As we reported last month, a recent PwC survey found that even ascompanies stockpile cash, few treasurers are shifting portions oftheir portfolio into riskier investments to increase the yieldthey're earning.

Three-quarters of the survey's respondents said their company'scash as a percentage of total assets either increased or remainedthe same over the past year, whereas fewer than one-quarter (22percent) said that ratio has decreased. As they decide where topark this cash, survey respondents' primary goals are preservingprincipal and maintaining liquidity. Maximizing returns placed afar-distant third.

One reason PwC conducted the survey in the first place is thatmany clients were expressing interest in shifting investmentstrategies in order to increase returns on their excess cash, butthe survey found that few are actually making this move. Anotherkey finding was that most companies lack the processes and systemsthey would need to effectively manage the risks and performance oftheir portfolio if they did begin to pursue higher yield on someportion of their cash. Treasury & Risk satdown with PwC principal Peter Frank to identify the gaps anddiscuss what companies can do about them.

T&R: What do you see as the keytake-aways of the PwC Cash Investment Survey?

Peter Frank: Excess-cash investmentmanagement is one of the most basic things that a corporatetreasurer does, and it tends not to be a tremendously dynamicactivity. Yet over the past six to 12 months, we've been getting alot of questions from our clients about investing excess cash. Ithink the questions have been driven by a few things in themarketplace: First, of course, companies continue to have improvingcash flow performance, so their cash balances are increasing.Second, there is an issue with companies accumulating significantportions of those cash balances in jurisdictions outside the UnitedStates. And the third driver is the continued low-interest-rateenvironment.

Companies' investment objectives continue to be focused onpreservation of principal and maintenance of adequate liquidity,yet at the same time there is growing impatience for havinginvestment portfolio yields that may be zero percent or a few basispoints. In the better cases, they're probably dozens of basispoints rather than several percentage points. So many of ourclients have indicated that they're reconsidering their investmentstrategies and considering how they can become more aggressive inhow they're investing for the purpose of capturing incrementalyield.

With that in mind, I think the key take-away from the survey isthat there hasn't actually been a lot of action in terms ofcompanies changing their investment strategy. Companies have a fewoptions for taking more risk to get increased yield. They couldexpand the types of investment instruments they use. They couldstep down the credit quality of allowable investments. Or theycould extend out on the investment horizon to enter intolonger-dated-maturity instruments. But the survey results suggestthat despite the talk, although everyone is interested in doingsomething differently, there hasn't been much change in whatcompanies are actually doing.

T&R: Is this a matter ofinvestment policies not allowing companies the flexibility to takeon a bit more risk in pursuit of yield?

PF: The survey suggests that policiesactually already accommodate some reasonable flexibility in termsof more aggressive investment strategies. I think it relates moreto the processes, tools, and infrastructure that companies areusing. As consultants, we help a lot of companies with putting inplace policies, processes, and systems to better manage all aspectsof treasury, including excess-cash investment portfolios. But wewere even a little surprised by the relatively small number ofcompanies that formally measure the performance of their portfolioor do any sort of risk analysis around their portfolio. [Only 51percent of respondents to the PwC survey said they regularlybenchmark the performance of their investment portfolio against anexternal benchmark.]

One other issue is the continued pervasiveness ofMicrosoft Excel spreadsheets; Excel is still the primary toolcompanies are using to manage their portfolios. We went into thissurvey with the hypothesis that there might be opportunities forcompanies to take a bit more risk in their portfolios. But to dothat from a control standpoint, you really have to have the abilityto accurately track and measure risk, and measure performance, inthe portfolio. Based on the survey results, it looks to us likeeven though companies may like the idea of taking on more risk toget more return, they by and large don't have the tools, theprocesses, the infrastructure that would allow them to do that in amanner consistent with sound risk management.

T&R: So, what are best practicesin managing the risk and performance of a corporate excess-cashinvestment portfolio?

PF: Well, some companies that aremeasuring performance are just looking at the return on theirassets. Instead, at a minimum you would want to establish abenchmark. You would want to say, 'Here's our investment strategy;here's our asset allocation. For this type of strategy andallocation, we would expect to get certain returns based ondifferent benchmarks that exist.' Looking at returns versusexpected returns based on a benchmark, even on a notional basis,would be the first step.

The second step would be to introduce some concept of riskmeasurement into the portfolio—so doing things like definingalternative portfolios based on different strategies, looking atthe risk and return profiles of those different strategies. Youcould use a risk technique like a sensitivity analysis, it could bea scenario analysis, or you could use more advanced tools likeValue at Risk (VaR).

