We think well-diversified portfolios enable corporate treasury teams and other investors to prudently manage their cash portfolios to ensure liquidity and minimize risks while achieving sufficient returns to meet day-to-day business needs. By spreading cash across various instrument types, whether it be bank deposits, money market funds (MMFs), short-term bond funds, Treasury bills (T-bills) , or commercial paper to name a few, cash investors may potentially reduce the impact of poor-performing assets in their portfolios.

To gain a better understanding of how well treasurers diversify their portfolios, we partnered with publication Treasury Management International to produce the 2023 Global Treasury Survey. More than 200 treasurers answered questions on a range of topics of interest to cash managers. Despite the clear benefits of diversification, Exhibit 1 shows a surprising lack of it . Notably, 38 treasury teams (18% of respondents) have 80-100% of their short-term investment portfolio in bank deposits while 14 teams hold 60-79% of their short-term investment portfolio in the same instrument.

EXHIBIT 1: LACKING DIVERSIFICATION

While bank deposits play an important role in a cash portfolio, we think there are opportunities to diversify to different types of cash investments.

Cash Segmentation: A Different Way to Diversify

The survey results indicate that most cash managers likely should seek ways to improve diversification while not compromising on liquidity and ensuring capital preservation. Diversification, beyond helping to manage risk, enables treasurers to strike a balance between more liquid but potentially lower return investments and less liquid, potentially higher return ones.

As we stated at the top of this article, there are a plethora of options available to corporate treasurers when it comes to cash diversification. However, there is one option less widely adopted but that we think is worth exploring: cash segmentation.

Cash segmentation may not be right for all due to the requirement of complex cash forecasting. In fact, it requires corporate treasurers to have a deep understanding of their cash flows and to split out cash uses into three separate maturity buckets. However, a cash segmentation strategy also has the potential to generate greater returns than a one-size-fits all approach to investing, and the cash follows the treasurer’s business cycle and objectives. 

As shown in Exhibit 2, with the cash segmentation approach, investors split their cash into maturity buckets based on the treasurer’s forecasts for different cash needs: operational (1 day to 3 months), reserve (3 months to 9 months), and strategic (9 months to 18 months). Corporate treasurers and cash managers must accurately forecast the timing of cash deposits and spending, which demands a deep understanding of cash flow patterns to determine the allocation of a company’s cash to each bucket.

EXHIBIT 2: HOW CASH SEGMENTATION WORKS

With cash segmentation, investors divide their investments into three buckets based on maturity and expected timing of cash demands. This diversifies the cash portfolio while potentially enhancing income.

Diversifying with Money Market and Ultra-Short Funds

As Exhibit 2 demonstrates, using money market funds and ultra-short bond funds  as part of a cash segmentation strategy can aid diversification while maintaining liquidity within a short-term investment portfolio.  Furthermore, money market funds can benefit investors whether rates are rising or falling. In a rising rate environment, these funds provide flexibility in portfolio construction as fund managers can actively refine their portfolios to optimize returns.

For example, money market fund managers can shorten the weighted average maturity of the money market investment portfolio, within the permissible range of zero to 60 days. This adjustment allows for the manager to reinvest cash every month, in order to potentially capture the higher income from rate increases. When rates fall, fund managers can extend maturities to stagger the effects of the rate reduction. By retaining higher yields over an extended period, money market funds can provide more appealing returns compared with short-term bank deposits in a falling rate environment.

Cash investors may initially struggle with the cash forecasting required to determine which funds to use, so partnering with an established and experienced partner, in an asset manager, may just be the answer. Asset managers are well-equipped to aid treasurers with forecasting, analysis and provide an important role in being able to interpret regulatory changes that rear their head from time to time. Whether in the US, Europe or Asia, Asset Managers have the experience and resource to quickly interpret and communicate how regulatory actions may impact a cash strategy or existing investments. Fund providers also often have market experts who can guide investors through implementation. In addition, dedicated portfolio management teams actively manage money market portfolios, with the idea of reducing risks for investors whether rates are rising or falling.

The Challenge of Investment Policy Restrictions

Sometimes treasurers are simply restricted from using money market funds or other options that may help diversify their portfolios. Investment policy restrictions often contribute to a lack of diversification since they prohibit the use of certain types of cash securities. Our survey provided clarity on the most common restrictions:

• 34% can’t invest in floating net-asset-value money market funds

• 31% can’t invest in ultra-short funds

• 27% can’t invest in stable net-asset-value money market funds

• 8% cannot invest in environmental, social, and governance (ESG) funds

Some of these restrictions may stem from the last round of regulatory actions several years ago. Treasury teams naturally prioritize safety and liquidity, so having a restrictive investment policy is certainly not irrational. However, the environment for cash managers has changed. So we think investors should consider reviewing their policies at least every couple of years to ensure they remain suitable for the current environment and are not prohibiting the potential for a better return while maintaining the key focus of capital preservation and liquidity.

Advocating for Diversification Now

We understand that discussing new products or policy changes around the cash component of an investment policy often takes a back seat for corporate boards, especially when yields are not stellar. However, elevated rates should incentivize corporate boards to take another look and potentially challenge old ways of doing things, including considerations around whether cash segmentation could be right for them.