Nigel Jenkins, managing principal with Payden Rygel and manager of the Payden Sterling Reserve Fund speaks to Room151 about the major issues impacting treasury investment strategy today.
Room151: In view of the recent base rate rise, what challenges and opportunities are emerging now for treasury investors?
Nigel Jenkins: Base rate rises certainly present both challenges and opportunities to treasury as well as other investors.
On the one hand, higher interest rates means greater income from investments, but, on the other hand upward movements in base rates can cause small marked-to-market losses on short dated bonds and bond funds.
Additionally, treasury borrowing costs might rise.
But, these rate moves need to be put in an historic context – and in this sense they are very small, very slow and likely to terminate at a much lower (real and nominal) level than in past cycles.
And they are likely to remain relatively low. Even though we believe rate rises will exceed those priced into the market right now, we struggle to see more than an additional percentage point on rates by the end of 2019.
That will still be a very low rate by any normal standards, and the other benefits of short dated bonds (diversity of issuer, more attractive credit spreads etc.) will be unimpaired by such moves.
R151: What alternatives to money market funds do you think treasurers need to be aware of?
NJ: We are big believers in the value of short dated bond funds, which out-yield money market funds and which out-perform them in the vast majority of circumstances.
And the marked-to-market volatility is also very small for high quality funds – investors get a good boost to yield and return with very little week-to-week or month-to-month volatility.
They also offer exposure to a much broader range of issuers.
And that is multiplied twenty-fold for those investors who are able to use non-Sterling bonds as well.
We would always advocate hedging out the currency risk – that is a small complication to put up with for such a broadening in the opportunity set.
R151: We’re seeing some reform to both money market funds (MMFs) and LIBOR. What impact will they have for the investor?
NJ: Unlike US Money Market reforms, we think that most UK MMFs already comply with the restrictions that will apply to Low Volatility Net Asset Value funds in Europe from January 21 2019.
Nevertheless, the recognition that MMFs themselves have some volatility should alert investors to the attractiveness of short dated bond funds.
The movement away from LIBOR has been a long-time coming, but we are seeing that hotting up now.
There have been four SONIA-referenced floating rate notes issued into the Sterling markets in the last three or four months and we expect many more.
R151: We’re in a period of great uncertainty: how do you see Brexit impacting your portfolio?
NJ: Yes, the Brexit vote and the range of possible outcomes is certainly a significant source of uncertainty.
Our own view is that either a compromise deal will be reached or a very vague outline deal will at least ensure that we enter the much-vaunted two-year transition period.
Either of these developments will in our view be beneficial for near term growth prospects in the UK, and should allow the Bank of England to continue modestly raising interest rates.
This will boost yields on MMFs and on our own short dated bond portfolio, the Payden Sterling Reserve Fund.
In the unlikely event of no deal or an antagonistic end to negotiations, we think that interest rates would be stable or falling in a slower growth environment.
In that case, treasurers with some exposure to bond funds do at least benefit from carrying some interest rate duration exposure.
R151: What’s your view on further base rate rises in near to medium term?
NJ: Given our pretty upbeat view on global growth through next year, and assuming the avoidance of a no-deal Brexit, we think base rates can rise three times or so by the end of calendar 2019, taking base rates to 1.5% or so.
Over the longer term, say the next three to five years, we think that base rates will average in the vicinity of 2% to 2.5% – around zero or barely above that in real terms.
R151: Treasurers will start to plan for next year’s treasury management strategy before too long. Given everything we’ve discussed, how would you begin to position a treasury investment book?
NJ: I would maintain a healthy balance between low-yielding near cash and short dated bond investments.
That helps to neutralise the impact from any upside or downside surprise in interest rates – it’s an example of diversification, really.
I would budget for an average yield from MMFs of just over 1% for the financial year.
Any balances that are expected to persist for longer than six to nine months would be better invested outside of MMFs.
And any treasurers that can consider currency hedged non-Sterling bond investments should do so – we are convinced that this boosts returns for little or no additional volatility over the medium term.
