Schemes can also opt for a fully bespoke solution. This means running the scheme like an insurance company and thinking of it in terms of an annuity book. You need income mfrom assets and hold gilts/credits and short dated credit, such as high yield and senior secured loans which don’t have a coupon, but do have decent redemption proceeds. It may only yield 5%, but the redemptions can be built into cashflows.
Longer duration needs high-grade quality such as government debt, but you could push the envelope and get half a percent on high-quality liquid assets by holding longer dated paper such as asset-backed securities, CLO markets securitisation of corporate loans, in a mixture of high-quality and short dated.
“Cash is doing little for your portfolio, apart from in the case of market default,” says Green. “It is not something strategically we would recommend you to be in.”
SAFE AS HOUSES?
Most funds will have cash on deposit or hold it in a liquidity fund. These will be highly liquid AAA-rated sterling funds and will deliver around the high forties in terms of return net of fees of about 10 basis points (bps).
Managers are looking to introduce more innovative funds, but there is regulation on the horizon that could scupper these and even ordinary liquidity funds, says Ian Lloyd, senior business manager, equity sales at LGIM.
“There is a lot of political change around money market funds, and we don’t know whether in the future we will be able to run constant NAV (net asset value) funds and may be forced to run a variable NAV fund.”
Currently, a constant NAV fund like LGIM’s Sterling Liquidity operates on a like-for-like basis – you put £1 in, you get £1 back. However, the EU considers money market funds to have been guilty of letting down investors in 2008 and so want things tightened up, says Lloyd.
“This may lead to the rise of funds which only invest in government securities, as this will be the only way we will be able to run a constant NAV fund in the future.”
Lloyd argues asset managers have gone a long way to improve transparency in the intervening years. LGIM reports all holdings to clients the moment and 25% of funds held on the overnight markets. There is 25% immediate liquidity and there is no client holding more than 5% of the fund.
“People are looking at cash as a more distinct asset class and are looking to mitigate risks. There is an increasing interest in treasury services – typically from local authorities, but corporates as well – who wish to park cash but benefit from an uplift if that period is longer than initially expected,” adds Lloyd.
“As banks want longer term funding, not cash overnight, putting cash into a money market fund allows you to give the risk to the fund manager.”
ALL THAT GLISTERS…
However, Judith Donnelly, a partner at law firm Squire Patton Boggs questions just how transparent even liquidity funds are. She has seen a worrying development that places the onus on schemes to pick the bones out of ever increasing amounts of disclosure data from asset managers, which trustees should be very wary of.
“The sheer volume of data means the manager can bury bad news – or unfavourable terms – within the documentation,” says Donnelly, and if trustees haven’t got lawyers combing every single part of the fine print, it’s their problem, not the manager’s.
Though this has been an approach used by alternative managers, it is now moving into the mainstream, says Donnelly.
“I have seen documentation from a cash fund that makes provision for closing following a run on the fund. Now, why would a cash fund need a gate?”, she asks.
A LITTLE BIT OF THIS, A LITTLE BIT OF THAT
The answer, says Redington’s Hansen, will increasingly be for schemes to have a suite of cash or liquidity solutions in place.
“They don’t all need T + zero all the time,” says Hansen, “which means they can create a ‘ladder’ across the liquidity portfolio,” she says. Start with the easy wins, she says, which are pragmatic things to implement that may on the face of it not make a huge difference.
One of these is to analyse fees, which she says remains a “very significant performance variation between different funds and is the main component of fees”.
This is the groundwork for building the liquidity ladder which is where the power really lies.
“This is more complex, but you can put in place a liquidity waterfall starting at the bottom with same day cash and low levels of risk and return up to the top which might be an absolute return bond fund.”
In between there are gilts, which can be turned to cash without selling them, though repo isn’t available to smaller schemes, plus other forms of short-term credit.
This doesn’t even necessarily have to be investment-grade, provided the scheme is confident it has sufficient liquidity and cashflow – and the governance budget – to be able to manage this risk.
WHO’S BETTER, WHO’S BEST?
More mature schemes will need a treasury function as cash becomes an important component of their operations. Just as banks have withdrawn from offering overnight shelter, some managers may not be keen on operating such a service.
The LDI managers are the most likely candidates to step in under such circumstances as many already use the service and Hansen says cash management is something that her team assess LDI managers on.
Whether a small scheme largely in pooled funds, or a large one with extensive LDI, all will find that cash will force itself onto the agenda as it demands to be given more attention. It may not necessarily become a core holding, but it won’t be ignored any longer.
