Jonathan Curry – global chief investment officer for liquidity and chief investment officer of HSBC Global Asset Management (USA) Inc
Liquidity and cash management have, of course, always been a critical component of a treasurer’s responsibilities. However, as uncertainty continues to influence the global economic outlook, treasury departments will not only have to continue to carefully manage their cash, but at the same time also find suitable risk-adjusted returns on excess funds. While some major central banks have started the process of unwinding stimulus, short-term interest rates are still expected to remain low in historic terms, even if above the current ultra-low levels that treasurers have had to navigate for many years.
Whatever the prevailing market conditions, the fundamental principles for a treasurer remain the same: managing the risks associated with investing cash both in terms of the preservation of capital and maintaining sufficient liquidity. Unfortunately, in the recent climate, seeking liquidity and capital preservation while earning enhanced yields is complex, to say the least.
An added challenge is the growing interest in sustainable investment solutions. One of the key features of the COP26 conference in Glasgow in 2021 was the large presence of ‘BIG’ business and finance, reflecting the increased pressure from all stakeholders for rapid company adoption of more sustainably focused business practices, financing and investment solutions. The search for sustainably invested solutions presents an opportunity for treasurers to align their treasury operations with their organisation’s wider sustainability objectives. However, this is complicated by pervading claims over ‘greenwashing’ and a current lack of consistency in determining how exactly these solutions define and achieve sustainable objectives.
Global data trends confirm that the COVID-19 pandemic is far from over, meaning there is no escaping the need for continued caution from a treasury management point of view, and ensuring access to near-term liquidity will likely still be at the forefront of the treasurer’s priorities. At the same time, they will need to work to counter the impact of low and negative yields, through optimising the level of surplus cash on the balance sheet and in some cases by looking for new cash investment solutions where appropriate.
Look under the bonnet
As has been the case in many areas of financial markets and related activity, money market funds (MMFs) have not been immune to regulation since the global financial crisis. The impact of the pandemic on markets has refocused regulator attention on the efficient operation of financial markets, with added focus on MMFs that access those markets on behalf of their investors. Regulatory reviews and consultations were launched in 2021 with participant stakeholders, both in the US and the EU. Treasurers who typically prize the current structure and utility value of MMFs will need to be aware of any resulting legislative changes and understand if or how that impacts them.
There can be a perception of homogeneity among MMFs, in terms of risk profile and returns, which is partly driven by the granular regulation in the major markets. The overreliance by some investors on fund ratings, as an alternative to doing due diligence on different funds and fund managers, has also meant that the differences that exist between funds’ risk management can be overlooked, or simply not understood. We need to dispel the myth that all MMFs are the same; how credit risk is set, the credit matrix followed, the fund’s client diversification strategy and how risk generally is managed, needs to be accurately understood to compare and contrast. And in the case of funds that are promoted with environmental, social and governance (ESG) considerations, how does that manager define and achieve this? Simply looking to a fund rating or a small set of metrics will not reveal the important differences in risk that exist between MMFs. Looking below the surface, doing your own, proper due diligence is critical.
Ultra Short Duration strategies
Treasurers with longer-term cash who are able to look down the credit-quality spectrum and further out in terms of maturity could consider Ultra Short Duration solutions to pick up additional yield on strategic cash reserves for which the investment horizon is at least six to 12 months. Investors can take advantage of Ultra Short Duration strategies to provide additional income and total return potential, with a relatively low level of additional volatility.
Simply put, Ultra Short Duration strategies are the next step along the risk curve from a MMF, and take on additional interest-rate duration and credit risk beyond the constraints of a MMF. Fund solutions in this space are variable net asset value (VNAV), compared to the majority of MMFs, which (typically within the EU) are constant or low volatility NAV.
