T. Rowe Price published a new paper in its "Price Perspective" series, entitled "Cash Management: How Does The Changing Landscape Impact Institutional Cash Investors?" Authors Joseph Lynagh, Justin Harvey, and Whitney Reid summarize, "The Tax Cuts and Jobs Act of 2017 required companies to bring profits earned overseas back to the U.S. at lower tax rates than had historically been applied to foreign earnings. This change encouraged multinationals with significant overseas cash to reconsider the domicile of their liquid holdings. In light of this tax change, combined with the divergent rate paths of developed-market yield curves, investors should reevaluate their current cash investment policies, guidelines, goals, and objectives. We believe cash investors will benefit from quantifying the risks they are willing to take and then strategically constructing their cash portfolios to reflect that tolerance."
They explain, "By segmenting cash investment pools into tiers based on operational needs, time horizon, and risk appetite, investors may be able to increase the income generated by their cash portfolios while preserving sufficient liquidity. T. Rowe Price has developed a comprehensive investment framework that helps cash investors design customized cash strategies reflecting their income goals, risk tolerances, and liquidity requirements."
TRP writes, "Given the combination of tax changes and an evolving interest rate environment, we believe cash investors will benefit from a broader and more dynamic cash investment framework that models potential allocations based on three key inputs: income and return targets, liquidity requirements, and risk tolerance. This framework, which involves multiple steps, provides important guidance for cash investors and could lead to more effective cash investment programs."
The paper tells us, "Our cash investment framework begins with segmenting cash holdings into four tiers based on investment time horizons, which range from short term (immediate cash needs) to long term (strategic cash). By allocating cash investments into tiers, investors can better align cash income opportunities with liquidity requirements. The four tiers … are segmented by maturity profile. They are further defined by a set of characteristics, including liquidity, representative vehicle options, and target asset quality."
It continues, "Our ultimate goal is to allocate cash across the four tiers in a way that seeks to meet an investor’s income, return, risk tolerance, and liquidity requirements. The optimal allocation among the tiers is contingent on a detailed cash flow and risk analysis that investors should revisit periodically as cash flow needs and market conditions change."
The piece states, "After segmenting cash requirements into tiers based on time horizon, we start the cash investment analysis by defining an investor's current cash allocation, investment objectives, liquidity needs, and constraints.... [I]nvestment vehicles available in Tiers 2 to 4 offered more attractive income opportunities than money market strategies and bank demand deposits. However, they introduced default and interest rate risk."
Lynagh, et. al. comment, "The relationship between interest rate movements and cash investment outcomes is quite complex. Rising interest rates are a double-edged sword for cash investors: The cash portfolio may initially sustain marked-to-market losses, but subsequent coupon and maturity payments can be reinvested at higher yields. Depending on the maturity profile of current holdings and cash flow timing, the break-even point for a cash investor to recover from rising rates may actually be shorter than many investors perceive. Similarly, a decline in interest rates may produce capital appreciation in the short term, but reinvested cash flows will have less return potential in the future."
They say, "Applying a range of interest rate scenario analyses can help cash investors quantify the opportunity and risk trade-offs of each cash allocation, which we define as higher income versus principal volatility. The former addresses the goal of our hypothetical investor to increase cash income; the latter represents the potential marked to-market losses that the portfolio may experience based on interest rate and spread changes. The goal is an analysis that integrates income opportunity with market risk."
Finally, the paper tells us, "As noted above, we believe recent tax incentive changes and divergent interest rate opportunities will encourage cash investors to reevaluate their cash investment policies, guidelines, and objectives."
It concludes, "By segmenting their cash into different liquidity tiers, cash investors can more efficiently deploy their capital across the risk and return spectrum. T. Rowe Price has developed a cash investment framework that we believe will enable cash investors to more acutely define their risk and return objectives while optimizing the total income produced by their cash investments."
