Trade-offs in the search for yield
Yield strategies pursued by treasurers are heavily influenced by how much excess cash they have – but whatever their situation they still face a tough task optimising returns.
Balancing liquidity against returns is a constant trade-off for treasurers, and at two ends of the spectrum are Zimmer Biomet, a medical devices company, and Paypal, the giant payments firm. The former is paying down debt, while Paypal is looking to preserve the value of its large cash pile. But whatever their situation, firms need to maintain some cash for operating purposes and unforeseen events. Meanwhile, this is happening amidst inflation.
“There is no magic, there is no free lunch, whatever we get in the markets better than govvies (government bonds) has a cost,” said Coralie Billmann, EMEA Director Treasury at Paypal. But treasurers are restricted over how they deploy company cash. “The principles are safety, liquidity and yield – and yield is a distant third,” said Pradipto Bagchi, Treasurer at Zimmer Biomet, speaking at the 2021 International Treasury Management Virtual Week.
Paypal’s treasury mainly focuses on highly liquid short term investments as customers require instant access to their cash. Those funds are also regulated.
Billmann said examples of investments include overnight deposits, cash held at banks and even short term commercial paper. “Our asset allocation is very close to a money market fund, so that we are really liquid,” she said.
Once Paypal’s liquidity needs are established, the search is on for those extra basis points. “Whenever we can take a bit of maturity advantage in the curve, we take it. Again always within this liquidity framework,” said Billmann.
She explained that the treasury will also consider taking on some credit risk by sometimes investing in corporate bonds, commercial paper, deposits with banks or investing with banks and firms with a special borrowing need, such as in euros. Asset backed securities and floating rate notes are also of interest.
“If you do your due diligence in terms of credit risk, you can easily pick up between 10 and 15 basis points without adding too much liquidity risk to the portfolio,” she said. “It’s really key for treasurers that have money to invest to be as close as possible to the market and to retain flexibility in the asset allocation.” That flexibility should allow treasurers to quickly take advantage of any yield opportunities, a characteristic Billmann sees as a competitive edge.
As of September 2021, PayPal reported holding $30 billion of customer accounts, invested in cash and liquid debt securities. Many of PayPal’s customer accounts are in the Eurozone where returns are zero or negative. To boost returns, PayPal uses internal investment management capabilities and tries to remain as flexible as possible in terms of asset allocation. The investment team may sometimes employ a tactical approach when some bond issuers may have more appetite in a specific currency if beneficial, but most of the time the increased yield is offset by the cost of neutralising the FX risk, a phenomenon known as interest rate parity.
Working the markets
Billmann explained the strategy: “If I take an example of AA (euro) bonds trading at let’s say minus 50 basis points … we can swap them into US dollars and invest in the US dollar yield curve and at the same time hedge this new exposure.”
Placing those funds into a US dollar corporate bond could see a 40 basis points positive yield, however, the cost of the currency hedge, which can be volatile, can nullify those gains. And the numbers can be eye-catching. PayPal reported holding $22 billion of notional derivatives connected with its investments in September 2021, although these are gross positions that don’t reflect actual exposure.
Using swaps can add complexity with Bagchi citing counterparty risk. “It’s (about) a holistic look at counterparty risk across all investment and exposure classes,” he said. He explained it is important to limit exposure to a particular counterparty.
“What we have done is size our liquidity needs,” said Bagchi. “And that portion of our investments are extremely liquid: money market funds, short term deposits, and commercial paper. If you have some excess cash, you can be tactical.”
He noted that returns on cash can be enhanced at some banks in exchange for less flexibility. “You have the ability to withdraw that cash, but not on a daily basis. That gives you higher returns,” he said. He added that it is possible to layer those investments with CDs (certificates of deposit) to gain extra yield from duration, while still maintaining a consevative and liquid portfolio. However, this is done within the limits of Zimmer Biomet’s treasury management policy to minimise credit risk.
Where liquidity is constrained, there are few other ways to boost returns. “At present, Zimmer Biomet doesn’t have a lot of excess cash above core needs, because we are in a deleveraging mode …… so we don’t really have long term cash,” said Bagchi.
A glance at Zimmer Biomet’s third quarter 2021 report shows progress is being made. It had long-term debt of $6.46bn, compared with $7.63bn in the previous three months. During that period cash rose to $919.6m from $802.1m. During the third quarter Zimmer Biomet spent a net $52.6m on interest payments.
Paying down expensive debt to reduce interest payments, can be a more profitable use of excess cash rather than chasing yields.
Even if deleveraging is a priority there are still reasons to maintain some liquidity: “(In the medtech industry) we tend to be serially acquisitive, especially bolt-on acquisitions,” he said. This means cash must be on hand to take advantage of opportunities.
The chase for yield is unlikely to abate any time soon as central banks remain constrained over how high they can raise interest rates without tipping deeply indebted economies into recession.
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