Finding the Sweet Spot for Cash

Audio Description

How do you keep enough cash to avoid forced selling—but not so much that it drags on returns? That’s the top question for nonprofits and foundations today. Our experts offer investment committees strategic advice for calibrating cash, one of the most overlooked parts of an organization’s portfolio.

Transcript

00:00 - 00:33

So we've all heard the saying cash is king and with many uncertainties characterizing this past year, investors definitely took this to heart. We have record levels of cash on balance sheets that would otherwise be invested elsewhere, really. And this is the case for a lot of organizations out there as well who keep asking us what are the best practices that you're seeing out there for managing this or how should we be thinking more strategically about our cash? This is a critical component in any organization's long-term investment success, but it's also one of the most overlooked. So, yes, you guessed it.

00:33 - 00:45

I've brought in an expert today to provide some insights and actionable takeaways for you. Hi, everyone, and welcome to Inspired Investing.

00:46 - 01:09

I'm your host, Clare Golla, Head of Endowment and Foundation Advisory Services at Bernstein. This podcast is where we strive to 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. So today I'm joined by Todd Buechs, a Senior Investment Strategist in cash management resource for us nationally here at Bernstein.

01:09 - 01:33

Thanks so much for joining us today, Todd. Thanks for having me, Clare. We are receiving so many questions from organizations across the country right now about cash management. It's really interesting. A lot of organizations actually have more cash on hand, surprisingly, at the start of this year than usual. They have experienced better than expected results in terms of fundraising towards year-end.

01:33 - 01:56

And others really de-risked when the market came back up after a significant decline early last year. So I'll just kick it right off. I've heard some statistics and maybe you could shed a little bit of light on this. Investors, by and large, are holding more cash than we've ever seen historically. Could you speak a little bit to that and maybe what some of the reasons may be? And this is by a landslide. There's a real dilemma.

01:57 - 02:21

Yields are low, markets are at highs, and fear was really high. When I look back to the time frame of kind of late February to the market low, when I talk about the market, I'm talking the S&P 500, the S&P 500 fell 35 percent in less than five weeks. So there was a lot of market activity around de-risking and fear.

02:22 - 02:46

So when I characterize it, I say that investors wanted two things, they wanted treasuries or they wanted cash back to buy treasuries. Everything else suffered. So what we've seen, if you just look at the Federal Reserve data, you can see that money market funds, so, daily liquid, one dollar net asset value, very safe money market funds, they surged by over one trillion dollars throughout this period.

02:47 - 03:21

If anything, they've come off a little bit. So it was even higher heading into fourth quarter and bank deposits were up another 1.3. That to me is indecision. I've got this cash. I'm afraid to go into the markets because something can happen again with another wave. I also am afraid to invest in bonds because the yield is so low. There's a real indecision here. So we are sitting at all-time, all-history levels of liquidity, cash, earning, and I think the technical term is zilch point nothing, in bank accounts or in money market research.

03:21 - 03:40

And we're talking less than 10 basis points. Right, well, and that's where the conversation starts with so many of our clients lately is, can you get us a better rate than we're getting at ABC Bank on our cash? And the real question that we turn around and ask them is, well, how are you thinking about how much cash you're holding? Right.

03:40 - 04:04

Like we can't do a lot about what the interest rate environment is, but maybe we can help out a little bit from a strategic perspective. And the fact is, you know, when we look at organizations, the conversations we were having with them last March and April were about what's our contingency plan in terms of spending less, you know, looking at a real Plan B in terms of operations, because things may be really tough for a long time.

04:05 - 04:32

What we have found is that for foundation funders, for investors who are donors, right, the market rebounded. And so the fundraising season, even if a lot of donors actually sort of front-loaded some of their 2020 giving in the midst of a crisis earlier in the year, we certainly didn't see, and this is just anecdotal right now, but we certainly haven't seen a disastrous year-end fundraising season that some organizations were facing.