But you want to analyze and model the potential risk within aportfolio so you can make a decision like: 'Our current portfoliois yielding 20 basis points. If we made the following strategychanges, we could earn 1 percent instead. But we could have avariation around that 1 percent, where in a 95 percent casescenario we might earn only 40 basis points, or in some cases wemight lose money on the portfolio.'

It's a good idea to establish benchmarks, develop alternativestrategies, and then look at the risk/return characteristics ofthose alternative strategies. With that information, a managementteam can come to a conclusion about what level of risk isacceptable.

T&R: Obviously, many companieshave a low risk tolerance for their cash portfolio. Whatalternatives should they be looking at?

PF: One thing companies could do isinvest part of their portfolio overnight in very short-terminstruments. I'm making this number up, but maybe that's 80 percentof the company's total cash investments. Or it might put asimilarly large percentage in money market funds or bank deposits.But the company might want to take a sliver of the portfoliosomewhere else. It might be willing to put 5 percent in corporatebonds, or put 10 percent in longer-dated Treasury securities.Management might say, 'We understand there's some potential riskassociated with doing that, but we understand that risk, we've putsome bounds around it, and we're comfortable that if adversescenarios happen, we can deal with it. We're willing to take therisk to get some incremental return.'

Our sense is that a lot ofcompanies are basically saying, 'We're not willing to take anyrisk,' whereas there might be an opportunity to take some risks inan informed way—in a smart way that's visible and transparent toeveryone in the organization—to get some extra return.

Just to be clear, we're not advocating that companiesnecessarily go out and do this. What we're saying is that theymight want to invest some time in thinking about it and applyingsome analytical techniques to evaluate in an objective way whetherit might make sense. Companies may conclude it doesn't make sense,and that's perfectly fine. But it seems like right now there'shand-wringing about excess cash dragging company performance down,while there are steps companies could take to potentially addressthe situation.

T&R: If companies are willing totake different levels of risk on different segments of theirportfolio, what should their performance management look like?Should they set up separate benchmarks for each segment?

PF: That's exactly right. We suggest thatour clients consider segmenting their portfolio, having discreteinvestment objectives, investment strategies, asset allocations,and performance benchmarks for those different segments. You mighthave a segment where part of the portfolio is for very-short-termliquidity. It's meant to handle the day-to-day, week-to-week,month-to-month variations in cash inflows and outflows. You mighthave zero principal risk tolerance and require one-day or two-dayliquidity for this whole portfolio segment. And you might manage itusing a benchmark tied to a money market fund index or somethingrelated to the Federal funds rate.

But then you might have another tranche of investment balancesthat is more medium-term. This might be cash you're going to usefor big capital expenses or for a deal of some sort, or that youmight need to provide a buffer against a downturn in the business.Maybe you would decide that you need to be able to tap into thiscash in no less than three months but no more than a year out. Soyou would want to have a separate investment strategy for thatsegment.

And then you might have another bucket that is truly excesscash. You might not have it earmarked for anything, and you mightknow you're probably not going to need it within the next year. Soyou'd have a different set of strategies around that.

The point is, it's a good idea to tie the segmentation of theportfolio to the potential uses of, and needs for, the cash. Fromthere, you can set the Street objectives, strategies, assetallocations, and performance metrics for each segment.

T&R: And is that kind ofportfolio management possible using spreadsheets?

PF: It's possible. The question iswhether it's optimal. If you are a smallish company and you don'thave tons of activity—if you invest overnight in bank deposits ormoney market funds and that's all you do—then spreadsheets may notbe the best solution, but they're probably fine. If you're at theother end of the spectrum and have investment balances around theglobe that you manage centrally or regionally, you have multipleportfolio segments, you are investing directly in individualsecurities of different types, and you have a high volume, then itis probably impossible to manage with spreadsheets. Well, maybe notimpossible; if you throw enough bodies at anything, it can be done.But spreadsheets wouldn't be an optimal solution.

T&R: Do you anticipate thatpressure is going to build for corporate treasurers to increasetheir level of sophistication in managing excess-cash investmentportfolios?

PF: As you know, the new money market regulations are changing significantly thepotential attractiveness of prime money market funds, which arecurrently the single most preferred instrument for most corporatesto manage day-to-day liquidity. It's too early to say exactly howthat will all shake out, but companies are going to have a lot tothink about. I think there's going to be a lot more pressure to doa better job of cash forecasting, and I expect that we might seemore companies doing more direct investing in money marketinstruments, rather than through funds. Both of these things will,in turn, place pressure on corporate treasurers to have betterinfrastructure and tools. The exact operational and strategicimplications of the regulations are still to be determined, but mysense is that this will be a big deal.

See also:

• Revisit Your Corporate Investment Policy