Searching for Yield

Amid low interest rates and money market reforms, companies seek better returns on their cash.
Vincent RyanNovember 26, 2014

To Peter Mitchell, chief financial officer of Coeur Mining, liquidity in the form of surplus cash has become as dear as silver and gold — maybe more so. For one thing, market prices of the precious metals, which his company mines, have declined significantly. For another, Coeur Mining terminated its $100 million line of credit at the end of this year’s first quarter.

“We’ve embraced a philosophy of having cash liquidity versus a line of credit because of the volatility in our EBITDA,” Mitchell says. Although the company is well hedged, “the availability of a line of credit can come very much into question, and you can trip over [maintenance] covenants just as a result of changes in commodity prices,” he says.

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Coeur Mining would like to make that surplus cash even more valuable by earning a decent yield on it, because the company is paying an interest rate of almost 8% on $450 million in high-yield bonds. “We’re looking for returns to mitigate the negative carry,” Mitchell says. But for the most part Coeur, like most companies, is earning less than 1% on its short-term investments.

As Mitchell and other CFOs know all too well, short-term cash investing has been an unrewarding task for the past few years. Thanks to the abnormally low interest rate environment, many companies have just piled idle cash in bank accounts. They haven’t lost much in yield because the market for short-term fixed-income securities has been distorted.

“Spreads have compressed between asset classes and maturity points along the short end of the yield curve,” explains Jerry Klein, managing director at HighTower Advisors’ Treasury Partners. “It’s an environment in which earnings credits and deposits have a favorable return compared with money market funds and other short-term securities.”

In a more normalized interest-rate environment — the one that may come around once the Federal Reserve starts tightening monetary policy again — the hope is that spending time and resources on investing surplus balance-sheet cash might actually pay dividends once again, says Klein, as spreads between vehicles of differing maturities and risk profiles increase.

Waiting for that environment to appear, some companies are already positioning themselves to earn higher returns or testing different asset classes. But that doesn’t mean CFOs will be throwing out what they’ve learned about cash management the past few years. “We can’t chase yield down the credit-quality curve very far,” says Mitchell, “and we choose not to, because preservation of capital is first and foremost.”

14Nov_Yield_p33Turning Off the Autopilot
Spurred perhaps by the frustration of earning very low yields, companies are tinkering with investment policies. A July 2014 survey of senior treasury and finance professionals by PricewaterhouseCoopers found that 13% of 92 companies were planning to expand their list of permissible investment instruments in 2014. In addition, 10% “expect to lower their minimum acceptable [credit] ratings in the coming year, potentially signaling a willingness to accept somewhat more risk in pursuit of higher returns,” says PwC.

If those numbers sound low, it’s because plenty of investment policies already permit investing in vehicles that contain some risk and therefore offer higher reward. Seventy-two percent of the survey respondents can already invest in commercial paper, 53% are permitted to invest in corporate bonds, and 27% are allowed to invest in repurchase agreements. Coeur Mining, for one, invests some of its cash in highly-rated short-term debt instruments, including commercial paper, through a separately managed account.

The company also invests in money market funds, which may no longer be regarded as the autopilot of corporate cash investing. Thanks to new rules from the Securities and Exchange Commission, all prime money market funds (which invest primarily in corporate debt) will be required to have floating net asset values (NAVs), exposing holdings to the possibility of principal loss. In addition, those funds’ sponsors will have the power to slow investor exodus in a crisis through so-called redemption gates and liquidity fees, making shares less liquid, not more. The new rules, some surveys of treasurers predict, could lead to billions of dollars exiting prime funds.

14Nov_Yield_p33bOr maybe not. Money market funds are highly liquid — at least when there is not a financial crisis — and can earn higher yields than certificates of deposit and commercial paper. Mitchell, for one, has no plans to pull his company’s cash from money market funds.

Nor does Raj Agrawal, CFO of Western Union. “Our strategy has always been about evaluating the quality of the investment,” says Agrawal. “Whether the NAV is going to be stable or change a little bit, for us it’s about the underlying investments in these funds.”

Others think that CFOs will have to reevaluate their strategies, though. “A mutual fund does not have a maturity date; it trades in perpetuity,” points out Michael Brunner, a senior portfolio manager at Morgan Stanley. “There’s never a point in time that we know if we hold a fund to maturity we are going to get full face value.” Even if all of a fund’s investments are government-backed debt, “by virtue of the fact that it’s in a mutual fund it is no longer a guaranteed investment,” says Brunner.

A Riskier Trade
How many companies, though, are sticking to guaranteed investments like Treasury bills? To companies that have lots of liquidity and long-term cash, municipal securities and corporate debt, not Treasuries, seem to be the big attraction. Western Union invests in municipal bonds, a market Agrawal says is “very deep and very strong and provides good risk-adjusted returns.” Municipal bond investments, of course, are exempt from federal taxes.

