Business Strategy

Now, More Than Ever, Cash Deserves Your Careful Consideration

At a time when cash management options for business owners have grown increasingly numerous and complex, choosing the right investment approach can make all the difference.

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If you’re like most business owners, you probably focus more on generating cash than managing it. While that’s understandable, treating cash as an afterthought can mean missing valuable opportunities and may expose your business to unintended risks, some potentially serious. You need look no further than the recent global financial crisis — and the abrupt demise of otherwise stalwart firms that found themselves suddenly short of the liquidity they needed to survive — to reinforce the potential benefit of a thorough assessment of your cash management needs and solutions.

“Cash management options are more varied and complex than many business owners realize, especially given new federal regulations on the money market fund industry,” says Jonathan Carlson, head of Separate Account Portfolio Management for BofA™ Global Capital Management. “It’s definitely not one-size-fits-all. Each approach has its advantages, and could be appropriate, depending upon your situation. Often a combination of options is the best way to go. Taking time to consider all the possibilities in the context of your risk tolerance, liquidity needs and business objectives is the most effective way to create a cash management strategy with the most potential for long-term success.”

Treating cash as an afterthought can mean missing valuable opportunities and may expose your business to unintended risks.

THE “DIY” AND MUTUAL FUND OPTIONS

For business owners who want control of their individual investments, the seemingly most straightforward investment choice is to buy your own securities. “This provides flexibility in terms of the assets you acquire, and it is the least expensive approach, at least in terms of management fees,” says Carlson. “However, given where we are in the interest-rate cycle, the yield you’ll get with this approach is likely to be on the low side. In addition, you may not have the resources and time necessary to manage the risks inherent in short-term debt.”

The time factor is especially important for a small company, but even in a large institution, the treasurer’s office has many responsibilities in addition to cash management. “Chances are, even large companies aren’t staffed to be able to take advantage of opportunities as they occur,” says Carlson. “Sometimes, if you want it done right, the answer is not to do it yourself.”

And if you opt for working with outside managers? If safety of principal and ready access to cash take precedence over potential returns and being flexible in your investment choices, then simply letting the money sit in a bank account could be the most effective option. “While bank deposit yields have been dropping dramatically, and that could be a factor to consider, you’ll have substantially dialed down the risk of losing your principal,” says Carlson.

Another conservative option to consider for companies focused on liquidity is a money market fund. “In exchange for a management fee, a company can free up valuable time and put its cash to work with professionals skilled in short-term fixed-income management,” says Carlson, who’s quick to add that not all money market funds are created equal. “Different funds focus on different types of securities, and risk and return objectives can vary accordingly. Management skill varies as well,” Carlson says. “That said, money market funds tend to be high-quality investments that are managed specifically to help achieve principal preservation.

“That’s a powerful thing, and for many businesses, a money market mutual fund can do an excellent job of meeting cash management needs.”

THE SEPARATELY MANAGED ACCOUNT OPTION

“But sometimes businesses put cash into a money market fund when they don’t really need ready access,” says Carlson. For companies holding cash that they don’t need immediately, a separately managed account can be a compelling alternative.

Among the advantages of separately managed accounts is their latitude to pursue potentially higher yields. Recent changes to federal rules for money market mutual funds limit portfolio risk and, by extension, fund yields. In contrast, managers of separate accounts can pursue high yields in a number of ways:

Increasing Portfolio Duration
While money fund managers can’t hold securities with maturities longer than 13 months, separate account managers have the flexibility — when it fits within the client’s risk profile — to venture beyond that threshold. Historically, issuers of longer-maturity securities have had to compensate investors for the higher interest-rate risk implicit in these issues by offering higher yields than those available on shorter-term debt. “By venturing out even slightly beyond 13 months, separate account managers can many times meaningfully increase yield potential without significantly increasing risk.”

It’s definitely not one-size-fits-all. Each approach has its advantages, and could be appropriate.

Adding Lower-quality Debt
By adding securities with credit ratings slightly lower than those allowed in money market funds, separate account managers may be able to achieve higher yields than those offered by money market funds, although they may be subject to greater market fluctuations and risk of default or loss of income and principal than securities in higher rating categories.