04:32 - 05:04

In fact, you know, like any sector, right, I think the nonprofit sector is very diverse in terms of how it's been affected by the pandemic in particular and what's been going on in our economy. We have some organizations that are actually receiving lots and lots of cash right now. So one of the questions I have for you is around dollar cost averaging. Right. So we have these organizations. Some have been cutting expenses or they may be liquidated some securities when the market came back up just to sort of have cash on hand.

05:04 - 05:39

Now they're wondering how do we, how do we think about investing this excess cash when the market is at all-time highs. Right. And we have some members of a committee who are really concerned, others are like we're fiduciaries, I'm not sure about the risk we should be taking, with others on the committee who are saying we're missing out because the market has gone straight up since the bottom. How are you thinking about that? First we try to bucket. I always ask that question, well, how much cash do you need over the next three, six, nine, twelve months? Determine if there is some liquidity.

05:39 - 05:58

Because what you don't want to do is invest today and have to sell tomorrow, because you've got some funding that needs to be said to be provided. But what I will say is over history, over time, you are better off being invested. There's an opportunity cost if the market goes up and I'm not invested. Oh, I missed it. Right.

05:59 - 06:25

There was no engraved invitation that came on March 23 of last year that said, OK, let's go back into the markets and there won't be any forthcoming from Bernstein or anyone else. So what could you do to take out that sting of, hey, I'm buying at the top? What I could do is I could break it up into tranches, I could take the emotion out and we're going to invest from the 15th of this month, the 15th of next month, the 15th of the month after that.

06:26 - 06:59

That way, I'm not tied to an entry point. I'm not tied to a specific level, but I'm getting myself invested. And if the market pulls back a little, we'll buy some of those stocks and bonds cheaper or vice versa. It's a way, is a plan to get people invested, to take that emotion and timing need out. And we often do that with private clients as well as endowments and foundations. Yeah, absolutely. And so when would you think, what's sort of the rule of thumb, this is what clients always ask is, you know, what's the rule of thumb? How many months should we be investing? Is it six months? Is it nine months? Is it 12 months?

07:00 - 07:30

What are some of the variables that may facilitate what response you have to that question? When we researched this and looked at the opportunity cost of missing out on market rallies, just think about if, you were in cash and didn't invest in March or didn't have assets in the market. I mean, if you started the year, we're down that 35 percent, you made all that up and more. So that opportunity cost, when you start going out past six months, you really could be missing out on some good market return.

07:30 - 08:02

So we wouldn't recommend more than six. But as a rule, it's generally three to six would be the longest I would consider a dollar cost average. OK, no, that's good to know. And we've stretched it further in some environments. But it was more, it was really more of an emotional decision to get everyone on board with just getting invested at some point over time. So that's really helpful to hear. The other piece about dollar cost averaging is, you know, this, it brings to bear like this whole idea of fiduciary duty.

08:02 - 08:25

Donors are giving money to an organization, contributing assets with the expectation that those assets will not lose value over time. They'll be deployed in service of the mission of the organization or until they are utilized. Right. If they're not meant for long-term growth, they will be maintaining their value, maintaining pace with inflation. Right.

08:25 - 08:39

So here we are. We're in this incredibly low interest rate environment. And if you sit on too much cash, right, those dollars are effectively losing value day in, day out. And so it becomes this sort of risk as a fiduciary.

08:39 - 09:01

Right, where you really do have to think about in terms of the overall, are we losing our purchasing power? I think if you're an individual calling the shots on your own portfolio, you can do that if you've got a lot of fear. I think there is something to be said for considering that. So I'm curious, you know, some folks, I guess, call it cash drag. You just spoke about a little bit. Could you talk a little bit about the effect of spending?

09:01 - 09:09

Right. Of course, if you're invested over time, you, over the long term, history would show, right, that being invested in the stock market, right,

09:09 - 09:25

will deliver stronger returns than if you were in cash. But what if you start to spend? How does that, I guess, complicate it a little bit? The conversation I would have when I'm sitting with you and a client, an endowment or a foundation trying to figure things out is, look, how much do you need over the next six months?