While Ultra Short Duration Bond Funds (USBFs) can typically invest in maturities out to three years, they aim to maintain a much shorter effective duration of six months or less, generally affording some protection against inflation. This ultra-short duration reduces the fund’s sensitivity to interest-rate fluctuations and comes with the added flexibility to invest opportunistically in maturities out to three years. These strategies can be delivered in pooled fund form or as segregated mandates set up to meet an individual investor’s specific requirements and guidelines
Sustainability to drive returns
With pledges made by more than 450 financial institutions in 45 countries, COP26 has been like none other, and will be seen as an inflection point for global climate recovery. The architecture of the global financial system is transforming, shifting climate change from the fringes to the forefront of finance. Along with financial institutions, the presence of big business at COP26, in larger numbers than ever before, reflects a major shift towards sustainability across all areas of corporate activity, including treasury.
Over the past 12 to 24 months, we have seen much greater interest in investments focused on sustainability across all asset classes, and treasurers are experiencing this, too. Improving ESG performance on treasury activity, coupled with only modest yield sacrifices forecast over the interest-rate cycle, has set ESG on course to becoming more mainstream for cash investments.
We launched our first ESG fund – the HSBC Sterling ESG Liquidity Fund – in October 2021 and the extremely positive response we have seen from investors in terms of helping to seed the fund has confirmed the interest in such a solution. Investors are looking for a robust ESG investment process that clearly differentiates itself from existing ‘non-ESG’ MMFs. An ESG investment process that includes a focus on engagement with issuers to promote change in practices to improve their sustainability performance is also resonating strongly with treasurers. Put simply, there must be a clear definition of how it will achieve its sustainability objectives. Launching a new MMF is always a major undertaking from a manager’s point of view, and it can present a challenge for investors, who may require a certain minimum fund size, but because of the interest in investing in sustainable solutions, investors have been able to look beyond that to support the nascency of ESG MMF solutions.
Even though ESG MMFs still represent a small slice of the ($6 trillion) current MMF sector, continued global investor focus around sustainability and delivering on global climate change goals has set ESG investing for a rapid climb. Pressure from clients, shareholders and regulators, paired with requirements to align investment practices with wider organisational corporate social responsibility commitments, are further driving ESG integration for treasurers.
As treasurers work towards applying ESG principles to their investment portfolios, they will face novel challenges, such as the lack of standardised methodologies in applying an ESG lens to the investment process. The perception of homogeneity is certainly not the reality. Investors will have to get used to data that they may not currently be familiar with, such as MSCI ESG scores, to name but one, and working with different research providers of sustainability ratings.
Helping our clients to build that awareness and knowledge is critical across all our financial disciplines and solutions. Only when treasurers are confident and comfortable with these new investment processes, and fully understand the implications for the exact make-up of money market securities within ESG funds, the liquidity and regulatory requirements, can they move towards deeper integration of corporate sustainability to meet increasingly pressured investment, regulatory and stakeholder demands. Over time, this can only help a treasurer enhance their approach to sustainable investing, and ensure they are selecting the strategies that best achieve that.
Investment outlook for major money markets
From a market perspective, we entered 2022 as a challenging period with clear risks affecting all financial stakeholders. At the time of writing, our base case is that inflation will be transitory and that the current heightened levels of inflation in the major developed market economies will begin to fall in the second half of 2022 as supply constraints ease and base effects come into play. However, we do expect to see some requirements for interest-rate rises in some of the major market economies in 2022, most notably in the US and the UK. Clearly, in the current environment, material risks to any base case projections in the market are set to continue, be that from monetary policy misjudgement or from the effects of the ongoing pandemic.
Nevertheless, weighing up the opportunities, risks and conditions impacting the current financial markets, there is scope for optimism. There is sufficient liquidity in the market looking for safe and attractive investments, which paired with ripe new areas of green investments and ESG opportunities as well as Ultra Short Duration strategies, makes a strong case for adding measured risk to portfolios. The market continues to innovate with new products being developed to respond to customer demand, including the increasing availability of ESG MMFs, green deposits and green commercial paper. For corporate treasurers and investment managers, this provides an opportunity to revisit investment strategies, ensure it remains fit for purpose and is aligned with the key strategic objectives of their organisation.