Demystifying Separately Managed Accounts

Abstract

A well-structured separately managed account may serve liquidity investors better than money market funds, especially when faced with uncertain interest rate prospects and opportunity costs. Given historical fed funds and LIBOR rates, a moderately structured hypothetical SMA portfolio outperformed a hypothetical MMF in each of the last three rate tightening cycles. Today, SMAs may be more appealing than in the past due to a more transparent Fed, recent bank and MMF regulations, and potential spikes in overnight demand from long-term bond investors. When using SMAs during a rising rate environment, we advise our readers to keep portfolio duration moderate, maintain a laddered structure and higher quality credits, and consider floating rate notes.

Introduction

As the Federal Reserve’s asset purchase program sailed into the sunset in October, some questions inevitably came to mind – when will the Fed start raising short-term interest rates? What will happen to my liquidity portfolio’s income and expected returns? How do I manage it in the upcoming rising interest rate cycle?
A frequent response to these questions is to shorten one’s portfolio duration to minimize interest rate risk. At an extreme, a liquidity account manager may be inclined to stay in money market funds (MMF) or transactional bank accounts to keep pace with rising rates.
While prudent strategies should anticipate a rising rate environment by making proactive duration and credit decisions, corporate treasury professionals today are faced with some unique challenges compared with previous rate cycles. We will show that, given historical evidence and in light of new challenges, separately managed accounts (SMAs) can be effective and advantageous in managing the rising rate environment.
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