ABN AMRO Asset Management - Liquidity Advisory Desks - Optimising the Trade-Off Between Liquidity, Risk and Return

For treasurers, achieving acceptable investment returns is becoming increasingly difficult. Their priority remains to preserve value, but with many companies currently cash-rich, there is often considerable excess liquidity that needs to achieve optimum performance. With interest rates low, treasurers can no longer simply invest this cash in high yield deposits or money market instruments.

The range of investment opportunities is greater than ever. While low-risk deposit or money market investments remain the primary destination of treasurers’ funds, there is a growing range of alternatives for excess cash that can be locked away for relatively long periods of time. These include financial instruments such as structured deposits and credit derivatives.

It is now possible for the treasurer to leverage the full capabilities offered by large financial services groups in order to achieve the optimum trade-off between liquidity, risk and return. This takes advantage of the full range of product, credit research, trading and investment management capabilities. But, for this to be successful, an investment strategy should be drawn up that matches the corporate’s guidelines or objectives.

LIQUIDITY ADVISORY

Today’s liquidity environment is demanding. For cash-rich companies, finding the right investment strategy requires lateral thinking, while implementing it calls for considerable fine-tuning. When deciding how to proceed, companies need to decide how much risk they are prepared to take, and whether they want to take responsibility for managing the funds themselves, or subcontract management to a third party within the context of a stated investment policy.

Drawing on years of experience in liquidity management, and with a recognized track record of innovation, ABN AMRO Bank N.V. has created its Liquidity Advisory Desks to provide a single port of call for treasurers’ investment needs. The desks, located in Europe, North America and Asia, design investment strategies tailored to corporates’ investment guidelines. They draw on the range of capabilities from ABN AMRO Bank N.V.’s transaction banking, asset management and treasury and financial markets businesses. Product specialists have the full array of financial instruments at their disposal, and blend them to attain the best returns for given liquidity and risk parameters.

Corporates can choose from either an ‘outsourced’ or a ‘do-it-yourself’ approach. Should they choose an ‘outsourced’ approach, ABN AMRO Asset Management would manage excess cash according to the risk, return and liquidity parameters laid down in the client’s investment guidelines. This suits corporations without extensive in-house investment teams. It has the added benefit of utilizing the asset manager’s risk management system.

In the case of a ‘do-it-yourself’ approach, the Liquidity Advisory Desk designs a strategy that it believes best represents the corporate’s goals. The corporate can then choose which parts of the strategy to adopt. This has the advantage of greater flexibility and control, albeit at the expense of running a full investment and risk management team.

DESIGNING AN INVESTMENT STRATEGY

Designing the investment strategy that best fits a corporate’s needs is a three-step decision- making process. It involves: balancing liquidity, risk and return; selecting a ‘passive’ or ‘active’ investment style; categorizing cash into time buckets.

In the first instance, the corporate needs to decide the desired trade-off between liquidity, risk and return. The need for liquidity depends on the outcome and quality of cash-flow forecasting.

Meanwhile, a variable range of factors will dictate the appetite for risk. Levels of risk may be restricted by lenders. Alternatively, shareholder, rating agency or corporate objective issues will influence risk appetites.

Selecting a ‘passive’ or ‘active’ investment style depends on factors already discussed. In some cases, the corporate may decide a combination of the two best fits its needs.

Categorising cash into three time buckets - short-term, medium-term and long-term - is an important step in determining the appropriate investment strategy. Short-term operational cash designated for daily cash management must be available instantly. Investments must be highly liquid and low risk. Medium-term cash, which will be available for between one week and three months, could be invested in instruments available at short notice.

Finally, long-term cash, available for periods of more than three months, can be invested across a wider range of options. This time horizon allows for more volatility, freeing the treasurer to focus on above money market returns. Normally, corporates keep this cash to a minimum because investment returns are unlikely to match the cost of capital.

In a world where the efficiency of all areas of corporates is keenly scrutinised, treasurers need to make the best possible use of their excess cash. The ABN AMRO Liquidity Advisory Desks can help the treasurer to create solutions that are finely tuned to the individual situation of the corporate.

IMPORTANT INFORMATION

This information is provided to you for information purposes only. Before investing in any product of ABN AMRO Asset Management (Netherlands) B.V., you should inform yourself about various consequences that you may encounter under the laws of your country. ABN AMRO Asset Management (Netherlands) B.V. has taken all reasonable care to ensure that the information contained in this document is correct but does not accept liability for any misprints. ABN AMRO Asset Management (Netherlands) B.V. reserves the right to make amendments to this information. ABN AMRO Asset management (Netherlands) B.V. is registered with the Dutch regulator (Autoriteit Financiële Markten).