Low rates = tough challenge: treasurers and cash managers still feel frustrated by the low yields on short-term instruments, but research and comments from industry experts suggest that few are ready to ramp up their risk to boost returns. Indeed, many face policies that mandate conservative investments.

Low interest rates are dandy for borrowers, but not so good for investment managers. Against the backdrop of a low-but-rising rate environment, corporate treasurers and investment managers are working hard to extract the most they can from their short-term cash and marketable securities--and finding the going tough.

[ILLUSTRATION OMITTED]

"Generally, corporate cash managers feel a bit frustrated with the relatively low rates of return that are available today in the short-term markets," says Michael Hutchinson, director of Short-Duration Management Solutions at SEI Investments. "Twelve months ago, the marketplace was forced to adapt to short-term interest rates that had fallen to a 40-year low, and though yields have increased through the past year, investors still want more."

Given the recent environment, managers are balancing their desire for stronger returns with issues such as liquidity, credit and structure, among others. Not surprisingly, many corporate treasurers and investment managers are keeping proprietary strategies close to the vest--indeed, many would rather read about the topic rather than being quoted about it. Still, some industry experts say that treasury managers may be feeling a little more freedom these days to keep more cash available versus no cash, as well as a little less pressure in managing their short-term position.

Nonetheless, there are some trends regarding policies, benchmarking, risk, providers and products that may be gleaned from a recent national research study, as well as from interviews with treasury management consultants and financial services professionals. While nuances of opinion exist, depending on any individual company's broader goals and resources, those interviewed concur that a carefully crafted investment policy for short-term investments is a critical component of any effort.

Written Policies Prevalent

Research conducted by Connecticut-based Greenwich Associates underscores this. After polling more than 700 cash management professionals at large U.S. corporations between May and July of 2004, Greenwich found that more than 85 percent of U.S. companies have a written investment policy that guides their short-term cash and marketable securities investing activities. According to the firm's associate director of institutional research and marketing, Ryan Randolph, an effective policy documents the goals and risk tolerances in writing and is proactively communicated by management to treasury staff.

Policies should not be static, and should be subject to ongoing review and revision to ensure that accepted practices are being maintained and that policies are consistent with a company's current objectives, Randolph adds. However, policies shouldn't be so fluid as to change without proper justification or merit.

[ILLUSTRATION OMITTED]

Craig A. Jeffery, managing director with Strategic Treasurer LLC in Atlanta, emphasizes the importance of a well-thought-out policy that contains a policy statement, as well as procedures and tactics that are built in to provide a measure of flexibility during changes in the economic climate. Issues to consider within a policy include protection of principal, adequate liquidity and duration and concentration of holdings. Jeffery adds that the schedule of various instruments should also be considered.

Henry Waszkowski, managing director with Atlanta-area-based Treasury Performance Group Inc., says that no single policy fits all, and that measures should be built in for various levels of approval regarding changes or modification of strategy.

"In some instances, for example, it may take a treasurer or CFO to approve anything over 90 days," Waszkowski says. Noting that a "primary rule" of short-term investing is "don't lose any principal,'" Waszkowski says some essential areas of focus include selection of instruments, concentration and maturity.

Benchmarking is another factor. According to Greenwich's research, a third of corporations studied benchmark their short-term cash and marketable securities performance against the London Interbank Offered Rate (LIBOR), while just over another third--36 percent--benchmark against an index of money market funds, such as the iMoney Net Money Fund Average. The research also revealed that fewer than one in 10 corporations benchmark against three- or six-month government paper or a peer comparison.

SEI's Hutchinson says that for the most part, companies are comparing the returns on their investments versus alternative products of similar quality and maturity date. "Money market funds and treasury bills quite often serve as a performance benchmark for cash management portfolios," Hutchinson notes. "Additionally, LIBOR is a comparative rate of return for those portfolios containing nontreasury securities such as commercial paper, certificates of deposit or repurchase agreements [repos]."

Too Much Cash?

Some managers are struggling with the problem of too much cash, say a few industry observers. "At first glance, it might seem impossible to have too much cash," says Brian Stine, a fixed-income specialist with National City Investment Management Co. "Cash traditionally has been invested with the goals of minimizing risk and maximizing liquidity. These goals, however, result in a very low yield. When cash is a material percentage of total assets, that low yield can be a significant drag on total income and key financial ratios."

Trying to assess what is deemed a "realistic" rate of return depends on an individual company's vantage point, as well as broader organizational objectives. Morris D. Marley, senior executive vice president and treasurer with North Carolina-based BB & T Corp., says that within the scope of some organizational policies, managers can only choose AAA-rated investments.

According to the 2004 Greenwich Associates research, it appears that most of the companies surveyed have a low risk/low return policy and expectation in managing their short-term investments. The study showed that most corporations had a targeted goal of returning a median 1 percent on their short-term cash and marketable securities, while just 5 percent expected returns above 3 percent.

The study also showed that fully three-fourths of all short-term cash and marketable securities allocations were to AAA-rated credits, while 10 to 15 percent were invested in AA-rated credits. The remaining allocations were to A-rated credits (4 percent); BBB to BB credits (1.1 percent); and securities with no ratings (6 percent). Portfolios in the technology, retail, utility and general industrial industries had lower allocations to AAA-rated securities than those in other industries, according to the report.

Treasury Performance Group Waszkowski's observations underscore the focus on quality. "People are staying in prime credits for the most part," he notes. "We're not seeing people going far down the quality chain."

Marley at BB & T says he has observed that AAA is still the investment choice for many managers, although he has seen some willingness to go to AA or A in some cases. National City's Stine agrees that high quality still dominates, adding that very few managers are willing to materially increase the risk or decrease the liquidity of their short-term investments.

"Most managers are unwilling to accept the idiosyncratic risk that accompanies lower credit quality," Stine says. However, he says that managers are becoming more sophisticated in looking at and quantifying the risk/return tradeoff. "Rather than automatically excluding investment options that possess some element of risk, managers are measuring the amount of risk and comparing it to the opportunity cost of not taking on risk," Stine observes.

In terms of providers, the Greenwich study revealed that 83 percent of companies surveyed indicated that they use their cash management providers for short-term investments, and that on average, respondents used more than one provider. For the more than 10 percent that reported using a non-bank provider, most were using institutional money funds from the investment banks.

[ILLUSTRATION OMITTED]

Some industry observers have noted a movement back to sweep accounts, in which excess cash is automatically "swept" into a money market fund or other conservative vehicle at the end of the day.

Cathy Coats, vice president and Treasury Services Sweep Product Manager at Wachovia Corp., says that from a short-term operating cash perspective, cash managers were challenged in 2004 to justify a sweep. Some sweep investment customers removed their sweeps and chose to leave excess dollars in bank demand deposit accounts to get earnings credit or parked excess dollars in non-sweep, FDIC-insured money market savings accounts. However, sweeps are coming back.

"As rates begin to rise, we are seeing a strong movement back to the sweep options, including sweep to repo, commercial paper, eurodollars and Evergreen mutual funds," Coats says. "We expect continued growth in these products as the interest rates justify the monthly service fees for the automated sweep."

Karen Kahler Holliday (karenkh@com cast.net) is a Mississippi-based freelance writer specializing in banking and financial subjects.