With inflation spiking, decision-makers at nonprofits and foundations are under pressure to eke out as much return as possible. We take a second look at cash, leaving no stone unturned in the search for value.
This transcript has been generated by an AI tool. Please excuse any typos.
00:00 - 00:26
In early 2021, we released a podcast episode around cash reserves that really struck a chord with investment committees across the country. In fact, it became our most popular and downloaded episode ever. Clearly, lots of folks wrestling with the best way to deploy excess cash. So today we're going to revisit and take that discussion a step further in a way that hopefully helps position investors for success in the environment ahead.
00:33 - 01:24
Hi everyone. Welcome to Inspired Investing. I'm your host, Clare Golla, head of Foundation and Institutional Advisory at Bernstein. This podcast is where we connect and share insights with listeners like you who are engaged in the nonprofit and broader philanthropy sector or who just want to learn more. We have had an overwhelming response to last year's episode on Cash, which really laid the groundwork for organizations on how to think about investing short-term reserves. But it also raised a bunch of questions because there is a gaping chasm between short-term reserves, you know, very strict cash accounts and those clearly invested for the long term. So back by popular demand is my colleague Todd Buechs. He is a Senior Investment Strategist and national resource for us around the country on strategic cash management.
01:24 - 01:35
Really happy to be here. I have been doing a lot of these calls with cash, whether it's for our nonprofits clients or for our taxable clients, it's definitely the topic of the day.
01:35 - 02:15
I was just mentioning that I had another call regarding an organization grappling with their strategic reserves and how to think about that this morning. It is every day I'm having that conversation, so I'm excited to have you here. And let's just start with sort of a little bit of a backdrop. So last year when we spoke, tons of organizations were holding excess cash for a variety of reasons. And you really helped us find a sweet spot for investing it. So maybe the best place to start would be okay, what's changed in the environment since that last conversation? How is, what's the outlook for cash now, you know, with inflation spiking, the Fed on a path to rising interest rates? How do you think about that?
02:15 - 03:09
So maybe it's good if we just kind of talk about where cash is, you know, what's happened over the last two years. This is about the anniversary where Fed funds went to 0%, zero to a quarter point, which is effectively been a 0% yield. Now, that doesn't mean that's what we think cash will do in the future. The Fed moved rates to be more accommodative because of the pandemic, and now the rhetoric is not to keep lower rates lower for longer. Now the talk is we need to raise rates to combat inflation. So my outlook for cash is improved if cash is going to be invested at rates that closely follow Fed fund's rates. So we're just talking about the daily liquid overnight stuff. I would expect that as the Fed raises, so will cash returns. So things have gotten better for cash.
03:10 - 03:58
Yes, things have gotten better for cash. However, we have a huge concern that we're dealing with, with so many committees across the country, and that is inflation. Right. And so even if things are getting better for cash, even if our inflation settles at some point around our median expectation, which is, frankly, over the next decade, what, two and a half percent, roughly speaking, that's still a concern, because every dollar that isn't keeping up with inflation is effectively losing its purchasing power. So with that in mind, how, Todd, would you think about an organization, say, that has funded its immediate liquidity needs, but, you know, they still have some reserves left over. They might be thinking about, you know, extra cash for six months or 12 months that they may not need in that timeframe. How would you think about that?
03:58 - 04:21
So in the last year, we've been able to kind of, I guess, put some muscle on the bone to our original thoughts last year. Last year, we talked about having a cash reserve. We knew that that would be a drag on returns, but it gave you the flexibility that should there be a drawdown in stock or equity markets, that we could draw on that cash and not then lock in losses.
