In what seems like deja vu, Pensions and Investments reported last week that institutional investors have stepped up their use of enhanced cash strategies, the same strategies that caused all sorts of carnage across financial markets in 2008. While the use of enhanced cash makes fine sense with appropriate risk management, our view is that many investors are entering these portfolios thinking that they are sort of like very conservative cash accounts but pay a bit more. This is a troubling situation and adds the risk that the markets will see an unhappy conclusion to this adventure.
According to the P&I story:
“Interest in enhanced cash strategies has returned, despite major upheaval during the global financial crisis. But this time, managers are warning clients to be careful.
‘To me, this is one of the interesting lessons we haven’t learned from the global financial crisis,’ said Barry F.X. Smith, senior managing director and global head of State Street Global Advisors’ cash business, Boston. ‘This has to be a risk-appetite discussion.’
Flows into these strategies have been ‘fairly dramatic’ in the past 18 months, as investors have fled near-zero returns from the safest cash investments, said Paul W. Reisz, senior vice president and product manager at Pacific Investment Management Co, Newport Beach, Calif. Enhanced cash assets in the U.S. market — which halved in 2009 to $16 billion from a year earlier — reached about $40 billion as of June 30, Mr. Reisz said.”
It makes sense that investors would be looking for something more productive to do with their money than let it sit around making Fed Funds or LIBOR plus a few bps. However, the most unsafe thing we ever see as consultants is a knee-jerk reaction against something in favor of something else that is often poorly understood. Based on our consulting projects and survey work, we are concerned that a push by US institutions towards enhanced cash may be just this type of reaction. We hate to say it, but we recommend keeping an eye on this space for an upcoming short-lived market bubble and hence disruption.
We also think that the move to enhanced cash is a logical reaction to the restrictions placed by the US government on 2a-7 funds. If more reforms are adopted in US money markets, expect to see more unregulated cash investments coming from institutional investors.
The full P&I article is here.