Businesses are facing tremendous uncertainty during the COVID-19 pandemic. It is unclear what business operations will look like and how the path to economic recovery will evolve. This makes liquidity management a key concern and challenge.

If market liquidity were an ocean, then the ocean has been rising. As an immediate response to uncertainty, companies have been parking cash in bank accounts, drawing on credit facilities, and issuing bonds. In addition, the Federal Reserve and U.S. Treasury have flooded the market with liquidity as a stabilizing measure. With the Fed announcing that it would buy corporate bonds to support U.S. credit markets, investment-grade bond issuance has reached a record high, with companies issuing $108 billion in investment-grade and high-yield notes in the first week of May.¹

In this ocean of liquidity, many companies are in the same boat: flush with cash and unsure about when and how to deploy it. Despite shoring up their liquidity positions, businesses are suffering from reduced visibility into their capital and liquidity requirements to meet business needs.

Lack of visibility compounds uncertainty

The current crisis has been evolving very differently than the market-driven events that characterized the 2008 global financial crisis, where the behaviors of market participants drove market instability. By contrast, it is difficult to chart an exit from the COVID-19 global crisis despite the Fed’s market-stabilizing actions. The pandemic’s cumulative effects on the real economy are still unknown.  However, there could be broad impacts to many companies and entire industries.

Pressures around positioning liquidity

Fed actions have caused downward pressure on market yields, and companies worry about the possibility of negative interest rates, given their large cash reserves. The U.S market is different than Japan or Europe, and businesses worry that negative rates could potentially trigger destabilizing financial market outflows by U.S. and foreign investors. Outflows from money market funds that have experienced large cash inflows during the pandemic, and outflows from the banking system as a whole

Under pressure to maximize liquidity beyond cash flow needs, some fixed income investors may be hoarding cash, while others, seeking to maximize yield, may be considering alternative asset classes beyond their company’s normal risk tolerances.

Organizations still need to be prudent risk managers and think about their investment portfolios in light of actual cash flow needs, and investment policy best practices. As a result, many organizations are doing too little with their cash investments, while others may be overstepping their risk limits.

Incorporate best practices into your investment policy

As organizations think about how best to navigate, it is important to review investment policy best practices such as the following:

1. Define objectives and align liquidity. Define the objectives for your cash portfolio within the general priorities of safety, liquidity and return on investment. In accordance with these objectives, distinguish between liquidity segments based on business purpose (rather than treating liquidity as one bucket). For example, earmarking cash for a particular project.
2. Segment cash by liquidity horizon. Maturity matching is a best practice, where possible. In the current environment, companies may not have the same level of visibility to match investments to the exact time horizon for when cash is needed. This may require an additional cash buffer built into liquidity portfolios to account for greater uncertainty. In a normal business cycle, a typical forecast horizon might extend out one year, for example. In today’s environment, the forecast horizon may be shorter.
3. Build in flexibility to allow for diversification. Build language into the investment policy that creates discipline towards the idea of diversification. Aligned with defined objectives for the portfolio, businesses should introduce flexibility for alternative products within their fixed income investment portfolios. As part of this assessment, it is important to define risk tolerances.Companies may not invest in every asset class in their portfolio today, but it is important to understand the approved investment alternatives, and document them in the investment policy.
4. Increase portfolio monitoring to ensure it aligns with cash forecasts. How often does the investment committee meet to review portfolio structure and allocations relative to liquidity requirements built into the cash flow forecast?  There may be value in meeting and reviewing portfolio positioning more frequently, especially if staff are working remotely.  It is imperative to incorporate a monitoring and reporting function within the investment policy to track the portfolio over time, and perhaps to allow for more frequent reporting during times of ambiguity.

The current environment requires businesses to be thoughtful about their investment policies and to work with their trusted advisors to develop strategies for managing liquidity and associated risks.

¹“The Fed thawed debt market and big companies built a $500 billion war chest to fight the virus.”, by Patti Domm, May 11, 2020, CNBC market insider. (Source: https://www.cnbc.com/2020/05/11/the-fed-thawed-debt-market-and-big-companies-built-a-500-billion-war-chest-to-fight-the-virus.html)