04:22 - 05:02
Now that the muscle on the bone is that we're starting to talk about cash needs to be cash. If I've got payroll or expenses that are coming up in the next several months, I don't want to take market risk. I want to make sure that I have it. It's safe and I can write those checks. But if I have a longer time horizon and when I put on my fixed-income hat and I look at time horizon, I want to match my time horizon with the risk I take in my portfolio. And why is that? Well, short-time horizon, I don't have the same amount of time for the market to recover and my portfolio to recover. But longer time horizon, I have that time. Now,
05:02 - 05:53
we're still mindful of, you know, if we're talking about a 1 to 2 year project, maybe, if you're fundraising for something, you want to protect that, you know, we can start talking about enhancing our cash returns. Now, that does not mean adding equities. It means adding more interest rate sensitivity, which means more yield to a portfolio of cash. And then we can start talking about enhanced cash plus, which, hey, I'm maybe adding a small amount of protected equity exposure where I'm protected on the downside, [...] on the upside. But when I start talking about the range of outcomes and the returns that are possible, I'm delivering more return that could potentially offset inflation over time. So will be a conversation with a board on matching time horizon with the level of risk in mainly a predominantly fixed-income portfolio.
05:53 - 05:55
So that's interesting.
05:55 - 06:13
You mentioned a little bit of equity exposure with some protection on the downside. This does have a role, right, in that gaping chasm between pure cash and very, very long horizon we're okay with volatility, right? Help me understand. Can you explain for our audience a little bit what you mean by that?
06:13 - 07:11
So there are a variety of different versions of this, different flavors for different firms. But we partnered with a third party to keep fees down, number one, and to maintain liquidity, many of the options available from other competitors. So this is something that's available through, in the public domain. But the partnership we chose was meant to be daily liquid. So you've got that flexibility. And what it does is it provides the use of very vanilla S&P 500 options. So not a complicated product. Protection on the downside. So should the markets fall, 15% before fees, that 50%, the money would still be flat. So there'd be no loss. After the market falls, if it fell more than that, say, 16%, then you'd incur some slight losses. So you've got protection on the downside and on the upside based on this different pricings of these options.
07:11 - 08:02
When the market gets more volatile, there's more value and options, people. There's a big equation that goes into that, but you can get more participation the upside. So instead of saying, I'm going to be in a fixed- income vehicle where I know the coupon it's fixed, and then my value could go up or down based on where interest rates move or values of securities move. Here, I've got kind of a potential to participate in upside in that portfolio, but protection on the downside, the bet would be for the Lehman. Hey, the market won't go down more than 15%. And then I've got the same kind of return as cash right now at 0%. But if the market goes up, I have the ability to participate in the upside more so than maybe equities while still knowing I'm protected. So yeah, and that's why we're only talking about a small piece of the enhanced cash plus allocation.
08:03 - 08:33
Right. I wanted to drill into that a little bit because it's a good example of how in a challenging environment we're really thinking about things differently. I think investors have to think about things differently, not just with regard to their long horizon portfolios, but in that, in those sort of reserves in between. And so there is a sort of gradation or spectrum, right, in terms of the exposure that you can access to different parts of the capital markets. So it's not an all or nothing. So thank you for walking through that a little bit.
08:34 - 08:58
All right. So here's a, I'm just going to shoot a common question at you and see how you would advise them. So I'm a nonprofit. I've access to a healthy line of credit. Okay. So I have some cash, access to cash when I need it as well as I've really got 12 months of reserves sitting in a money market. And I come to you, as so many organizations do, and I say, What kind of rate can you get me on cash? I'm looking for a higher rate on our cash.
08:59 - 09:41
So let's first we level set, what is cash? Daily liquid, $1 minus set value, which means zero volatility of principal. So if we start from there and we know that the Fed is at zero to a quarter point, which effectively means zero, I mean, there is right now today and today is the 2nd of March, there is $1.6 trillion sitting in a reverse repo facility, which sounds really complicated, but it's the rate that money market funds are able to invest with the Fed. And the Fed provided that because rates are so low, so 1.6 trillion is making five basis points. So that's cash. If we talk about enhancing cash,
09:42 - 10:18
So let's talk about kind of the intermediate between cash, full cash, daily liquid, no volatility, but no return essentially. Enhanced cash plus, enhanced cash. We allocate majority of the portfolio. So say, it depends on the board, but it could be anywhere from 50 to 65% in cash. And then we allocate to longer maturity strategies, we call it duration, which is interest rate sensitivity. So I'm investing in something that is more sensitive to rate movements. And on March 2nd of 2022, we expect rates will go up.