Optimizing the Mix of Securities
The 13-month maturity limit keeps money fund managers from being able to consider many kinds of securities. Separate account managers can blend diverse securities, such as corporate and municipal bonds, structured products and asset- or mortgage-backed securities, and thus may be able to increase yield and reduce investment risk by holding smaller positions in a larger number of well-diversified securities.

Customization
“A separate account can be customized to help meet your liquidity needs, risk tolerance, yield preferences and any other guidelines about the assets you want in your portfolio,” says Carlson.

Reporting Flexibility
Another major difference between money market funds and separately managed accounts is that separate account investors own the securities in the account rather than shares of a fund. Not only can an investor determine the amount of buying and selling within a portfolio (which may provide tax advantages), but this structure also promotes greater transparency and flexibility with regard to reporting. “If you own shares in a money market fund, you receive statements that basically provide one line-item of information,” says Carlson. “When it comes to separate accounts, we can report on them when and in any way you want. We have no portfolio holdings disclosure rules that require waiting a certain amount of time before you can have access to information about holdings in your portfolio, and we can show a portfolio’s characteristics and exposures in great detail.”

Low Account Minimums Are Possible
“Many business owners think that separate accounts are only for Fortune 500 companies,” says Carlson. “It is true that account minimums — as high as $200 million at certain firms — can be prohibitively high for all but the largest institutions. But while we at BofA Global Capital Management manage balance sheet cash for many Fortune 500 companies, we also offer completely customized separate account management for accounts of at least $25 million, and partial customization for accounts between $10 million and $25 million.”

Expertise Could Be the Biggest Advantage
Perhaps the biggest potential benefit of choosing a separate account is the focused expertise it provides. Says Carlson: “For both small and large companies, cash management is only one part — and not the main part — of their responsibilities. We do nothing but manage liquidity portfolios. Our highly experienced managers and credit analysts live and breathe these markets every day. At the same time, we have access to the insights of Bank of America’s economists, strategists and analysts when it comes to keeping abreast of broader macro trends impacting our markets. We believe we offer focus, expertise and knowledge — and in a cost-effective way — that many companies would find impossible to duplicate.”

Focus and expertise are particularly important when it comes to managing the risk of capital loss. With separate accounts, a stable $1 net asset value cannot be maintained at all times, despite a manager’s prioritization of principal preservation and portfolio liquidity over yield. It is possible to lose money, say, if there’s a big sell-off in bonds or a credit loss in a portfolio. “That’s an important consideration,” says Carlson. “Still, for many clients, that risk of capital loss is outweighed by the advantages of owning a separate account.

“Moreover, at BofA Global Capital Management, we look to manage the risk of capital loss in every way possible. Our first and most important goal is principal preservation. Only after attending to that priority do we begin to address liquidity and yield considerations and the trade-off between risk and return.”

Match the Method — or Methods — to Your Needs
“Each approach to managing cash has its advantages,” says Carlson. “The separate account option has a lot going for it — especially given the current interest-rate environment — but it isn’t right for everyone. For some companies, the simplest approach — just leaving it in a bank — can be best. Others do best when keeping all cash management in-house or utilizing money market funds. For most businesses, however, a portfolio-based approach that combines these cash investments may make the most sense. Many cash investors rely on a single investment — such as bank deposits, or a money market fund, or multiple funds with similar risk/return profiles — when they can often do much better by availing themselves of the full array of investments available.” Such an approach, he says, can provide valuable diversification as well as potentially better returns.

JONATHAN CARLSON is a managing director and head of portfolio management for liquidity strategies separate accounts at BofA Global Capital Management. A member of the investment community since 1988, he earned his B.A. in economics and English from Amherst College and earned his M.B.A. in finance from Northeastern University. He holds the Chartered Financial Analyst designation and is a member of the Boston Security Analysts Society.

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Opinions expressed in this article are those of the featured representative of BofA Global Capital Management as of 11/18/11 and may differ from those of U.S. Trust and/or Bank of America Corporation and its affiliates. This article is designed to provide general information about ideas and strategies. It is not intended to give you suggestions about your specific portfolio or serve to provide recommendations to buy or sell securities in a particular sector. It is for discussion purposes only, since the availability and effectiveness of any strategy is dependent upon your individual facts and circumstances. Information in this article is not intended to constitute legal, tax or investment advice. You should always consult your independent attorney, tax advisor, investment manager and insurance agent for final recommendations and before changing or implementing any financial, tax or estate planning strategy.

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