Cash Management Considerations for Institutions

Given their fiduciary and custodial responsibilities, for many institutions, the need, willingness or capacity to take on significant investment risk can be low. Consequently, the approach to cash reserves and treasury management becomes more focused on risk than on investment.

Risk, in the context of reserves, is represented chiefly by inflation, liquidity and credit risk. Balancing the often-competing requirements for security, access and real return is a key concern for institutional investors and implementing robust structures and controls can help alleviate this burden.

Treasury Policy

A crucial starting point for any institution is to establish a Board-approved Treasury or Cash Management Policy. This policy gives clarity on procedures, responsibilities, and controls around how entities can manage their financial reserves while linking with strategic objectives. 

In drafting this policy, it is useful to segment reserves into distinct liquidity tranches, differentiated by objectives, time horizons and risk profiles; and which are unique to the organisation, their financial position and their operating and strategic needs. By apportioning capital in this way, institutions can ensure adequate liquidity and flexibility in the achievement of their objectives and mission. 

Table 1: Liquidity tranches for segmenting cash reserves

Source: Davy

Figure 1: Building blocks for formulating a robust treasury policy

Source: Davy


Provision can also be made for the institution’s policy around responsible investment where there is a requirement to invest in instruments that exhibit positive environmental, social and governance (ESG) characteristics. 

It is vital that the treasury policy is reviewed annually, at least ,and that it is an active document which can be adapted to reflect the evolving yield environment and strategic needs at any point in time.

Portfolio Approach

When it comes to investing funds (whether short-term or longer-term capital), one of the most fundamental guiding principles should be to maximise diversification. Diversification is key to preserving capital, generating returns and ensuring liquidity. For low-risk investors, diversification means investing across a range of cash and cash equivalent highly-liquid securities; incorporating a mix of counterparties and issuers with high credit ratings; blending fixed and variable return streams; and staggering security maturities to match capital programmes. Overall, diversification is a time-tested and essential investment strategy that improves the balance between risk and return.

Managing credit risk is a vital element in positioning a liquidity portfolio. Credit risk can be managed through rigorous due diligence processes, by using credit rating agencies (such as Standard & Poors) and through minimising exposure to single counterparties.

Education

Another important consideration for entities is understanding the nature of the investments and the associated underlying risks when committing capital. Employing a diversified approach necessitates looking beyond the traditional deposit offerings from pillar banks for an element of the reserve pool. 

Government bonds and money market funds are examples of securities that can be included in the liquidity solution set. Government bonds are issued by governments when they need to raise funds. They are issued with the full backing of the country’s reserves and offer a high degree of capital security. Bonds pay a coupon or dividend usually annually. Money market funds invest in short-term bonds from a wide range of institutions with strong credit ratings. They offer good diversification and liquidity.

Being educated and guided by an experienced institutional adviser on the characteristics of these cash alternatives is crucial as they offer varying degrees of liquidity, safety and yield.

Capital Preservation

In our experience, the return of capital overrides the return on capital for liquidity investors. In some cases, entities can be so risk averse that they keep their cash sitting in instant access accounts or very short-dated term deposits earning minimal return. This is also often the easiest or default approach given existing banking relationships, competing priorities and the fact that executives are generally time poor.  However, this approach exposes capital to the erosive impact of inflation. With the long-term inflation rate in Europe projected at 2.0%*, the purchasing power of the capital is significantly reduced over the longer term. Incorporating low risk securities (such as government bonds and money market funds) to complement deposits can help to mitigate the impact of inflation but importantly maintains that capital preservation objective. 

The adoption of a disciplined approach to cash management represents, first and foremost, good governance. Moreover, with the universe of low-risk investments expanding and against the current economic backdrop, thinking beyond traditional bank deposits can provide institutions with avenues for growth without sacrificing security or liquidity. 

At Davy, we work closely with the executives, trustees and directors of corporates, institutions, and charities and non-profits, managing risk and investing appropriately to ensure strategic objectives can be met.

Book a consultation today and speak to one of our advisers about how we can work together to establish your organisations's financial goals.

*Source: JPM long term capital market assumptions, October 2024 and Davy