In 1993, the last time interest rates cycled through a low phase, many corporate investors thought they had found the magic bullet that would generate adequate, if not impressive returns. The solution: load up on derivatives that in theory keep the return-on-investment machine churning. In the end, however, the strategy proved to be a career-ender for many, as flawed bets on exotic derivatives triggered significant losses and even threw a wealthy California county into bankruptcy.
Fast forward nearly 10 years. The picture is fairly similar: Aggressive rate-cutting by the Federal Reserve has once again all but eliminated meaningful yield on liquid investments, and again treasurers are looking for alternatives. This time, however, having been burned by the derivative debacle of the mid-1990s, smart is taking a back seat to safe, and finance executives have decided to park their money until Alan Greenspan finally decides it's time for rates to rise. That means sticking with short-maturity investments, protecting principal and waiting.
The inaction might defy convention, given treasurers' innate desire to put cash to work and at the best rates possible. But experts say sitting tight just might be the best response to the current rate climate. "Nobody wants to be exposed if something goes wrong," says Elyse Weiner, vice president and market manager for large corporate clients in the treasury services unit of J.P. Morgan Chase & Co.
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She's hardly alone in her opinion. "It's always tempting to pick the high point on the yield curve, but that's a dangerous strategy right now," says Ben Campbell, president of Capital Advisors Group, a Boston-based corporate investment strategy firm. "Never take more risk than you normally would just because rates are low." Campbell insists that, historically, cyclical lows last an average four to six months. That means it's smarter to get ready for rising rates than to lock in longer-term rates that are relatively attractive.
That is not to say that snake-oil salesmen aren't still out there, trolling for gullible corporate investors. "We've seen some schemes involving derivatives and structured products that seem too good to be true," says Lee Epstein, president and CEO of Money Market One, a San Francisco investment dealer that specializes in corporate cash investing. "They'll make more money all right, but for the dealers, not the investors."
Furthermore, meager rewards have not entirely undermined creativity. "We've seen a real push to free up as much cash as possible through pooling and through tighter A/P and A/R management and then use the cash to fund operations, pay down debt or, if there is a surplus, get it all invested," Weiner says. Pooling and cash concentration products are booming as treasury shops work to offset lower yields with more principal, she reports.
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Then, there are people like Bob Prantis, treasurer of the $1.7 billion Xilinx Inc., a San Jose, Calif.-based software company. Xilinx's strategy is to split its cash between a liquidity pool that is managed in-house and a return pool that is managed by outside investment pros. For the liquidity pool, Xilinx buys plain vanilla money-market instruments and earns whatever rates they pay. In the return pool, managers have sold securities, taking gains that somewhat offset the lower coupons. "We're certainly feeling the low rates, but we haven't changed our strategy," Prantis says.
Even Orange County, Calif., the most conspicuous casualty of the pursuit of high investment returns in the mid-1990s, is playing it safe. John Moorlach, the county's treasurer and tax collector, says most of the county's more than $4 billion in investments is split between two money-market portfolios: one for the county yielding 2.78% and another for the school district yielding 2.79%. The county also has a $660 million longer-maturity portfolio, which is bringing in a respectable 3.965%.
Other steps companies are taking include tightening their cash forecasts and investing earlier in the day, when rates usually are a little better, says Diane Reyes, North America business management head at Citibank N.A. in New York. "They're getting very precise," she says. "Traditionally, if they had $100,000 left to invest late in the day, nobody was concerned, but now they're getting it all placed as soon as they can." Another option has been investing in money-market funds, particularly those with the longest average weighted maturities, which were the best performers last year, says Capital Advisors' Campbell.
But money market funds should lose their luster now that short-term rates appear to have hit bottom and are expected to begin rising sometime late in the third quarter. Paul L. Soske, manager of treasury consulting for Wisdom Technologies, a Pittsburgh-based cash-management software company, suggests that a move from overnight liquidity to something like 30-day CP will garner a slight reward then. Cash investors can then go back to laddering maturities to keep investments maturing on a schedule that matches the need for cash, he adds.
But for those who can't wait, Campbell suggests corporate debt. Corporate issues have been punished with unusually wide credit spreads recently. When the economy recovers and those spreads return to normal, investors should get a nice bounce. "We think that's the area of greatest opportunity," he says.
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