10:18 - 11:02
Now, notwithstanding the volatility we've seen, what can we get in those services? Those intermediate duration or intermediate maturity strategies have yields over the next year, conservative yields of anywhere from the high 2% up to almost 5%. And realize that if I want more yield, that means I'm taking some type of risk. So if I want more yield over cash, it means I'm either taking on some illiquidity, some credit risk, or interest rate risk. And that's why we would work with a board. We'll have a kind of a base case, but we'll work with the board to say, what's the right amount of that intermediate allocation for the board's purposes.
11:03 - 11:48
Yeah. And what does intermediate mean for you and your organization specifically? That's great. So it's really shifting the question, is shifting the conversation away from how much can I get on my money market? Sure, you should do that. You should, you know, look at the rates that you can receive on that sort of pure cash. Right. But where you can really, I think, move the needle more effectively is thinking more strategically around how much of this can I really not touch based on other access to cash? Maybe it's a line of credit, maybe it's other revenues or whatever it might be. How much do I not need to touch for a little while so that I can actually start to move along that spectrum and gain a little more? Great. Thank you.
11:48 - 11:58
Okay. So then I'm going to move the conversation here, Todd, to another very tricky aspect. You know, you would think that cash would be so simple, right? But it's not.
11:58 - 12:10
the number of questions I get, Claire, it it seems like it would be. It's not. I get so many questions every week. I've got a lot of cash. What can, what can you get on it? I've been disappointing people for quite some time, about two years.
12:10 - 12:54
You go down this rabbit hole is like, how do we really think about this and kind of eke out some value, right? And so, you know, one of these these situations is, okay, the environment isn't static, right? So there's going to be market action, additional fundraising, new sources of liquidity, all sorts of things on the upside, reduction of expenses. The flip side is, right, you can have an unexpected increase in expenses or things like that. So how do organizations know when to transfer funds, right, from one of these pools, from like pure cash? We have more than we had really planned on. Right. How do they know when to move, you know, along the spectrum, certain dollar amounts along the spectrum, say, from the very short to this first step of the intermediate
12:54 - 13:07
So I think planning is important. Right. And generally in these conversations, I lead with, first of all, I like my job and I don't want to be fired. And I know you don't want to be either.
13:07 - 13:09
I don't want you to be fired.
13:09 - 13:54
Yeah, I know. I like my job. So what the conversation will be, let's take a bucket approach, see, what is that immediate cash need? What's the buffer? My line of questioning is, Clare, what do you expect to be able to need a check for over the next 30 days, 60, 90? Or what is the biggest check you've ever had to write on short notice, something like that where we can dimension how much cash you need and then let's give it a buffer, because we don't ever put an organization we work with in jeopardy of not accomplishing a mission. Right? So mission accomplishment, number one. Now if we can start looking at that level of cash that's being held, let's just say that you had $1,000,000 cash. That would be a nice position to be in.
13:54 - 14:23
Yeah. And let's say that your operating budget for the year is 500,000, nice, easy round numbers. If that can flex over the year and maybe there's a, you know, repairs that need to be done to a facility, something like that, that could be another, I don't know, 100,000. If we keep 600,000 in cash, now we've got a nice buffer allowing for things that we have to worry about, but we cannot have 400 that we don't have earmarked for anything.
14:23 - 14:59
Now, working closely with the individuals that look at the budget, you can say, well, what else could you use that for, or in the past have you used that for. Or if there's no other needs, if there's no flexing of that, of that spending and you know that's going to be carried to the next year and may be rolled into, based on fundraising, rolled into operating, maybe you could extend some of the kind of maturity or increase the interest rate risk on this to enhance what you're getting while you're waiting. Because, you know there's that baseline of stuff you're not, those funds that you're not going to touch. Yeah. So that's the conversation, how we try to try to kind of size those pieces.
14:59 - 15:00
15:00 - 15:08
And then we talk about what's the additional return that you get by giving up some of the safety of daily liquid cash with no volatility.
