Short-term cash Featured

7:00pm EDT February 24, 2008

The market’s recent turbulence signals the need to revisit short-term cash investments. Not long ago, investors were flocking to high-yield instruments. Now the pendulum has swung back in favor of less risky strategies. Successful liquidity management involves striking a balance between retaining accessibility to cash and earning predictable income from excess funds.

“Organizations need to understand what their cash needs are to determine how active or passive they want to be with their investments,” says Scott Horan, Vice President and Group Product Manager for Treasury Management at PNC Bank.

Smart Business spoke with Horan about the different types of liquidity, how the investment approach varies for each type and how to best strike a balance between risk and return when making short-term investments.

How has recent market turmoil affected how organizations manage their short-term cash?

When you look at what clients were investing in six months to a year ago, there was a lot of talk about higher yielding instruments, such as enhanced cash funds, cash plus funds and auction rate securities. However, auction rate securities had problems in that they were no longer considered cash equivalents. And enhanced cash funds and cash plus funds have had their liquidity problems. In response, clients that were the most aggressive have generally backed up one level on the risk scale.

The other thing that we’ve seen clients do is reorder their short-term cash investment criteria. It used to be that No. 1 was return, liquidity was a distant second and safety a very distant third. Now the order has been completely reversed: No. 1 is safety, No. 2 is liquidity and No. 3 is return. People are more concerned about the return of their money than the return on their money.

What are the different types of liquidity, and how does each investment approach vary?

There are primarily three different types of short-term cash: operating cash, reserve cash and strategic cash. Operating cash is not very predictable and tends to be what a client has in his or her checking account or in very short-term investments. Usually, with this type of cash, investments are pretty conservative and somewhat passive. Reserve cash is the amount of cash — outside of operating cash — that a client always wants to have on hand. For example, clients may know they need $1 million on hand in cash from an operating perspective, but they never want to be below $5 million because they want a little bit of cushion, or reserve. Typically, reserve cash is kept close to hand but may be directed to short, liquid investments like a money market mutual fund. Strategic cash tends to be longer term but not normally out past a year. Perhaps you have a certain amount of cash that you know you’re going to use to buy a building or equipment. You don’t want that cash to sit idle, so in this kind of situation you might be willing to lock up the cash in order to get a better rate of return.

What are some typical investment options for short-term cash?

There are three broad categories to choose from when investing short-term cash. The first category is individual-type securities, such as Treasuries, U.S. Government agency bonds, variable-rate demand notes, auction rate securities and commercial paper. The second type is a pooled investment, such as a money market mutual fund. With this option, the risk is diversified and you receive a blended return. The third type of category is bank liabilities. This includes bank repurchase agreements, bank time deposits, including certificates of deposits, and bank money market deposit accounts.

How can a business strike a balance between risk and return with short-term investments?

It is important to document your investment guidelines and policies. We talked earlier about return, liquidity and safety. An organization needs to determine what is most important to it. By understanding how to manage these three criteria and understanding the investments themselves, a company can effectively balance risk and return.

In the current environment, what steps should a company take to re-evaluate its short-term cash position?

If a company has already established its investment guidelines and policies, it should revisit them. If this information isn’t documented yet, it is important to start the process. This includes defining desired maturities, comparing current investments, understanding the ratings of the investments and examining diversification within the portfolio. These steps help to ensure that an organization’s investments are appropriate. <<

This article was prepared for general information purposes only. The information set forth herein does not constitute legal, tax or accounting advice. You should obtain such advice from your own counsel or accountant. Under no circumstances should any information contained herein be used or considered as an offer or a solicitation of an offer to participate in any particular transaction or strategy. Opinions expressed herein are subject to change without notice. Bank deposit accounts are provided by PNC Bank, National Association and PNC Bank, Delaware, which are Member FDIC. Certain non-deposit investments are not insured or guaranteed by the FDIC or other government agency, are not deposits or other obligations of, or guaranteed or endorsed by, any bank and may lose value. © 2008 The PNC Financial Services Group, Inc. All rights reserved.

SCOTT HORAN is Vice President and Group Product Manager for Treasury Management at PNC. Reach him at (412) 768-9910 or