Taking a Trip in the Yield Time Machine

Trading desks across the country serve as conduits through which corporations and banks look to fund their balance sheets. A morning spent on a short term trading desk can be an eye opener for anyone seeking yield opportunities. I like to compare it to the act of peering into a bakery window – you may not be aware exactly which pastries are the worst for you but you can certainly draw some conclusions just by looking at those that appear to be the most tempting. Here at Capital Advisors Group, our credit team and our traders help control the yield “temptations” through carefully researched buy lists. Those lists are then used by our portfolio managers as they work to construct investment portfolios that map to the specific liquidity needs and risk tolerances of our clients.

Money market fund managers across the country employ a similar process, but newly mandated liquidity targets that require very high daily and weekly liquidity levels have dropped the weighted average maturity (WAM) of money market fund portfolios to just 30 days (According to Capital Advisors Group’s FundIQ research of 15 of the largest AAA rated prime institutional money market funds). In the “olden days,” as my kids would say, (from 1983 to 1991), money funds were allowed maximum WAMs out to 120 days. Therefore, the challenge for today’s money fund managers is how to achieve a nominal yield after screening for appropriate credit risk, building mandated liquidity buffers and planning for unforeseen redemptions. While money funds maintain their reign as a perfectly sensible liquidity vehicle for cash investors, there is a new, more costly liquidity premium to be paid by those seeking yield.

However, one of the greatest opportunities investors have to safely add yield to their cash investments is to develop their own liquidity targets that map to their own cash flow budget, thus creating a cash portfolio specifically customized to their liquidity needs. This process can often result in an average maturity similar to those circa 1980s of twice that of today’s allowable maximum money fund WAMs. Taking additional latitude with a portfolio’s average maturity from this modeling may allow investors to reduce credit exposure relative to prime money funds while increasing return at the same time; a significant accomplishment for any treasury professional. At the very least, this liquidity forecasting process can allow treasurers to examine the opportunity costs of money funds as an investment strategy.

This evaluation process begins with identifying one’s own cash flow needs, planning for cash cushions and unpredicted events, and modeling the portfolio structure to meet those requirements. From that point one can factor in a variety of flavors of credit risk using prime money funds as a base liquidity option. This process can allow investors to sample a broader view of investment options while examining opportunities to reduce credit exposure and potentially increase return. Therefore, given the limited yield opportunities in the money market fund universe these days, we felt it would be interesting to focus this month’s Research Spotlight on the liquidity premium one may pay by investing in today’s money market funds versus the average maturities the industry enjoyed in the “olden days”.

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Best Regards,

Ben Campbell
President & CEO