Printer Friendly

Playing the corporate investment game - literally.

Where is the cash? This question is faced everyday by corporations that by their very nature generate substantial funds from daily operations. Banks have worked hard to accelerate the collection of funds via lock box operations, automated clearing mechanisms including zero balanced accounts, and timely collection of receipts. The next logical step is to decide on a rational approach to investing the cash from operations until it's disbursed for payrolls, taxes, and capital expenditures. Herein lies a problem that can result in substantial losses, despite the best efforts to carefully invest these temporary funds.

What to do? What to compare? Whose advice to seek?

More important, what do other companies do in a similar situation, and what is their portfolio likely to comprise in terms of instruments and maturity? These are questions I posed to attendees at a seminar, entitled "Managing Liquid Assets for incremental Return," sponsored by KPMG Peat Marwick.

Each participant was asked to manage a $100-million portfolio over a two-day period. The only constraint was that $5 million be made available on the second day to cover unexpected cash requirements. The allowable instruments ranged from straightforward repurchase agreements to floating rate notes and variable rate demand bonds.

I did ask participants to follow the investment guidelines their companies currently use in constructing their portfolios, because we wanted as realistic results as possible. We applied interest rates for the first day, as well as foreign exchange rates, and I talked briefly about the existing outlook for the economy. The game-players used instruments with which they were familiar and some new vehicles as part of the portfolio mix.

As for the types of executives who played, the cast included chief financial officers, treasurers, cash managers, and controllers. Their institutions ranged from the largest money center banks to foundations, large corporations, securities firms, and small, closely held companies.

Look at the table on page 12 for a rundown of the investment strategies used by groups from mid 1988 to the end of 1989. The results are interesting and tend to mirror the universe of instruments available to the corporate investor. (See the chart on page 13 for a list of instruments from which the executives could choose.)

The tally

What do we conclude from this data? In the first instance, despite the fact that U.S. government direct and agency obligations are clearly the lion's share of outstanding debt, the participants' use of these vehicles ranges from a low of 7.9 percent of the portfolio to a high of 19.5 percent. yet corporate investment guidelines typically allow for up to 100 percent of holdings to be invested in U.S. government obligations. Certainly, the convertibility of this vehicle to cash ranks high, although with the exception of tax exempts and preferred stock obligations it is a lower-yielding asset. Commercial paper, on the other hand, represents a mix consistent with that found in the table of potential instruments; namely, it represents roughly 10 to 15 percent of the portfolio.

The rationale

Why did participants make the choices that they did? Ease of investment and acceptable credit risk are some of the reasons they felt comfortable with the obligations. No restraints were placed on the portfolios from a credit viewpoint; therefore, it was assumed that only Al- or P1-rated obligations were held in the portfolio.

Perhaps the most interesting aspect of the comparison is the diversification the executives used in creating their portfolios. The distribution of the lengths of maturity of the instruments reflected a group assessment of interest rates.

However, when I attempted to compare the individual results with the composite from the types of instruments, I found differences. For example, in one session a participant decided t6 invest entirely in repurchase agreements maturing overnight. While this view was correct from an interest rate standpoint, it concentrates the portfolio in a market segment that historically has experienced difficulty. Witness the spectacular failures of ESM Government Securities, Bevil Bressler and Shulman, Lombard Wall and Drysdale-each resulted in a large loss. Risk concentration is a subject you must carefully analyze and evaluate before creating a short-term investment program. Too often, companies do not research and analyze investment guidelines for potential pitfalls. Twisted policies?

What does this say about investment guidelines? Well, in constructing an investment policy that can be effective, you must always bear in mind the supply of the issue available in the marketplace. Some firms will twist an investment policy to accommodate a tax issue and thereby ignore the realities that alter the playing field. For example, is it prudent to have an all tax-exempt portfolio, when liquidity and safety play an equal role in the marketplace where these securities are purchased and sold?

Have we forgotten that

Salomon Brothers abandoned this market entirely in relatively short order? From a return standpoint, an all muni portfolio may be attractive, but let us not forget the all-important mechanics of buying, selling, and holding securities.

The key conclusion of these results is that diversification of assets should play a large role in the development of any short-term investment strategy. Yield alone cannot be the ultimate measure of a successful program.
COPYRIGHT 1990 Financial Executives International
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1990, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

Article Details
Printer friendly Cite/link Email Feedback
Title Annotation:Portfolio Management
Author:Cody, Mathew R.
Publication:Financial Executive
Date:Nov 1, 1990
Previous Article:A guide to choosing the right auditor.
Next Article:How changes in MIS affect the CFO and the CIO.

Related Articles
Con: tactical asset allocation: a sure-fire investment technique or just a fad?
Corporate investment: do you play the loser's game?
Stocks 'R' us: teaching your kids about the stock market gives them a jump-start on investing.
Marshall fills Pape Jam void.

Terms of use | Privacy policy | Copyright © 2018 Farlex, Inc. | Feedback | For webmasters