Payroll company Paychex, meanwhile, has about 55% of its $5 billion portfolio in municipal bonds rated AA or better. The average duration of that portfolio is a little over three years, says Efrain Rivera, Paychex’s CFO. “A 10-year municipal is at about 90% of where Treasuries are, but we are getting a tax-free yield,” he says. “That’s a good trade-off. The market is deep, and we like the risk profile.” Rivera says the company has looked at government obligations, “but we think right now municipals give us the best combination of yield, maturity, and safety.”

Other companies seem eager to increase their returns by investing in corporate bonds, which offer a yield premium. According to data from Clearwater Analytics, as of October 1, more than 45% of its clients’ corporate cash holdings were parked in corporate debt that wasn’t commercial paper.

“We like the corporate space,” says Morgan Stanley’s Brunner. “The real key is staying in investment-grade [paper]. We have companies that have very strong balance sheets, good cash flows, and are considered very good credit risks.”

But what will happen when interest rates start rising — and bond prices fall? “Investors are likely to become uncomfortable with bond losses and look to stocks,” says Lee Levy, founder and general partner at Canid Asset Management. Pension funds and institutional investors, Levy points out, “have enjoyed incredibly strong returns from their bond portfolios for the last 20 to 30 years. They will see those gains reversed for the first time in a generation. The asset allocation landscape will look radically different than the last 30 years, and many managers might not be prepared for this change.”


Paychex, at least, is trying to prepare. The company invests 45% of its surplus cash in a portfolio of less than 30 days—“more typically 3 to 7 days,” says CFO Rivera. The portfolio invests in variable-rate demand notes, another tax-exempt investment, but more liquid. They earn as little as 5 to 10 basis points, however, so Paychex also leaves some cash at its banks to get an earnings credit.

Why split the portfolio? “We think interest rates will rise, and we need to have a more balanced posture when they do rise,” explains Rivera. “It really hasn’t changed the last three to four years. We always wanted to have a portion positioned at the short end of the curve. If you go longer, you’re getting to get hit with losses as interest rates rise.”

And what will happen to the 55%–45% split when interest rates do rise? “We will evaluate the duration of the portfolios,” says Rivera. “A steep yield curve might lead to one portfolio philosophy. If it tends to be flatter and more gradual, that will lead to a different one. The Fed will raise interest rates on the short end, and the question will be what the ripple on the long end of the curve will be.”

The hardest thing for finance departments might be to stay patient and figure out how to play this interim period. Money market funds have two years to comply with the SEC’s new regulations. In addition, the continuing message from the Federal Reserve, at least as of late October, was that its Open Market Committee would be very slow in raising interest rates.

In the meantime, recent movements in the equity and bond markets hint that the era of low volatility may be ending. The benchmark 10-year Treasury note moved 20 basis points in 12 hours in late October. Volatility, of course, causes wider swings in investment prices. A more normalized interest-rate environment may offer more opportunity — but it contains plenty of risk too.

Finance chiefs know it’s a double-edged sword, but many won’t be sad to see the era of near-zero yield come to an end. Says Mitchell of Coeur Mining, “We welcome the time when we start to see a better return on excess funds.”

Vincent Ryan is editor-in-chief, digital platforms, at CFO.

14Nov_Yield_p34v2Step into Liquid

To do any kind of cash investing successfully, but especially when extending maturities, a company must segment its cash assets. Capital Advisors Group advises putting corporate cash into three categories: “daily liquidity,” “planned liquidity,” and “market liquidity.”

In Capital Advisors Group’s hierarchy, “daily liquidity” refers to cash balances kept on hand for unanticipated fluctuations in the needs of the business, and “planned liquidity” refers to “seasonal needs and cash expenditures.”

Western Union calls its three similar buckets “liquid cash,” “core cash,” and “strategic cash,” which is similar to Capital Advisors’ “market liquidity.” Strategic cash is long-term money, cash the company may not need for 6 to 12 months. “We can drive for a longer-term investment that comes with a little bit more yield,” says Agrawal. “We don’t give up on the quality of the investment, but we do have the ability to play with the maturity.”

For each liquidity bucket, the following investment vehicles may be appropriate, according to Capital Advisors Group:

• Daily liquidity: Transactional bank deposits, stable-NAV money market funds and other pooled investments, overnight repos

• Planned liquidity: Term deposit accounts, Treasury and agency securities, high-quality corporate and financial credits

• Market liquidity: High-quality asset-backed and mortgage-backed securities, in addition to the aforementioned instruments. — V.R.