The views expressed in this column are those of the author and not SVB Financial Group.
They say two thousand zero zero
Oops! Out of time
So tonight I’m gonna party
Like it’s 1999
In my conversations with CFOs lately, I am hearing more
and more about their desire for higher return.
This is in great contrast to inquiries in ’08 and ’09
which focused on the more arcane aspects of our business: custody, insurance,
controls and money fund holdings (good topics all, but you have to admit they
are a bit dry).
Today, there are CFOs who believe earning an extra
$100,000 or so from their investment strategy choice will elicit kudos from
their boards. While it’s true that extra
earnings help defray the many expense challenges they face each day, taking
extensive and unnecessary market risk has very recently been proven disastrous.
A more appropriate approach for investing strategic cash is to ensure
diversification by creating a separate portfolio of investments across very
high quality issuers in security types that have proven safe throughout a
variety of economic cycles. In other
words, consider managing to the right reward/risk ratio given the desire to
ensure the safety and liquidity of funds
for use in the not-too-distant future.
On the flip side, in recent discussions with the VC
community, it’s obvious there is no desire to push envelope. In fact, when I’ve brought up conversations
like the one above, current audit-committee members expressed varying degrees
of shock and horror that such an attitude persists, and assured me that their
CFOs do not take this view.
But I wonder.
Even during the liquidity crisis, Wall Street attempted
to revive the auction rate securities market with a security they cleverly
entitled “windows.” The objective was
the same: offer a yield pickup for cash investors in exchange for cataclysmic
exposure with a low probability.
When investing your corporate cash, the crown jewel of
your company — IP aside — this is not a good strategy.
Auction rate securities quickly died away in early 2009
at the height of liquidity concerns. But
today, I think this sort of flawed strategy actually could get off the ground
given an increased desire for return.
The experience of the pre-crisis era was to focus on
return, almost ignoring the first two objectives of any sensible corporation:
capital preservation and liquidity.
According to the most recent liquidity survey by the Association of
Financial professionals (AFP), companies that have an investment policy now
rank their top three objectives in order as principal safety, liquidity, and
return — similar to their rankings pre-crisis levels, after rating return at
zero during 2009.
In that prepubescent world, audit committees rarely
analyzed their corporate cash holdings, or if they did, it was a tiny agenda
item allotted about as much time as the coffee break. Although our team spent a lot of time arguing
against this sort of view, many CFOs persisted and as a result suffered the
In retrospect, I believe the fact that risk is a
nebulous concept while reward is definable helped drive these well-intentioned
managers to come to an inappropriate reward/risk ratio. In other words, it was difficult to
understand the difference in risk between commercial paper and auction rate
securities, but the yield pick-up of 0.25 percent was readily apparent — and
appealing even at the 5 percent interest rate level.
Today, with money market yields near zero, a 0.25
percent yield pick-up looks like a godsend and many investors don’t even bother
to calculate this increase in dollar terms.
In addition, there are many CFOs that did not have
large cash balances over the past few years, but now do. The inquiries and trials of ’08 and ’09 do
not register for them as they simply didn’t have any investments to speak of. Now, they want to earn some return on their
cash and that is where the trap can close tight.
Unfortunately, I smell a restoration of the rapturous
desire for return on cash (with little regard for risk) that I haven’t sensed
in several years and I am getting a bit fearful for the typical cash investor.
Lack of due diligence on the part of the investor leads
to many pitfalls. A fiduciary that is
compensated based on the successful achievement of your objectives — rather
than the successful placing of sketchy securities — can help guide you through
Don’t fall into the trap of high yields. Keep your corporate funds (and your job)
Personal income and personal spending were flat and
unchanged for June, and both were revised 0.1 percent lower for the previous
month. These measures indicate that consumer demand has slowed as the labor
market remains soft. Households are more cautious and have increased savings to
a 6.4 percent rate.
The PCE deflator (YoY) increased by 1.4 percent for June,
after a 2.1 percent increase in the 12 months through May. This is the
preferred inflation gauge for the Fed, and it continues to convey a benign
inflationary environment. Excluding food and fuel, PCE remained flat on a month
to month basis.
Change in non-farm payrolls came in at a loss of 131K
jobs for July, and the previous month was revised down to a loss of 221K. Much
of the loss was due to the cuts on government census workers. In addition,
private payrolls increased by 71K, but June was revised down to 31K from 83K.
The unemployment rate stayed at 9.5 percent, as more workers left the
workforce. These data indicate that the labor market remains suboptimal.
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those of the author and do not reflect the views of SVB Financial Group,
or SVB Asset Management, or any of its affiliates. This material,
including without limitation the statistical information herein, is
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upon information from third-party sources that we believe to be
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such, we do not represent that the information is accurate or complete.
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