Sponsored article: Caroline Hedges from Aviva Investors examines the need for active cash management to achieve a higher than average return.
Last year saw the already mountainous pile of negative-yielding debt around the world grow even larger, reaching a record $18 trillion in December. At the time of writing, UK government bond yields out to five years were negative and yields on money market instruments were also negative for some issuers over certain durations. Central bank intervention and record-breaking fiscal stimulus has driven excess liquidity in the front end of yield curves to record highs.
With inflation expectations, even from the most optimistic of economists, unlikely to exceed the Bank of England’s target, we can expect real interest rates to remain close to, or below, zero for another three to five years. As a result, investors should be prepared for returns on their assets that are likely to fall short of expectations for months and even years to come.
Yet this needn’t be a cause of concern. We have been dealing with deeply negative yields for quite some time in Europe. As investors, now is the time to employ an active cash management strategy to achieve an overall higher average return. In other words, it is time to get savvy with your cash investment without sacrificing your requirements for capital preservation and liquidity. This can be achieved by segmenting cash into buckets allocated to different strategies.
Strategic cash
In its simplest form, cash can be segmented into operational cash and strategic cash. Operational cash is used to describe day-to-day requirements: your cash that may, or may not, be spent in the near term. Strategic cash relates to cash that is not required to be deployed immediately but might be needed in the near future, for example to pay a supplier in three months’ time or fund a project in six months.
Operational cash can be invested in a AAA-rated prime money market fund (MMF), providing you with diversification versus a bank deposit with access to your liquidity when you need it.
For cash that is not needed immediately (i.e. with a three-month investment horizon and beyond), there are opportunities to take advantage of a range of alternatives to offset the lower yields in prime MMFs without sacrificing credit quality. This cash can be invested in AAA standard MMFs or AAA short-duration bond funds (liquidity plus funds) that target a higher return but have a similarly conservative approach to credit and liquidity risk. In many cases, these funds have a bias towards AAA rated assets, improving your overall credit risk metrics.
If you have a longer investment horizon (12 months and beyond), you can enjoy a little more volatility by investing in unrated standard MMFs or short-duration bond funds. If you target a fund with an investment horizon that matches your forecast horizon, you are also matching the volatility of the fund to your liquidity requirements—what we call savvy investing. It also pays to invest this strategic cash in a fund that invests in slightly different assets or issuers than your prime money market fund, as this increases the diversification of your overall cash allocation.
Liquidity plus funds delivered high risk-adjusted returns throughout both the global financial crisis and, most recently, during the Covid-19 crisis, achieving extraordinary returns in a short timeframe. The premium pickup in GBP for a AAA liquidity plus type fund over a AAA MMF is currently around 50bps. This is a sizable excess return when yields on MMFs are close to zero.
As you invest further down the credit curve and take more duration risk, the incremental return becomes marginal because yields at the long end have become depressed as central banks expand their balance sheets through asset purchase schemes. This explains why a sweet spot has been created along the curve in targeting the best risk-adjusted return in AAA liquidity plus funds, and why interest in these funds is increasing.
Caroline Hedges is global head of liquidity portfolio management at Aviva Investors.
**Key risks
The value of an investment and any income from it can go down as well as up. Investors may not get back the original amount invested. The Fund invests in money market instruments such as short term bank debt the market prices/value of which can rise as well as fall on a daily basis.
Their values are affected by changes in interest rates, inflation and any decline in creditworthiness of the issuer. This is not a guaranteed investment, an investment in a Money Market Fund is different from an investment in deposits and can fluctuate in price meaning you may not get back the original amount you invested. This investment does not rely on external support for guaranteeing liquidity or stabilising the NAV per unit or share. The risk of loss of the principal is to be borne by the investor.
**Important information
Except where stated as otherwise, the source of all information is Aviva Investors Global Services Limited (“Aviva Investors”). Unless stated otherwise any opinions expressed are those of Aviva Investors. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested. Past performance is not a guide to the future. The content of this presentation does not purport to be representational or provide warranties above and beyond those contained in the Prospectus and subscription documentation of the Fund. The Prospectus and the subscription document contain the full terms, conditions, representations and warranties in respect of the Fund. The underlying holdings of the fund should be considered in order to establish an appropriate minimum holding period. The content of this presentation does not purport to be representational or provide warranties above and beyond those contained in the legal documentation and subscription documentation of the Fund. The legal documentation and the subscription documents contain the full terms, conditions, representations and warranties in respect of the Fund. Nothing in this presentation is intended to or should be construed as advice or recommendations of any nature. This document is not a recommendation to sell or purchase any investment. It does not form part of any contract for the sale or purchase of any investment. Changes in exchange rates between currencies or the conversion from one currency to another may also cause the value of the investments to diminish or increase. The value of Shares expressed in a currency other than the Base Currency will be subject to exchange rate risk in relation to the Base Currency. You may switch between funds in the Aviva Investors Liquidity Funds p.l.c. Details on switching are provided in the Share Dealings section of the Fund’s prospectus. The sub-fund is subject to the tax laws and regulations of Ireland. Depending on your own country of residence, this might have an impact on your investment. This document should not be taken as a recommendation or offer by anyone in any jurisdiction in which such an offer is not authorised or to any person to whom it is unlawful to make such an offer or solicitation. The Prospectus and Key Investor information Document (KIID) are available at www.avivainvestors.com
Issued by Aviva Investors Global Services Limited, registered in England No. 1151805. Registered Office: Authorised and regulated by the Financial Conduct Authority. Contact us at Aviva Investors Global Services Limited. 159318 — 05/01/2022.
Photo by Markus Winkler on Unsplash
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