Stepping Out of Buy & Hold: A Corporate Treasurer’s Perspective on Total Return Investment Strategies

Executive Summary

The most compelling argument for total return strategies is demonstrated by a difference of 1.73% in annualized returns between the 1-month and the 1-3 year Treasury benchmarks in the 1995-2004 period. The return difference translates into $26.6 million for a hypothetical investment with a starting value of $100 million.
Even though neither of the 1-year and the 1-3 year Treasury benchmarks has had a negative-return year since 1995, wide dispersion of returns exists from month-to-month. The return swings include worst monthly returns of -0.26% and -0.96% for the 1-year and the 1-3 year benchmarks in the same period, respectively.
Marked-to-market value changes may have unexpected or undesired impact on a corporate investor’s financial statements. As an example, the principal value of a $100 million investment could have shrunk by $2.4 million in 2004 with a 1-3 year total return strategy.
Total return investing often involves active trading, results in higher portfolio turnover, and generates larger realized gains or losses. While realized gains may increase tax liabilities for some investors, realized losses reduce accounting profits for all accounts. For the 1-year benchmark, trading securities to rebalance index duration alone would have resulted in $400,000 in gains in 2000 and $143,000 losses in 2003.
A total return investment mandate tends to work better for a corporate cash account that has a moderate investment horizon; stable and predictable cash flows; moderate interest rate and credit risk tolerance; and better understand of financial statement and tax implications of total return investing.

Introduction

“Buy-and-hold” and “total return” investment mandates often treat the investment process in a very different fashion. The objective of the former is almost entirely on maximizing yield on investments at the point of purchase, while the latter attempts to achieve a higher level of “all-in” return that includes both coupon income and price appreciation.
In managing corporate cash portfolios, we are often asked by clients when would be an appropriate time to consider a total return strategy. In most cases, stepping out of a buy-and-hold strategy into the area of total return is not merely a change of mentality or risk appetite. Instead, it is often associated with the life stages of the corporate investor. As cash assets start to build up and the pattern of cash expenditures become predictable, it is often advisable for a corporation to explore higher return opportunities using a total return strategy. Meanwhile, accounting and tax considerations, especially in the case of publicly traded corporations, may also become relevant decision factors.
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