Cash is often referred to as “the forgotten asset” when the performance of pension funds is analysed on a comparative basis. It is often the part of the fund that, while not ignored by fund administrators, often sits with them and is not actively managed. This may well mean that it does not produce returns that reflect market rates, and so does not earn as much for the beneficiaries as it might.
Because of funds’ requirements, it has been difficult in the past to identify suitable instruments that provide the necessary risk limitations with accessibility and good returns. Things began to change in 1995 when institutional investor market funds were set up in Europe. Such funds had been operating in the US for around 20 years at that time, and had proved popular with and successful for fund managers.
Today, short-term, euro-denominated, interest-bearing cash management funds are at the forefront of managers’ thoughts when they look at asset allocation, and represent total investment of $55bn (e65bn), up from some $42bn at the beginning of the year.
“These funds are growing in size and are increasingly being used by pension funds,” says Gijs Kaars Sijpesteijn of ABN Amro. “They are a great vehicle for outsourcing cash management if you do not want to manage your excess liquidity on a daily basis. In any mandate there is an element of cash, anything up to 5% of total assets, because it is impossible to be fully invested, as there is always income. This cash can be a substantial amount and needs to be managed professionally like any other asset.”
On the general issue of outsourcing fund managers are also looking at the practical side. As money market funds are actively managed, there is added value from an administrative point of view. They offer the kind of access that a bank account does, but the day-to-day decisions about how the fund is run is someone else’s concern.
Although a look at how similar investment worked across the Atlantic prompted interest, the Barings crisis jolted people into looking after their cash. That particular debacle made managers realise that a part of their asset portfolio could be at risk if it was simply languishing in a custodian’s vaults. Although the euro cash funds are in their infancy compared with their American cousins, the growth and diversity of the instruments is quite startling. So what are managers looking for?
As we are discussing cash, the first issue is security. Consequently AAA-rated funds are the starting point. The next issue is liquidity, providing either same-day access, or at least such access with a couple of days’ grace, which is a requirement for pension funds. Finally there is the question of yield, and if the custodian bank holds the cash whether or not it is competitive.
Peter Knight at JP Morgan IM in London says, “First of all the pension fund managers must be happy with money market funds, and with the AAA rating. This can be provided by the rating agencies, but larger providers will have their own in-house approved list. Secondly, I would suggest they would probably want to check the management. We offer a dedicated client service desk, which is backed by the latest technology. Really, managers should view these instruments as a commodity, and the extra services are what count, adding value. Finally they would apply a typical fund managers test and look at resources. Obviously fees will be an issue, although most of the larger funds are crammed into a narrow band. On the question of yield, I would suggest checking the daily returns, as interest in these funds is added daily, and compare what you are getting from your bank.”
Andrew Ellis, executive director at Goldman Sachs, feels that yield is not necessarily the main selling point for such instruments. “In order of importance I would say that firstly we are looking at stable funds. The key issue here is not to lose money, and the stable net asset value system is designed to maintain the value of the principle investment. Experience from the US over the past 25 years confirms this works.”
Again, Goldman Sachs deals in the highest quality credits. “We are talking about a minimum A1P1 rating for short-term investments, and 50% of the portfolio must be A1 plus,” says Ellis. The investment banking arm of Goldman Sachs provides independent credit research for the investment managers. “We outsource the credit research, and institutions like to see this, again this is another job which they would otherwise be doing themselves, and provides added value.”
Secondly, Ellis looks to flexibility. These funds offer daily liquidity via an underlying portfolio mix of short and longer-term investments. “After these two issues I would turn to yield, which obviously must be as competitive as possible. One interesting point here is that immediate access to cash is not penalised, as is often the case with banks when a fund seeks to exercise maturity before the end of the term.”
Kaars Sijpesteijn agrees that fees are similar between competing cash fund managers and that returns are also comparable but says size is important. “You do not want to be the majority owner of a fund, and the construction of the portfolio is also important as this can influence liquidity. On the question of liquidity it is also worthwhile looking at the turnover of the fund to see whether it is genuinely as liquid as the provider suggests.”
Knight says that JP Morgan’s distribution in this area is through the asset management arm or capital markets division. “These funds are ideal for cross-border investors, which is where the bigger groups concentrate, although some specialists do look at narrower funds.” JP Morgan’s minimum investment in a cash management fund is $10m.
A similar average investment is identified by Kaars Sijpesteijn. “Our clients are normally treasury managers and come from a global base, including the US. The minimum investment is $1m but the average is $10m.”
The rules on type of holding are complicated, but include the expected items such as repurchase agreements, commercial paper and floating rate notes, although no security may boast maturity of more than one year. “The average weighted security will be 60 days, with very few as long as one year and many much shorter,” says Knight.
One important aspect of these funds is that they should not be confused with managed currency funds, where speculation is permitted. All these funds are single currency-denominated. Nonetheless, how they invest is important for any pension fund manager looking at trusting them with his cash. In particular there is the question of diversity. “We look for a 5–10% maximum diversity, and some funds will spread even more widely. The smaller the fund the more important the diversity is,” says Knight.
The question of weighting within the fund is addressed by Ellis. “Weighting will be determined by interest rate views. It is a question of where is it most efficient to be on the yield curve, and balancing yield with liquidity. Once we have a clear picture of core liquidity we can make investment decisions.” On the question of size, Ellis says there are significant advantages in being part of a larger fund. “Investors can take comfort from a broader pool of investors, also there will be more liquidity and spread of investments, subject to certain limits.”
There are no rules on the amount invested in any particular sector or under any particular name, but pension fund managers will want to be happy with the make-up of the portfolio. This by turn will reflect the providers’ investment strategy. “We make our own assessments in-house,” says Knight, “to provide a balanced portfolio, and also look at countries to assess creditworthiness. Again this shows we provide a service with added value.”
Ellis says that while Goldman Sachs has a global client base, European interest in these instruments is growing. He says they are keen to attract more pension funds, and believes this may be helped by the fact that more and more companies with pension funds themselves are looking to invest in cash management funds.