09:26 - 09:58

How much can the portfolio sustain when it comes to the level of spending? And then because we know that cash is a drag by dollar cost averaging, once you determine the amount of cash you need for your operating budget, it takes the responsibility away from a fiduciary where I don't want to pick the wrong time to go to the market, Clare, I am going to make sure it is the right entry point. And that's where our research has shown that carrying too much cash is a drag. But the right amount may be enough as a rainy day fund or six months of spending. Let's just look back at the beginning of the year.

09:58 - 10:19

If you had six months of cash that were on the balance sheet and that was your rainy day fund, I'm not going to touch it unless the market's down five or five percent or more. You wouldn't have touched in January and February. The portfolio would have earned, your cash would have under-earned. But in March and April, you could have spent from the portfolio to support the spending.

10:19 - 10:36

I don't have the drag. I'm not locking the losses by saying, Clare, we need another check, sell some equities way down here and some bonds down a little less. You can spend from the cash, not replenish it, and let the portfolio grow. And you would have been a lot better positioned.

10:36 - 11:02

So it's a conversation that has to mesh with your organization, your time horizons, dollars on the balance sheet, and why it's good to have someone to kind of bounce those thoughts off of and help you organize thoughts within an IPS (investment policy statement). Well, yeah, absolutely. And that's where it comes into, so interesting, so often we see an organization, and we'll start to work with an organization, where they have an investment policy statement and they have a spending policy for their long horizon portfolio.

11:03 - 11:37

But there's no policy with regard to their cash or intermediate term reserves, what I would call sort of those funds that we know we don't necessarily need to spend. It's not that cash flow in and out all the time, but it's what an individual might use as their money market account or their, it's that next kind of level of rainy day fund. And that's where organizations are really struggling now, because if you, if you write into an investment policy statement that you do have this other bucket of funds, it should be maintaining pace with inflation because you're not pulling it in and out all the time.

11:37 - 11:58

You may have some of this for four years, right. You probably won't be spending all of this. That should be allocated differently than your checking account. Right. It shouldn't be necessarily what your endowment looks like or something that's meant to be growing in perpetuity. But there should certainly be some sort of growth there. And so that's a conversation.

11:58 - 12:31

And how to size that has been a major conversation that we've had with organizations. And how do you do that in a way that maintains pace with inflation but potentially has less volatility than the long horizon portfolio? We're also asking organizations what access to cash do you have? Right. So not necessarily just what do you have? What do you need to hold in your checking account? But do you have a line of credit? Do you have the ability to borrow based on margin, right, from your investable assets?

12:31 - 12:51

What kind of liquidity do you have if you needed it in a pinch? Right. Because that's just another lever that organizations can pull that enables them to, to a certain extent, maybe invest a little bit more over the long term. And the sizing of it is tricky. I mean, you know, you mentioned the "It depends" answer. Right? It does depend.

12:51 - 13:20

But I love that you mentioned how do we take that responsibility or that stress away? You're never taking the responsibility away from fiduciaries, but you are taking the stress away from getting in a situation of trying to time the market by putting certain structures in place. So here's a question for you. Let's take two different types of scenarios, right? There's a nonprofit that had, say, a banner fundraising year or they've already de-risked, they're sitting on a lot of excess cash. Right.

13:20 - 13:43

Versus an institution that, frankly, has just been struggling in this pandemic. We work with cultural institutions. We work with churches and synagogues. We work with educational institutions that maybe need to raise cash because they've depleted their cash reserves. How would your advice differ for each of those types of situations? I think the second one is easier. They've been struggling. They're investing.

13:44 - 14:04

They don't have a lot of cash, as we saw today. So this is that, we're recording this on the 20th of January. We just set all-time market high again. This is a great time, especially you're a nonprofit, you don't have to worry about capital gains, to lock in some of those gains. This is not a conversation we would, that we are having in late March, where I'd be locking a lot of losses.

