Capital Advisors on Optimizing SMAs
Capital Advisors Group released yet another white paper, "Optimizing Separate Account WAM in a Rising Rate Environment." The introduction says, "Faced with the challenges of banks turning away non-operating deposits and prime money market funds subject to redemption fees and gates, institutional cash investors increasingly turn to separately managed accounts (SMAs) as a viable cash management alternative. SMAs benefit from a customized and stable liquidity profile, wider investment selections, easy monitoring and direct control of credit risk, and higher return potential. In a rising interest rate environment, however, SMAs may experience unrealized losses. How does one optimize portfolio weighted average maturity (WAM) to maximize return potential and minimize unrealized losses? We plan to tackle this question with a scenario analysis of several model portfolios to show that, even in a rising interest rate environment, it still pays to extend the WAM in an SMA beyond that of typical prime money market funds.... For our experiment, we designed two sets of model portfolios with laddered maturities.... The WAMs for the two sets of three portfolios are 1.5 months, 3 months, and 6 months, respectively. The portfolios reinvest maturity proceeds at the end of each month for the same maturity at prevailing yield levels so that the WAMs return to the beginning levels for the subsequent month." It concludes, "For institutional cash investors unsure of the SMA approach in a rising interest rate environment, our scenario analysis suggests that despite, or because of, a rising rate environment, a laddered portfolio of agency and corporate securities of modest WAM could outperform the government money market fund alternative on income returns with negligible unrealized loss concerns. For accounts that do not accept credit exposures, agency portfolios may sufficiently defend against rising interest rates up to three rate hikes in a 12-month period if today's yield curve to RRP relationship holds constant. A corporate credit portfolio may outperform the government money market fund alternative if interest rates were to increase by up to 1.00% in the next 12 months."
