From those who think about cash as bills under the mattress, to those who picture it as a riskless deposit because a bank holds it, it is seriously time to break it down for everyone.
Cash, as in bank notes, is still trash in a sense. It burns a hole in your pocket, it is readily available therefore prone to be spent, and its value decreases every single day due to inflation.
When treasurers think of cash, they think about an allocation to short-term liquid instrument, which range from risk-free to safely risky. Before even starting, they set a cash investment policy framework, which addresses the following points:
- Is the overall goal to preserve capital, or achieve a market return
- What are the currencies in which the cash could be invested
- Who deals with it internally, and do we delegate the management to a third party
- What types of benchmarks do we follow, if any
- What types of investment, for what duration and credit risk
- How do we track and evaluate the performance
- What are the control measures and custody rules we should abide by
- Do we want to explicitly ban some investments, such as non-ESG compliant. In that case, what is ESG for us as a company
I know, this is quite a list, but the answers would form a solid foundation to a cash management policy that adequately responds to the investment horizon of your company’s cash. Cash needs are usually broken down into 3 categories: daily, next 6 months, and next year or more. The exercise of the manager then consists in appropriately allocating to instruments across the desired horizon, liquidity, and return.
Fully understanding risk is where treasurers mostly struggle. Listed instruments are subject to interest rate fluctuation. Bank deposits embed higher credit risk than perceived (think Lehman Brothers). Private placements or Term deposits are not liquid. However, stirring completely away from these risks is not an option, as zero risk means zero return, actually negative return.
Also think diversification across instruments, and providers. Too often I see treasurers allocating all their cash to certificates of deposits issued by one or two banks at best. Far too concentrated, while the maximum issuer exposure should be 5%. How many depositors considered that Lehman, Bearn Stearns, or Credit Suisse were “safe”.
Lastly, let’s also address systemic risk. The holders of Brazilian Reals or Venezuelan Bolivars learn this notion the hard way, when their savings base currency can drop 20% or more in a month. EUR and USD have become more volatile and prone to shocks as well.
Besides, companies assets can be subject to freezes unilaterally decided by central parties, and executed by banking intermediaries. The direct control of assets via web3 wallets can be part of the alternatives for diversification purposes.
In a nutshell, I realize every day that business cash management, if not properly handled, is prone to misconception and cognitive bias. In order to mitigate the risks, having a clear framework and seeking external expertise are a must.
360 Advisory LLC is a Boston-based RIA managing investments, including crypto