14:05 - 14:40

So if there's ever a time, a market top is a great time, a very defensible time for an organization to take some gains. I can't call that because I can't predict where the market's going to go. We can model all we want. So in sizing that, I would want to look at what's the spending I'll need, what suspending the portfolio can sustain. And if the market pulls back and I don't have that ability to sustain spending, what's a reasonable amount of cash that could get me over whatever hurdles I need for spending? So like I said, that six months, it took around six months for the market to return to where it was.

14:40 - 14:57

S&P 500, bond market returned before that. But still, I mean, if I've got six months, that gives me a big leg up on not having to lock in losses. So for someone who needs cash, very difficult decision, who's heavy in cash, I'd say, look, take some gains now. And we have a large foundation.

14:57 - 15:18

I work on the West Coast nonprofit where every year we have this conversation. What's the spending needs? Let's set that up. They'll take less moneys when the market is down and then look to the proposed spending over the rest of the year. But if it's a good market, they'll take maybe a year's worth of spending. For the nonprofit or the organization that has a lot of cash,

15:18 - 15:45

well, same conversation. How much cash you need, how much you set aside. Don't worry about the decision of when to sell, but now it's the time to invest. And I would recommend that three to six months, depending on the board's comfort, depending on how much buffer they have and how much cash they have. So it's really advice that is tailored to the organization. It's what we specialize in. I mean, I have these conversations now probably two to three times a day.

15:45 - 16:05

This might be a good time to also review an investment policy statement, because when I review older ones, very stringent, can only on AAA-rated treasuries or government agencies. OK, that means you're signing up for kind of zero to 10 basis points. You're not signing up for a heck of a lot of return.

16:06 - 16:30

You may need to revisit that with your financial adviser and say, where do we need to go? Where are we going to need to go to sustain funding or to keep up the purchasing power with the rise of inflation? Yeah, no, that's a really good point, because we see a lot of investment policy statements that are outdated. They were written five years ago or however many years ago, and to ensure that expectations are in line with reality.

16:30 - 17:03

Right. That it's an important thing to note in terms of what some of the restrictions may be in terms of the investments. A number of organizations right now, too. I mean, one of the things that we're working on as we're looking at investment policy statements is not only adding in that sort of Intermediate Reserve or board-designated reserve or whatever someone might call it, but providing some language. Right. And so, of course, every organization is unique, but we're seeing things like anything above three months operating expenses, right,

17:03 - 17:35

will be invested in X, Y, Z accounts or anything over and above that needs board approval or some sort of framework that takes a little bit of the stress off of the committee, avoids, I think, being on that hamster wheel again and again, sort of like, as people roll off of the committee, as CEOs and executives leave and change over time, people aren't scratching their heads and saying, wait, what did we do? How much did we leave? We've now we've accumulated all this cash again.

17:35 - 17:57

What are we supposed to do? And so it does, it just gives, I think it gives the the committee some power, it empowers them to make a decision in the best interest of the organization without sort of having to spin your wheels. So on the upside, it also gives the manager a clear mission statement.

17:57 - 18:30

This is what our intentions are. Now, I just rewrote an IPS for a captive insurance company. And in it we provide, hey, look, this is our target allocation, because things will change. If we could start today with 70 percent allocation to equities and 30 percent to high credit quality bonds. And if the markets move, the equity markets move more than the bond market, we're already out of whack. So most nonprofits are at 70 percent stocks, 30 percent high credit quality bonds. But what can we let it get to? What can we do in times of raising cash? What's the level of cash that we can hold?

18:31 - 18:58

And if you say hard limit, no more than 10, you know, do we want to be buying at an all-time top? So give yourselves some leeway. Maybe that's the time when you review on a quarterly basis. Where is our cash? Are we approaching 10 percent? And if so, what are we going to do when we get there? Yeah, and it requires to, right, that you have that sort of ongoing communication with your investment advisor to ensure that, right, you're all on the same page, so... Shameless plug.

