Have regard to risk and security when deciding where to invest.
A guarantee is only as good as the giver. There is no such thing as an absolute guarantee.
When investing cash:
use internal resources if there is a fully functioning professional treasury;
use your clearing bank or custodian;
use a specialized investment manager;
use suitable pooled funds (money market funds), perhaps through a treasury portal.
Simplicity and transparency are key factors.
The current crisis has highlighted the importance of liquidity and credit.
Lessons from Recent Experience in Financial Markets
It has become crystal clear that cash must be treated as a separate asset class. This means taking care when considering how, and with whom, cash should be held and invested.
It is equally clear that risk is a very relevant factor for cash. Institutional investors have discovered in the past year that so-called safe cash investments have not been as secure as they thought. For many years, investors have ignored the fundamental principle that extra yield is associated with extra risk. It is now clear that the especially attractive rates paid by Icelandic banks came with significant additional risk.
In times of plenty we tend to overlook or downplay risks and concentrate on the rewards. All we tend to think about is who is top of the league table so that I can maximize my interest income. What can be all too easily forgotten is that the return of your money is always more important than the return on your money.
A flight to quality, or perceived safety, can quickly become an unstoppable tsunami that can take the good with the bad; witness the ever-lengthening queue outside Northern Rock (a British bank) last September, and the subsequent effect on confidence in all British banks. Everyone now wants a guarantee, and an absolutely safe investment.
What does “guarantee” itself mean? We now know that it is only as good as the counterparty that gives it. Having to worry about counterparty risk is something most of us thought was the thankless and purely box-ticking task of compliance officers, or the credit committee. Now we know better. It must be stressed that it is very unusual for an institutional investor to receive a specific guarantee on a cash placement, except to the extent that a bank, or investment product, receives overt support from a relevant authority that one trusts.
What no one wants to say is that, ultimately, there is no absolute guarantee. This may seem more obvious now, after a year in which we have seen that AAA credit ratings do not guarantee security, and that even a government guarantee is only as good as the economic strength of the country that gives it.
The whole financial world is built on confidence, and if that is fatally cracked then the whole pack of cards can come down, with disastrous economic consequences for us all. That is why all the major governments and central banks, in both West and East, finally acted as decisively as they did toward the end of 2008, coughing up some US$6.75 trillion to save the world. This is equivalent to some 10% of the entire US$65 trillion global economy (CIA World Factbook 2007), and has been used to recapitalize banks, buy up toxic assets (including subprime-related assets), make loans to financial institutions, and give state guarantees to get the wholesale markets moving again. Even with the size of this unprecedented rescue, risks remain in the financial system according to a recent Bank of England financial stability report.
- Page 1 of 4
- Next section So What Choices Does a Treasurer Have When Investing Cash?