Using Separately Managed Accounts (SMAs) to Ride the Tides of Uncertainty

Abstract

Recent events serve as a prelude to what is to come from the new administration. Active cash portfolio management with a separate account solution helps manage policy uncertainty, market volatility, headline and geopolitical risk. Fiscal and monetary policies, international relations and political conflicts may bring more uncertainty in 2017 than in other recent years. SMAs deserve a closer examination as active risk management tool in this age of uncertainty.

Introduction

Financial markets, along with the rest of the world, witnessed the eventful first two weeks of a new administration. President Donald Trump swiftly signed a number of executive orders that affect healthcare, trade, hiring, energy, education, border security and national defense, among others. Despite controversies, financial markets largely remained calm with equity prices and bond yields marginally higher.
These recent events serve as a prelude to what is to come, when a full slate of policies and initiatives from the new administration are in full swing. Despite the pro-growth, inflationary and deregulatory undertone to Trumponomics, many market observers acknowledge looming uncertainties ahead and wonder how to react to the new president’s moves.
Coupling fiscal policy uncertainty with the Fed’s path towards higher interest rates and large sums of corporate cash parked in government money market funds, corporate treasury professionals have a tough task ahead. We advocate for a well-structured separately managed account (SMA) solution to help weather the stormy seas of policy uncertainty, market volatility, headline and geopolitical risk.

What Lies Ahead

Without repeating too much from our recent commentaries, we are mindful of a number of sources of uncertainty that may impact cash investment decisions:
Interest Rates and Yield Curve Effect: While the general market consensus is for interest rates to move higher, we do not know how soon or how much federal infrastructure spending and tax cuts will work their way through interest rates. The pace of rate hikes by the federal open market committee (FOMC), consisting of a fresh set of voting members and the administration’s appointments to the two vacant seats, remains an open question. We cannot quantify how much monetary tightening may counteract fiscal stimulus. In the event of policy failures, or successes for those impeding growth, interest rates could reverse directions. In short, uncertainty exists for both short and long term rates and anywhere along the yield curve.
Stimulus, Deregulation, Twitter, and Credit Implications: Both fundamental and technical factors can influence how credit instruments perform. Uncertainties exist on a variety of fronts that could help or hurt credit spreads and liquidity of corporate securities. Tax and spending policies, a changing regulatory framework, trade and immigration policies could all have profound impacts on corporate profits, consumer credit, and ultimately the credit metrics of eligible securities. The president’s penchant for governing by twitter also raises uncertainty for companies in his crosshairs.
Geopolitics, Power Brokering and Market Reactions: Adding to the aforementioned uncertainties, geopolitics and current events could move markets in unexpected ways. 2017 is a big election year for Germany, France and the Netherlands. The U.K. is set to start Brexit negotiations. The US is adjusting its strategic relations with Russia and China and changing courses in its Middle East policies. These events, individually or together or as catalysts for other events, may bring unwelcome market volatility and liquidity effects not seen since 2008.

SMAs for Uncertain Times

As a separate account manager of institutional cash for more than two decades, it has been our philosophy that SMAs are appropriate for institutional treasury organizations primarily as a risk management tool. Besides higher income potential over money funds and bank deposits, it is portfolio customization that makes them a valuable cash alternative. With the passing of prime money market funds as the predominant institutional cash vehicle of choice, SMAs deserve a closer examination for the following reasons:
Total Return vs. Liquidity SMAs: There exists an erroneous conception in the cash management world that separate accounts actively trade securities beyond traditional money market credits with substantially longer portfolio duration and total return objectives. While these products can prove valuable for a segment of the market, SMAs also can exist as liquidity vehicles constructed primarily with money market securities, with minimal trading and with income objectives. We speak of managing uncertainty in the liquidity SMA context more so than the total return SMA context.
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