18:58 - 19:29

Todd, you authored a blog this past fall that outlined some of the issues that we've brought up today, but also really laid out, I would say, a grid. Right, for how to think about different pools of assets. Do you want to talk a little bit about that? Sure. So the pools, as I said, well, when I have these conversations with CFOs or CIOs, or boards, I give them a homework assignment because I can't decide the amount of cash you have to have.

19:29 - 19:51

But when we think about the risks you want to take on moneys, cash should be that short-term need, that bucket that I ask CIOs, what is the check you need to be able to write today or tomorrow, and now with very low yields, it may be out to six to nine months. What's that check? And we define cash as something that's daily liquid.

19:51 - 20:19

So if things change, new projects, something comes up, you need funds, you can get to it that day. And additionally, that there'll be no volatility or de minimis. I'm talking about really a basis point movement. Right. So really no potential to lose principal. Now, for that certainty, you get rewarded with a few basis points of return. So not much return. Now, if we can identify moneys that are longer. My goal is to get to the end.

20:19 - 20:41

Let's say you had 10 million dollars in cash, which obviously you'd be in pretty good shape if you were. I wish all of you that are listening had that amount of cash sitting inside. But if we did and we determined we needed a million dollars for our operating budget for six months of spending and we get down to two million dollars, you know, we're not going to do, we don't have an earmarks for a project, that was just we had some really good fundraising years.

20:41 - 21:04

That's the piece that I can say, you know what, within the investment policy statement, I can put this in something that may be more illiquid, maybe a little risky or something like that, to get me some more returns so it can grow while the rest of the portfolio works to support that spending, that excess. So I'm looking at the buckets and we're trying to match the allocation, the amount of risk you'll take and the certainty of need.

21:05 - 21:17

Think of it like a 529 plan. If I have a new baby and I establish a 529 plan, I could be all in equities. But as I get closer and closer to when she's going to go to college, I got some certainty of need.

21:17 - 21:44

I know I'll have to write the checks. So in those target date funds, they'll go from all equity slowly but surely to more and more bonds and cash at the end, because I know my need is coming. That would be my cashbook. Now, that's great. And we'll make sure that everyone has access to that blog. It's really a great outline and sort of when people are looking for that rule of thumb or guideposts for thinking about these different buckets of assets, it's a great one. Thank you so much, Todd.

21:44 - 22:07

Like, there's no question that nonprofits and foundations, like other investors, were thrown a curve ball or two, right, in 2020, to say the least, and finance and investment committees definitely want to have frameworks in place for cash holdings, right, that both protect in the downturns like, we think March, but also avoid unnecessary dragging, right. During the upswings like we've seen in more recent months.

22:07 - 22:30

And so, your insights today, Todd, were extremely helpful as always. So any final thoughts or parting words that you'd like to share with the audience before we wrap it up? In conclusion, I think the key here for any organization is to right-size the amount of cash. If you want that comfort of knowing I have that back-up spending, so we won't have to spend in a market drop or sell out of a portfolio, lock in losses.

22:30 - 23:01

That can be a great thing. Very empowering to keep you in your long-term allocation. And we know you need that in a low return environment. Conversely, having too much cash, we know that being in cash is going to be a drag. You get three times over the last 50 years, you get three times the return being fully invested over cash. And that was back when cash was yielding a lot more. So think about that now going forward. Zero in cash or, you know, kind of mid single digits or higher and a 70 percent stocks, 30 percent bond allocation. Just to decide that

23:01 - 23:18

right allocation. And we can help with those conversations. All right, then. So thanks, Todd, for being our special guest today. And thank you all for listening. If you'd like to learn more on Bernstein's endowment and foundation advisory services, please do see the link to our blogs in this episode's description.

23:18 - 23:49

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Hosts
Clare Golla
Managing Director—Head of Foundation & Institutional Advisory Services

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