BofA Global Capital's Nancy Jerez, Managing Director, Head of National Institutional Sales, recently wrote a white paper entitled, "Is Your Investment Policy Due for a Course Correction?," which is subtitled, "An Updated Investment Policy Can Help Treasury Professionals Navigate Today’s Difficult Markets." She says, "As a treasury professional, you may face tough challenges these days trying to protect principle, maintain liquidity and optimize the yields on your organization's balance sheet cash. While it's never been easy to achieve those disparate goals, it's particularly difficult now due to a perfect storm of low interest rates, shifting regulations and macroeconomic headwinds generated by the European sovereign debt crisis and tepid economic growth in the U.S."

Jerez explains, "In this environment, it is especially important that you maintain an updated investment policy, an indispensable tool for those tasked with managing balance sheet cash. A detailed investment policy serves several purposes: it codifies your organization's investment objectives; it defines key portfolio metrics, e.g., liquidity levels and credit quality; and it identifies the investments you may leverage to achieve your investment goals. Structured correctly, an investment policy helps ensure that your investment strategy accurately reflects your risk tolerance and liquidity requirements, while providing guidance to the professionals managing your cash portfolios. Perhaps most important, it can instill the all-important element of discipline in your investment program."

The "Perspectives on Liquidity" "white paper" continues, "Because each organization's investment policy will reflect its own liquidity needs and return objectives, each policy will be unique. That said, all investment policies should feature the following: A clear articulation of your organization's risk tolerance, liquidity requirements and return objectives; Allowable securities (and those to be avoided); Guidelines for the construction and management of your investment portfolios; and, Mechanisms to promote ongoing compliance with the policy. In short, a sound investment policy is central to the effective management of balance sheet cash because it requires that you clearly articulate your investment objectives and detail the means by which you'll seek to achieve them."

Jerez writes, "The first step in updating your investment policy is to inventory all of your organization's cash because an investment policy is most effective when it encompasses all cash holdings. This means the investment policy must account for all investment vehicles (bank deposits, money market funds, separate accounts, and portfolios managed in-house); the purpose of the cash (for daily operating expenses or reserves) and the location of the cash, e.g., home country or abroad.... Once all of your cash holdings have been accounted for, you need to determine your investment objectives. The cornerstone of any effective investment policy is the clear statement of your goals, because those goals drive -- or should drive -- the development and implementation of your investment strategy. Most organizations list principal preservation as their primary objective, with maintenance of liquidity and achieving attractive yields as secondary and tertiary goals."

She explains, "Whatever the nature and needs of your organization, your investment policy should define the amount of cash necessary to fund daily operations and how it should be invested. Daily operating cash typically is invested in deposits or money market funds because they offer daily liquidity. Your investment policy might stipulate that operating cash be invested only in these highly liquid vehicles. For more stable cash, meaning the cash you do not require access to on a daily basis, you might consider investing a portion of it in a separate account, which may be able to offer higher yields than those in money funds. If you include separate accounts in your investment program, your investment policy should clearly stipulate the types of investments you consider acceptable and those you deem inappropriate."

Jerez tells us, "A prominent feature of most investment policies is the allowable investments section, which simply defines the security types you'll permit in your cash portfolios. Allowable investments generally reflect the organization's unique investment objectives and risk tolerance. It may define allowable securities for portfolios managed internally and others for the cash managed by outside advisors. Once defined, your allowable investments must be regularly updated to account for new investment products and to reflect shifts in the market."

She explains, "When we talk about diversification in the context of an investment policy, we're talking about concentration limits for your cash portfolios -- both those managed internally and others overseen by outside managers. Your policy might spell out the maximum concentrations allowed per issuer and per security type as follows: No more than 5% of the portfolio to be invested in any one issuer; No more than 50% of the total portfolio to be invested in corporate notes and bonds; No more than 10% of the total portfolio to be invested in asset-backed securities; and, The policy also might stipulate that your organization's investment in a money market fund cannot account for more than 5% of the fund's total assets. While these diversification guidelines can help limit concentration in a particular sector or issue, rigorous concentration limits can sometimes lead to unintended consequences, such as too much inefficiently invested cash."

BofA Global's Jerez writes, "Liquidity is the lifeblood of an organization. Creating and/or regularly updating an investment policy can help you maximize liquidity by clearly articulating your investment objectives and the steps you'll take to achieve them. The policy establishes the guidelines that will determine the key portfolio characteristics that drive portfolio construction and performance. Put simply, a regularly updated investment policy positions you to achieve your investment goals by providing the clarity of purpose and discipline that are central to the success of any initiative."

Finally, she says, "Of course, the effectiveness of an investment policy depends on the quality of the information and analysis on which it's based. The policy must be thoughtfully structured to reflect your organization's needs and the market's evolving risks and opportunities. Unfortunately, today's volatile market environment and investors' sensitivity to risk can undermine efforts to craft a sound investment policy. Strong risk aversion may lead to unnecessarily conservative investment guidelines, for example. At the same time, the complexities of today's short-term debt markets -- and of specific investment products -- can result in less-than-optimal policy guidelines regarding allowable investments and diversification. Given these realities, it is vital that you accurately assess the expertise and resources your organization can bring to bear when structuring your policy. If you have any doubts about your ability to effectively evaluate and update your investment policy, your first and most important task should be to identify an investment firm with the expertise, the resources and the objectivity necessary to help you capture the many benefits a well-structured policy can deliver."

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