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The trick to managing cash? Be creative.

Managing cash may sound like a mundane task, but if you do it well you can transform your cash management function into a corporate profit center.

VERY FEW OF THE responsibilities you face as a financial executive are more important than corporate cash management. You must ensure that sufficient cash is available to fund all corporate requirements, ranging from working capital to acquisitions, equity buy-backs and loan repayments.

Because of the overriding importance of funding such corporate cash needs, most companies don't think of liquidity management as a profit center. But, if you can predict your spending projections reasonably accurately, you can invest cash that you don't need immediately and contribute to your bottom line.

First, examine whether you should revise your liquidity management strategies to take full advantage of today's low interest-rate environment and current market opportunities. An investment strategy predicated on Treasury bills and money-market funds may have produced high yields in the 1980s, but with current yields on these issues now so low, you may find it pays to be more creative.


Are your investment policies out of date? Most companies' policies are focused on minimizing risk, sometimes allowing investments in only the most conservative of money-market vehicles. If your policies are similar, you may be hindering your cash returns.

For example, some policies contain unnecessarily restrictive average maturity provisions. If you expect your firm's cash reserves to remain on the balance sheet for a period of time you can reasonably anticipate, your investment policy should be broad enough to match the maturity of investments to the date you expect to need the cash. This is especially important in today's environment, given the steep condition of the yield curve.

To illustrate, one company that hadn't reviewed its investment policy in over a decade maintained a 90-day average maturity policy restriction on a large pool of funds targeted for a facility expansion three years away. By extending the investment horizon out to match the three-year cash requirement, the firm generated incremental yield exceeding 150 basis points. Of course, enhancing returns is not always as simple as extending maturities, but this example points out how important it is that you periodically review your corporate investment policy in light of your funding needs and market conditions.

On the other hand, corporate investment policies should always remain tight enough to protect against the opposite extreme. Searching for higher yields, some financial executives have been lured by derivative securities, exotic tranches of CMOs, preferred stock or CDs of weak thrifts. Such investments typically sacrifice liquidity and safety, while offering little or no extra return.

Take, for example, that breed of collateralized mortgage obligation known as "inverse floaters." Issued by a federal agency with a short average maturity and typically a very high yield, it certainly sounds safe enough. However, nothing could be further from the truth! Inverse floaters are unusual instruments because their interest coupons float in the opposite direction of interest rates in general. They're risky because they're frequently leveraged, meaning that for every half point change in interest rates, the coupon on the inverse floater could change by a factor of two, three or even four times. Granted, if rates drop, the potential reward from these instruments is significant, but what if rates rise? A 5-percent coupon could quickly turn into a 3-or 2-percent coupon, along with a drop in principal value of as much as 20 percent to 30 percent.


The toughest challenge for financial executives managing corporate cash is to purchase issues offering the greatest underlying value. J.P. Morgan and Citicorp, both huge banks, are rated AAA and BBB, respectively, thus standing at opposite ends of the investment-grade quality spectrum. You might decide that, based on their sizes and ratings, both are suitable investment candidates. However, if you use value as the yardstick, you might ask: Does the incremental yield offered by Citicorp compensate for the difference in quality? If the spread between the two debt issues is wide enough, selecting Citicorp might be appropriate. Otherwise, Morgan should be your choice.

While value is a criterion you should apply to all of your investment selections, remember it's not a constant. For example, government agency securities have been a good way to add yield to a portfolio in the past, but the incremental yield offered by agency securities versus Treasuries is low right now--10 basis points or less in most instances. In fact, some seasoned Treasuries occasionally provide higher yields than comparable-maturity agency issues. Under these circumstances, you should avoid agency securities since they offer little, or even negative, incremental value.

Traditional staples of the money markets include certificates of deposit and bankers acceptances. But, with lower-cost funding alternatives now available to banks, CDs and BAs are scarce, sometimes causing yields to be uncompetitive. The commercial paper market and many newer segments, like asset-backed issues, have taken the place of much bank issuance. Getting your approved list stretched to permit these newer issues can add significant value.

Certain classes of investors are legally restrained in the type, maturity and quality of securities they may own. This results in buying patterns that often drive down the yield on securities they're eligible to hold. For example, money-market mutual funds can buy only issues maturing within one year. If your investment policies are flexible enough to allow you to buy 15-month maturities, then you aren't competing with money-market funds -- and often can capture meaningful yield increases.

