Stepping Out of Buy & Hold

Executive Summary

The most compelling argument for total return strategies is demonstrated by a difference of 1.17% in annualized returns between the 1-month and the 1-3 year Treasury benchmarks in the 2005-2014 period. The return difference translates into $13.9 million for a hypothetical investment with a starting value of $100 million.
Even though neither of the 1-month or the 1-3 year Treasury benchmarks have had a negative return year since 2004, wide dispersion of returns exists from month-to-month. The return swings include worst monthly returns of -0.20% and -0.79% for the 1-year and the 1-3 year benchmarks in the same period, respectively.
Marked-to-market value changes may have an 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 $1.0 million in 2014 with a 1-3 year total return strategy.
Total return investing often involves active trading and may result in higher portfolio turnover and 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 $22,000 in gains in 2010 and $145,000 losses in 2009.
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 understanding 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 based 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 may be 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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