Navigating the Changing Cash Landscape
Money market reform, driven by the 2008 financial crisis and the rebound from a prolonged period of low interest rates, is changing the way investors think about cash.
According to Alan Markarian, senior vice president at U.S. Bank and national manager for its Investment Advisor Services group, the term “cash” means different things to different people.
“I don’t think ‘cash’ is a term that’s universally defined the same way from investor to investor, advisor to advisor,” he says. “For retirement and core investment accounts, it’s generally the transitory cash that’s created from income payments or the rounding that naturally occurs during trade execution. For operational accounts that need liquidity to fund activities outside of the investment account, a much larger allocation to cash is possible, which can often be a sizeable portion of a portfolio.”
Markarian says he prefers to think in terms of ultra-short-term investments, rather than cash.
“To me, the ‘cash’ portion of a portfolio is everything that trades same day or T+1 and has a short duration” he says.
Those buckets include among others: money market funds, government issued debt, commercial paper, tax-free state-specific funds and bank balance sheets. The first FDIC sweeps came on the scene in the early 2000s, but didn’t take off until the past 10 years, as a result of the financial crisis and money market reform.
Breaking the buck
Prior to the 2008 crisis, investors tended to keep ultra-short-term investments in money market funds. When Lehman Brothers collapsed, however, the largest of those funds, the Reserve Primary Fund, found itself exposed by its Lehman bond holdings. Institutional investors pulled billions of dollars out of the fund, driving the share price to 97 cents, breaking the buck.
“When the Reserve fund broke the buck, it created a ripple effect in the psyche of the industry,” says Markarian.
Breaking the buck pushed the Securities Exchange Commission to put in place reforms. Prime institutional money market funds were required to have a floating net asset value rather than a fixed $1 share price. The reforms also resulted in the institution of liquidity fees and redemption gates halting withdrawals to certain money market funds.
“What money market reform did, at least in some people’s eyes, was change prime money market funds from being a true ‘cash sweep’ into a short duration mutual fund that can be traded same day,” Markarian says. “While that distinction might seem like an irrelevant nuance, it’s not. It led to billions of dollars fleeing prime funds in search of a home that makes investors, CIOs and CFOs more comfortable.”
Shifts in holdings
Money market funds are still widely used for ultra-short-term investments, but the financial crisis changed the way their risk is perceived. Money market reform added complexity that makes them more burdensome to hold.
Concurrently, interest rates have started to rise after a long stretch of low interest rates, driving interest in cash as an asset class. The environment has pushed some advisors to shift cash holdings to FDIC Sweeps, which spread cash across numerous FDIC-insured accounts, boosting the level of government insurance for large amounts of cash.
“This combination has contributed to the attractiveness of other options, such as FDIC Sweeps and separately managed short-term portfolios,” says Markarian.
Kyle McAndrew of Stone Castle, a firm specializing in cash management, confirms this trend.
“What we’ve seen is a drastic shift,” McAndrew says. “Money market reform had a big impact. The value of cash has really increased. It’s FDIC-insured. It earns an interest rate, and it’s accessible. We did see a massive shift.”
As the environment continues to evolve, and experienced partner can provide resources expertise and support to help you make the best decisions based on your needs.
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