund tolerance is a plus or minus benchmark weight of up to 10%.
“What this basically means is that we don’t hold cash as an asset but that we happen to hold cash when we are shorter than the benchmark weighting in equities or whenever we have alleviated some of our exposure to bonds,” says Fernandez. “At the same time, because we have a relatively large exposure in derivatives with some fairly big exposures in Europe-wide indices, we tend to have more cash than if we were actually in the cash market.” Fernandez explains that this is a by-product of exposure being channelled through futures or derivatives rather than through the cash market. “Whenever we invest, for example, in the futures market we have to put up a margin deposit which gets rewarded at Libor minus rates – but this is only a small portion, say 5% of the underlying assets. We manage the remaining 95% as if it were pure cash, with repos and euro-denominated very short-term highly liquid securities – mostly in the one-day or one-week category.”
These, he says, all tend to be highly liquid assets, in case the fund wants to unwind a position or change tack very quickly. Fernandez says the fund has technically to hold at least 1% in highly liquid assets by Spanish law, but that it could be holding more substantial levels. “In our case we are in a transition from Spanish to European-wide benchmarks, especially on the equities side, so we tend to have an abnormally high exposure to derivatives. At the end of September, for example, we probably had a 20% cash exposure, but that doesn’t necessarily mean we have 20% in cash. A large chunk of that was actually invested in the market via futures, meaning that actual cash exposure could have been anywhere from 3 to 5%.
He notes that at the time Fonditel happened to be taking a rather defensive cutting exposure to paper – selling the long-dated bonds and then deciding which medium and short-term denominated bonds the fund would opt for.
In principle, Fernandez says he has few qualms about using money market funds but is unsure of their appropriateness or value for money in the pension field.
“Money market funds are not something we are intellectually opposed to, but we tend to find that cash management procedures are best applied to corporations rather than pension funds. Our trustees also rightly tend to be wary about paying double commissions for what seems to be a large management fee. We would have to go to great lengths to convince the trustees to switch from the reasonably good investment we have had on the short-dated end of the yield curve. They would just say to us: ‘Why do you guys want to move from this good investment?’ ”
Philip Neyt, general manager of the Brussels-based Bfr115bn (e2.85bn) Belgacom pension fund, says the fund also does not treat cash as a defined security. “We do not manage cash as an asset. It is not taken into account in the benchmark.”
He adds that, in normal economic conditions, if yield curves are not inverted, then having cash in the benchmark is not a good idea: “Otherwise it is to easy to outperform the benchmark.”
Neyt explains that the fund does manage a little cash, solely for the paying of pensions, which comes out at around Bfr1bn per month. “We can estimate this fairly well and what we try to do is to minimise the cash we have, and assuming we have a positive balance, transfer the rest to the manager.
“Basically, we try to be efficient with our investment and hold as little cash as possible. Most of our assets are transferred to investment managers to be invested in the market, not held in cash. We are long-term investors and feel this is the best way to do it – independent of timing issues, that is.”
He adds that this doesn’t mean the fund’s managers are not holding cash. “Of course a cash holding can be part of a bond strategy in a barbell structure with cash on the short term and a bond position in the longer term. Or cash for the underlying value of futures on the equities side. It is a part of the equity or bond strategy.”
Neyt says the cash held by the fund for pension payments, which tends to represent around 1%–2% of the overall portfolio, recognises the fact that the fund’s liabilities are still in Belgian francs until 2002. “Sometimes, though, it is hard to know what we have in naked cash or as part of an investment strategy.”
And while he believes cash management to have become more efficient post euro for investment managers and custodians now able to hold cash in one euro account instead of 11, with the concentration of assets that go with that, Neyt doesn’t think Belgacom will change strategy, although he says the fund is always open to new ideas.
“We don’t see cash as an asset class in the future for us. For example, we have 55% of our portfolio in index management, and if you have a benchmark with no cash, in which the yen, dollar and pound are hedged into euro as we do, this means the index manager is forced to have some cash in forward contracts. To manage this cash with a small tracking error in line with the benchmark is not easy. We won’t be looking to take positions on the dollar or the yen, for example.”
Neyt concedes though that the low interest rate environment is making funds look at different solutions, with Belgacom no exception. “More important to us at the moment is our hedging strategy and whether we should go partially hedged or use active currency managers.” Currency management will be first on the programme before cash management.
And he explains his feeling that cash can be managed as part of a tactical asset allocation, but not part of a strategic allocation. "I feel much safer with securities than cash. With cash you have to manage it with top-rated banks and look closely at diversification. Risk is also an important issue, with the likes of the Barings collapse in mind."
Unsurprisingly, many funds opt for the more traditional custodian route for cash management. Henk Boer, secretary of the investment committee at the Delft-based Dfl3.3bn TNO pension fund for Dutch policy and research groups, says the fund runs all its cash through its depository bank. "Our custodian Kas Associatie does all the cash management on an agreed tariff basis, which is linked to the Ibor money rate in Amsterdam."
He explains that the fund has no desire to return to managing cash in-house, or by any other method. “This is a very easy way of managing the cash. We used to manage it ourselves but we are very happy with the way it is done now and we don’t have to manage the money on a daily basis. I think in the end it is the best way to do it.”