Back in September 2016, we ran a blog post titled “A Fresh Look at Cash Management”, in which we discussed several important changes that were about to be implemented the following month. The changes involved “prime” money market funds, which offer higher yields because they incur more risk. The changes that were implemented in October 2016 called for prime or institutional money funds to move from a stable $1.00 price per share to a floating net asset value that would reflect the daily market value of the underlying portfolio. In addition, prime money funds would have the ability to charge redemption fees if the “weekly liquid assets” of a fund fall below 30% of total assets. Furthermore, under those conditions prime funds could also suspend redemptions for up to 10 days. While these are big changes, they will only have a negative impact in times of extreme stress, as in the financial meltdown of 2008. In the event that money markets freeze up, the prime money market funds would be given time to get things in order before having to meet redemptions. In the meantime “retail” money market funds could still be marketed as stable NAV products as long as they met certain quality and liquidity guidelines. For more on this see our post from September 2016.
We concluded that post by suggesting that these changes presented an opportunity to take a fresh look at how non-profit organizations manage their cash balances. We further suggested that the focus on the relationship between yield and liquidity might nudge some cash managers to more distinctly measure their real liquidity needs.
Let’s say an organization has an average running cash balance of $5MM. Now let’s look at the average net monthly outflow. In addition factor in recurring and seasonal factors. More likely than not there is a portion of that cash position that absolutely has to be 100% liquid at all times. Let’s call that the Safe bucket. On the other end of the liquidity spectrum there may be a bucket that has an extremely low probability of being tapped at any given time. We’ll call that the Cushion bucket. Finally there is a segment of the total cash position that lies somewhere in between the Safe bucket and the Cushion bucket. We’ll call this the Managed bucket.
The Safe bucket can be filled with the most liquid and high quality of investments, such as stable-value money market funds invested in US Government securities. The Managed bucket can perhaps take a little bit more risk. This may include the prime money funds, which no longer pledge to pay the NAV (i.e. a dollar in and a dollar out) and it could also include ultra-short bond funds whose mandate is total return within the context of a maturity structure that can be towards the outer limits of money market fund guidelines. The Cushion bucket may also include ultra-short bond funds but may also include slightly longer short term bond funds. In terms of duration, the Safe bucket would have no duration, the Managed bucket may have 3-6 months duration, while the Cushion bucket may have a duration of 6 months to a year. The idea is to create a spectrum of liquidity across the portfolio in an effort to safely increase returns.
How would this have worked since September 2016? Well the Safe bucket portfolio would have had a total return of about 70 basis points. This is based on the specific performance of some well-known low cost stable-value money market funds. The total return reflects the type of fund together with the increase in short term rate that we have seen in the last 15 months. The Managed bucket would have had a total return of about 1% if it were solely invested in prime money market funds. If it were invested 50% in these funds and 50% in ultra-short bond funds the total return could have been as high as 1.50%. Finally the Cushion bucket would have had total return of about 2% if invested in ultra- short term bond funds and 2.50% if invested in short term bond funds (based on returns of some the better funds). If 40% of our cash portfolio were in the Safe, Bucket, with another 30% in the Managed bucket that would leave 30% in the Cushion bucket. Given such a distribution total returns would have been roughly double what they were using the US Government stable value NAV money market funds.
The point of this, in case you haven’t noticed, is that this is a good time to be reviewing cash management, especially for those with floating rate debt.