Financial executives managing corporate cash can also take advantage of seasonal factors in the money markets. For example, tax-exempt purchasers can usually buy more advantageously during June and July, a time of elevated supply stemming from large seasonal issuance of short-term tax and revenue anticipation notes. To a lesser degree, mid-April presents a good buying opportunity as investors liquidate short-term municipal holdings to settle tax obligations.


If your company has limited its liquidity management selections to fixed-rate income issues, you might want to consider floating-rate securities. However, you need to evaluate floaters from an appropriate maturity perspective. Many companies overlook floaters because most are issued with relatively long financial maturities. But a floater with a stated five-year maturity and an accompanying quarterly reset has price volatility characteristics more like a three- or six-month instrument than a five-year bond. As such, you should consider it a short-term, not long-term, security.

Currently, yields on floating-rate issues with quarterly or semiannual resets are 50 to 70 basis points above money-market levels, a handsome payoff indeed. Interestingly, the yield variance between a quarterly resetting floater and a 90-day money-market instrument is not so much due to greater risk but to market inefficiency caused by a smaller universe of informed buyers.

Both government agencies and the private sector have issued floaters. Most corporate issues carry an A or better rating and usually have spreads of at least 25 to 40 basis points above government paper. Government agency floaters with a 90-day reset are generally priced at the three-month Treasury bill rate plus 30 basis points, or at three-month LIBOR plus 15 basis points.

Despite their attraction, floaters aren't risk free. For instance, you should always scrutinize their interest-rate reset features in particular. There are a variety of interest-rate reset methods, with some floaters having rate ceilings or floors. Returns can be dramatically affected by these factors, should interest rates change suddenly or dramatically. So gain a thorough understanding of rate reset features before you purchase.


If you decide to delegate responsibility for your cash management to an outside manager, here are some tips for establishing a good working relationship:

* Use referrals to uncover a few solid candidates. Request that each potential manager provide information about the firm's commitment to the business, its service standards and investment performance track record. Evaluate the performance of each candidate over an entire interest-rate cycle. Look for consistency in return as well as the absolute level of return.

* Make an effort to understand and to judge the risks that were assumed to achieve the returns. Make certain you're comfortable with the manager's investment philosophy and that it's compatible with your company's business philosophy. Also, ask how the advisor has done with accounts operating under investment constraints similar to yours. Then compare these returns with your in-house experience.

* Don't base your selection on historic investment returns only. Service ability is also vital. If your company needs earnings and valuation reports on a monthly or quarterly basis for financial statement purposes, make certain the advisor can issue reports that conform with your accounting standards in the time frame you require.

These reports should include descriptions of each holding, the current yield and market value, accrued earnings for the period, cash earnings for the period, and so forth. If your fiscal periods end at odd times, be sure this too can be accommodated.

Equally important, be sure the portfolio manager is committed to communicating regularly and is accessible when needed to explain strategies and to review your company's cash management needs.

* Whether your outside advisor or a third party holds your assets, you must be assured of impartiality, loyalty, competence and confidentiality. There must be no self-dealing. In a properly structured custodial account, your assets will be protected from fraud, embezzlement and theft. The custodian shouldn't be able to encumber the funds in any way. Bank money managers often provide custodianship at no charge, while an extra fee is sometimes involved with investment advisors.

One way to test an investment advisor is to turn over a portion of your cash reserves and observe the service and performance. If you're satisfied after six months or a year, increase the manager's share. Many corporations decide to keep very short-term, low-risk securities under in-house management, while engaging an outside professional to handle more complicated or longer-maturity strategies.

* Finally, remember that a competent investment manager typically charges a fee equal to 20 to 50 basis points annually. Continually monitor whether the investment decisions the manager makes for you justifies the cost.

Mr. Anderson is executive vice president of Wells Fargo Bank, Asset Management Division, in Los Angeles.
COPYRIGHT 1993 Financial Executives International
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1993, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

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Title Annotation:State-of-the-Art Treasury Management
Author:Anderson, Alexander M.
Publication:Financial Executive
Date:May 1, 1993
Previous Article:How to raise capital, privately.
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