Published: October 01, 2014
Since 2007, we have seen corporations accumulating ever-larger cash balances, keeping cash for a ‘rainy day’ or holding out for investment opportunities in the future as market confidence increases. In 2014, this situation is starting to change. In September 2014, mergers & acquisitions were at their highest level since the previous record in 2007, and as business confidence starts to improve in some countries, we are seeing investment in core business activities increasing.
According to the results of the ACT’s recent Corporate Cash and Liquid Investments Survey 2014, 72% of corporate treasurers say their firms have plans to use balance sheet cash, while 18% of respondents say their company has plans to run down cash aggressively. However, cash investment will remain an important priority: companies continue to hold significant levels of cash on their balance sheet, while 43% still expect to hold more cash than in the past given continuing uncertainties. While treasurers hold differing levels of cash, and the purpose of doing so may vary, cash investment remains a primary consideration.
Over recent years, a major problem experienced by many treasurers is finding sufficient repositories of corporate cash that fulfil security and liquidity objectives. While companies that are embarking on capital-intensive projects and M&A may experience some relief, the challenges facing all corporate investors have been exacerbated by an extended period of low interest rates, particularly in euro. Following the ECB’s cuts in benchmark rates in June and September 2014, short-term rates are now trading far below zero. This has achieved the ECB’s desired effect of reducing the cost of EUR against the USD more significantly than previous cuts, and triggered a sale of EUR. However, for corporate treasurers, negative rates lead to the prospect of a further slump in investment returns beyond the negligible returns since the global financial crisis. This issue applies to all investors in short-term instruments, of course, but the consequences for money market funds have not been too dramatic so far, i.e., returns have not declined in relative terms more than any other instrument, and funds continue to offer the benefits that investors have always prized, namely secure, diversified assets with same-day access to liquidity.
While the prevailing low interest rate environment impacts investors in all short-term instruments, there are specific developments taking place in the MMF sector, largely prompted by changing regulations. For example, in 2010, CESR and ESMA published guidelines to provide investors with a common definition of short-term MMFs (short-term MMFs) and money market funds (MMFs). This categorisation made it easier for investors to make more informed investment decisions, including deciding whether to invest in constant NAV (net asset value) or variable NAV funds. For example, short-term MMFs may have either a constant or variable NAV, while MMFs have a variable NAV. While many investors continue to be attracted to constant NAV, short-term MMFs, constant NAV funds now comprise less than 20% of €-denominated money market fund assets under management in Europe (€89bn of a total €480bn in assets), although corporate cash represent a sizeable proportion of this amount.
Given the fall in interest rates, the return on short-term MMFs will be hit harder than MMFs as they are able to invest in longer-term instruments. For example, investment maturity for short-term MMFs must be less than 397 days, whereas MMF can invest in up to two year maturities Short-term MMFs have a weighted average maturity of less than 60 days and weighted average life of less than 120 days, compared with 6 months and 12 months respectively for MMFs.
Consequently, MMFs offer corporate investors the ability to increase their return on cash without compromising their cash preservation and liquidity objectives. Already, we are seeing a dramatic increase in interest from corporate investors: many have used short-term MMFs and short-term cash deposits until now, and are now exploring MMFs and even enhanced products such as short-term bond funds. The only time we have seen a similar spike in interest, and subsequently adoption of MMFs, was when Eonia traded close to zero negatively in 2012.
Over the next few weeks and months, once treasurers have worked with their company boards to make the necessary adaptations to treasury policy, we expect this interest to translate into investment in these funds. While in some cases companies will need to make changes to their accounting systems to accommodate constant NAV funds, this is typically a relatively straightforward process.
With corporate treasurers adapting their investment policy in response to unprecedentedly low euro interest rates, it will be interesting to note the extent to which this will be a permanent shift in behaviour rather than a short-term reflection of current market conditions. After all, appetite for short-term MMFs with a constant NAV is continuing to grow in USD and GBP, where negative interest rates are not a consideration. The situation with the euro is rather different, however. Euro rates are unlikely to rise again in the foreseeable future, and there is no certainty that short-term MMFs (specifically those with a constant NAV) will be permitted under future regulations, assuming that European regulations evolve in line with those in the United States. Consequently, we see the increased appetite for euro-denominated MMFs and bond enhanced funds as a medium- to long-term change in corporate investment appetite, reflecting the unique market conditions in the Eurozone that are likely to exist for a number of years. Short-term MMFs (including constant NAV funds) and other types of fund, such as MMFs and bond funds, will, however, continue to co-exist, so long as regulations permit, reflecting the spectrum of investor demand. As a leading provider of MMFs, short-term MMFs and bond funds, Amundi will continue to offer the funds that meet these demands, including varying appetites for constant or variable NAV funds.[[[PAGE]]]
The factors that contribute to client confidence in investing in our funds continue undiminished as they have for the past 25 years, during which time we have navigated a vast range of market conditions. In particular, our comprehensive skill set, conservative risk policy, and hands-on management policy reassure clients that their cash is in safe hands when they invest with us. When CESR announced the two categories of money market funds, we took the strategic decision to invest substantially in the MMF category of funds, recognising the opportunity that these funds offered to investors for improved returns without compromising on their risk management or liquidity objectives. Since then, we have developed a wealth of expertise in terms of breadth and size of funds. For example, our flagships (we have three funds above 15bn) EUR MMF is close to reaching €20bn in assets under management, which enables us to satisfy the investment requirements of institutional investors of all sizes.
In addition to proven expertise in MMFs, we invested in bond enhanced funds far earlier than many other fund managers. These funds are within the bond category rather than money market category of funds, but are still designed for the needs of corporate investors, specifically those who are able to invest a portion of their cash for a three-, six- or twelve-month time period. As a result, we have built up an impressive range and size of funds, therefore attracting investors of all sizes. For example, our EUR 6-month bond fund has €3bn in assets under management, with more than €2bn in our EUR 12-month fund. Since the global financial crisis, many treasurers have invested in improving their cash flow forecasting. This enables them to segment their cash into operating cash (for working capital where same-day liquidity is required), core cash (short-term cash required for specific purposes such as scheduled projects, investments, tax or dividend payments) and strategic cash. This is cash that is not required for either working capital or funding specific liabilities. Increasingly, while preservation of capital remains an essential investment objective, treasurers are recognising the opportunity to seek a higher return on this cash by investing for a longer tenor.
Although it will take some time for this growing confidence to translate into a change in investment behaviour in some cases, we are seeing a definite increase in interest in longer-term investment strategies prompted by both market developments, particularly negative interest rates, and internal changes, such as improved cash flow forecasting. The final element that could prompt a further shift in behaviour is regulatory change, both within the money market funds industry, but also Basel III. It seems inevitable that at some stage, banks will need to impose negative interest rates on certain types of deposit, recognising both the reality of current market conditions, and the need to satisfy a liquidity coverage ratio. At Amundi, we help corporate investors leverage the improvements they are making within their business to design and deliver strategies that meet treasurers’ investment objectives within an ever-changing market and regulatory landscape.
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