Making a Case for Separately Managed Accounts
With traditional, comingled investments consistently losing their appeal, many companies are examining new strategies for managing their corporate cash. Today, separately managed accounts are gaining traction among corporate treasuries thanks to an investment environment where money market funds (MMFs) are no longer invulnerable or profitable. Still, treasurers who want to leverage the investment opportunities associated with separately managed accounts often face an uphill battle. Challenges exist both within finance and with senior management concerned about liquidity and headline risk.
For many, the first step in moving toward separately managed accounts involves education. But reaching out to everyone en masse with the same rationale for making such a move won’t work. It’s critical to reach out to all stakeholders and address their specific concerns individually. We have seen evidence of a disconnect between investment committees, senior management and the frontline investment staff. In some cases there’s been a wide gap in the tolerance of risk between these different groups. Bridging that gap is the treasurer’s responsibility and arguing about yield enhancement is probably not the right tactic. Instead, the focus should be on the benefits of separately managed accounts: diversification, control and transparency.
Companies feel much safer when they know precisely where their money is. Even when MMFs were the preferred investment vehicle for treasuries, visibility into ultimate parent companies and counterparty risk was always an issue. To win management approval, Treasury needs to focus on the fact that moving to separately managed accounts will give them a level of investment transparency they never had with MMFs. The landscape has changed, so should the investment strategy. Treasuries can move to separately managed accounts and have a very conservative investment policy. In the end, it’s all about risk management.
Once treasury, finance and the executive committee have agreed to pursue a new investment strategy that focuses on separately managed accounts, the next step involves building an internal infrastructure of policy and technology. Treasury needs to work on creating the right framework even before it outsources a single penny. Having the right investment infrastructure is critical to the success of the programme and can be instrumental in gaining audit committee buy-in. The last thing treasury wants is to delve into the programme head-on and start experiencing compliance violations and other issues.
Establishing and executing the right framework and infrastructure includes three important steps:
Establishing investment policies is a critical first step. Even investors not planning to invest in BBB-rated debt right away should have provisions in the policy at the time it is established, rather than add them later on. Critical to forming an investment policy is that it needs to be flexible enough to allow treasury some leeway in making investment decisions, and it should be written with long-term objectives in mind (even though most are reviewed at least annually). Most companies are happy to share their investment policies. Investors who want to review an example can often lean on their peers for advice.
Nearly 80% of the companies surveyed by the Association for Financial Professionals (AFP) have already implemented investment policies. That figure is higher (90%) for companies with revenues over US$1bn. Most have three stated objectives: safety of principal, liquidity and yield. Policies typically have a threshold credit rating of no lower than single-A rating, although some go down to the top levels of BBB-rated securities.
In descending order, they typically list the following permissible investment instruments: treasuries, agencies, commercial paper, MMFs, repurchase agreements (repos), eurodollar deposit, municipal bonds (munis), asset-backed securities (ABS), enhanced cash funds (only 16% for companies with US$1bn or more in revenue according to the survey), variable rate demand notes (14%) and auction rate securities (6% – although most people have pulled out of that market even if their investment policy allows it).1 Policies have percentage limits on individual names and on sectors. They list which counterparties they’re willing to accept and whether or not the money can be outsourced to external managers – a particularly important provision.
Once the policy is complete, it’s time to implement the infrastructure to support the investment strategy. A high-functioning infrastructure supports treasury’s ability to not only effectively manage multiple, internal and external portfolios, but also to manage the risk across these portfolios with the ability to know where the cash is, how much of it is there, and the risk profile of the portfolio on a daily basis. Information must be accurate, timely and reliable. Streamlining processes is important. Getting the accounting right is important. Treasuries can buy systems to solve some of these issues, but should be very conscious of ensuring they stand up to auditor scrutiny. Being able to close the books and get the accountants and auditors to sign-off is critical.
Most custodians offer some form of basic accounting and reporting, but they are frequently built on legacy technology from disparate systems. With limited ability to expand and adapt to the changing accounting and regulatory environment, they are often rudimentary.
Because bank systems can be disparate and operate independently, information typically has to be manually rekeyed. As such, there is no direct cross-over from the custodial data (where the securities are held) to the accounting and reporting system. Under such conditions, generating the required reports is cumbersome, available only monthly or quarterly and offers little – if any – analytics and performance evaluation data by manager. The data is essentially static and rarely useful without significant manipulation.
Investors should never work from different numbers for portfolio accounting, compliance, performance and risk analytics for any reason. Ideally, those numbers should reconcile and should be drawn from the same dataset. Being able to analyse the portfolio by manager, issuer, security or credit rating are all critical tools for treasury to perform its risk management role. A useful degree of analysis is only possible – and can only produce actionable information – if the data reconciles across the entire portfolio.
Compliance is a concern as well. With the right system, investors can look at all relevant compliance factors. Given the market’s volatility, tracking compliance has become a more frequent and critical task for treasury, particularly with recent downgrades. Counterparty risk can also be difficult to track and sometimes pushes investment policies out of compliance unknowingly. Investors need to be able to answer the question: “Who is responsible for the security?” Risk analysis is also very important right now, whereas performance has been less of an issue.
One of the elephants in the room that needs to be addressed is the management of the corporate accounting and financial reporting, in addition to monitoring and acting on portfolio risk and compliance. Treasuries have to look inward and determine whether they possess the necessary human resources and expertise to effectively manage these functions internally. Most often, the security-level risk management, trading and credit monitoring capabilities with an external manager far exceed what can reasonably be expected within a corporate investment environment. A corporation’s ability to recruit, compensate a team of credit, portfolio management and back office professionals is limited, relative to the institutional investment management space. This has led many treasuries to outsource at least a portion of their investments to external asset managers.
For whatever portion of the portfolio an investor decides to outsource, it is important to find the appropriate manager(s). That’s not an easy task and typically involves lengthy RFPs. The AFP website contains some examples, and peers may be willing to share their own selection criteria as a starting point. First-timers often go with bigger firms, which typically serve as the asset management arms of their banks. Since the minimum entry points at some independent managers are very high, investors should include the amount they intend to outsource in the request for proposal (RFP) to weed out the big players.
Working with a consultant to limit the universe can be particularly useful for investors who do not have the time to perform due diligence on a range of asset managers. Relationship banks can be helpful as well. The ultimate goal is to find a set of managers that are familiar with corporate cash, since not all managers are. Some are accustomed to primarily managing pension fund money and are unfamiliar with corporate realities, such as limitations on credit that do not match up with the benchmark, and restrictions on realised losses. Investors can also look for general managers, although companies with specific investments targeted for outsourcing (i.e., ABS/MBS, BBB, or corporate credit) may want to narrow their search to firms that specialise in specific mandates.
Building an internal infrastructure of policy and technology will be critical for investors as they prepare for what could be a protracted period of market uncertainty. Structuring investment policies, implementing an accounting and reporting platform and selecting portfolio managers must be done logically and deliberately. In the end, investors should feel confident that there are alternatives that do not require them to assume additional risk. Given the right infrastructure, investors can still focus on safety of principal, liquidity and yield, without sacrificing diversification, transparency and control.
1 The 2011 AFP Liquidity Survey, 28 June 2011.