15:08 - 15:30
Yeah, that makes a ton of sense and it's really where our teams are spending so much time right now, having those conversations. But then also, right, if our job is to help a fiduciaries fulfill their duty, to help make their lives as easy as possible and really help codify decisions, not just what decisions were made, but
15:30 - 16:25
but One recommendation we're making is that every organization is different. You should definitely have these conversations on a regular basis with your advisor and your team, but codify that in your investment policy. You can write in if you believe that funds over a certain number of months of operating expenses or a certain dollar amount really can move from strict cash to up the spectrum; have that in there, right, and review, we're always recommending that folks are reviewing their investment policy annually and making adjustments if necessary. But that's a way for committees to avoid a conversation that we've been engaged in quite a bit recently, which is scratching their heads saying, What did we do the last time? How have we made these decisions in the past? Right. So to provide that framework and really codify it is I think, a critical piece of the puzzle as well. Have you seen organizations doing that?
16:25 - 17:13
I have. And what I'd say is that if you ask any portfolio manager, I don't care who she is, she's going to say, I want more leeway so that I can lean into opportunities. Now, that doesn't mean irresponsibly leaning into something, but she's going to want to be able to increase an allocation to some type of asset class or maybe increase the interest rate sensitivity of the portfolio. So what I would say is you put hands on it. Look, we understand that we have the ability to increase the return on a portfolio at any given time. Let's look at what kind of handcuffs we put on the portfolio manager or on the allocation to an IPS, so that she can maximize the returns on cash or elsewhere in the portfolio.
17:13 - 17:42
So I would, I always encourage a yearly review of the IPS and that we think about the conditions with which you'd want to change it, but write it, not too broadly, because you have to really define what that bucket is for. But let's, let's think about how can we allocate, how can we be smart about allocating and give enough leeway to a board or financial committee to then shift into enhanced cash or enhanced cash plus to get additional returns?
17:42 - 17:49
Absolutely. Both structure and flexibility is how we describe it. I couldn't agree more.
17:49 - 17:57
So, Todd, before we wrap up, any final thoughts on this cash and the spectrum of reserves conversation?
17:58 - 18:44
So what I would say is that you're not alone. Obviously, I've never been a podcast celebrity but feel pretty important from last year. And as I said, lots of lots of calls, lots of incoming calls about cash. Yeah. So this is a conundrum everyone's dealing with. I'd want to encourage those on the podcast to put something in the portfolio. We can work with you to help work on investment policy statement that gives you sufficient leeway, not so much that you're going to take too much risk. I wouldn't say riding into it, you know, a 60% allocation of stocks would be an extreme in a cash portfolio. But try to align that because it's going to be challenging with a higher inflationary environment to keep up the purchasing power.
18:44 - 18:44
18:44 - 19:15
That goes hand in hand with an expectation for lower returns going forward. So we need to help the organizations that we work with eke out as much return as possible. The good news is rates are going up. And while that may sound like a headwind to bond portfolios, we want to wring our hands. We want bond portfolio yields to go up. We want rates to go up because we want them to yield more so that can provide a less risky stream of returns to our clients.
19:16 - 19:37
Absolutely. And in the meantime, I agree. Just trying to find value wherever we can. Right. It's more important than ever. So, Todd, that is all we have time for. I could talk with you about cash management and interest rates and volatility all day long, but we got to stop. Thank you very much for joining me.
19:38 - 19:54
It was a pleasure. And believe me, Clare, I get that a lot. And I'm definitely, that's tongue in cheek, because cash can be pretty dry. But I think having a real framework around how you think about it as an organization can really benefit you in the long run. Thanks,
19:54 - 19:59
Thanks,, I appreciate it. I recognize how important it is and thank you. Thank you, Todd.
19:59 - 20:32
Thank you all for listening. If you'd like to learn more on Bernstein Foundation and Institutional Advisory Services, please see the link to our blogs in this episode's description. If you enjoyed this episode and have not subscribed to our podcast yet, please go to the iTunes Store, Google Play or wherever you listen to podcasts to subscribe and rate us. Also, please e-mail us with your thoughts, questions, and feedback to insights@Bernstein.com and be sure to find us on Twitter at BernsteinPWM.
- Clare Golla
- National Managing Director—Philanthropic Services