Investment Strategies

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The treasurer should develop a strategy for investing funds. This can range from being passive (and requiring no attention) to those that are quite active and call for continuing decision-making.

At the most minimal level of investment strategy, the treasurer can do nothing and leave idle balances in the corporate bank accounts. This is essentially an earnings credit strategy, since the bank uses the earnings from these idle balances to offset its service fees. If a company has minimal cash balances, then this is not an entirely bad strategy – the earnings credit can be the equivalent of a modest rate of return, and if there is not enough cash to plan for more substantive investments, leaving the cash alone is a reasonable alternative.

A matching strategy simply matches the maturity date of an investment to the cash flow availability dates listed on the cash forecast. For example, ABC Company’s cash forecast indicates that $80,000 will be available for investment immediately, but must be used in two months for a capital project. The treasurer can invest the funds in a two-month instrument, such that its maturity date is just prior to when the funds will be needed. This is a very simple investment strategy that is more concerned with short-term liquidity than return on investment, and is most commonly used by firms having minimal excess cash.

A laddering strategy involves creating a set of investments that have a series of consecutive maturity dates. For example, ABC Company’s cash forecast indicates that $150,000 of excess cash will be available for the foreseeable future, and its investment policy forbids any investments having a duration of greater than three months. The treasurer could invest the entire amount in a three-month instrument, since this takes advantage of the presumably somewhat higher interest rates that are available on longer-term investments. However, there is always a risk that some portion of the cash will be needed sooner. In order to keep the investment more liquid while still taking advantage of the higher interest rates available through longer-term investments, the treasurer breaks the available cash into thirds, and invests $50,000 in a one-month instrument, another $50,000 in a two-month instrument, and the final $50,000 in a three-month instrument. As each investment matures, the treasurer re-invests it into a three-month instrument. By doing so, ABC always has $50,000 of the invested amount coming due within one month or less. This improves liquidity, while still taking advantage of longer-term interest rates.

A tranched cashflow strategy requires the treasurer to determine what cash is available for short, medium, and long-term investment, and to then adopt different investment criteria for each of these investment tranches. The exact investment criteria will vary based on a company’s individual needs, but here is a sample of how the tranches might be arranged:

The short-term tranche is treated as cash that may be needed for operational requirements on a moment’s notice. This means that cash flows into and out of this tranche can be strongly positive or negative. Thus, return on investment is not a key criterion – instead, the treasurer focuses on very high levels of liquidity. The return should be the lowest of the three tranches, but should also be relatively steady.
The medium-term tranche includes cash that may be required for use within the next three to 12 months, and usually only for highly predictable events, such as periodic tax or dividend payments, or capital expenditures that can be planned well in advance. Given the much higher level of predictability in this tranche, the treasurer can accept longer-term maturities with moderate levels of volatility that have somewhat higher returns on investment.
The long-term tranche includes cash for which there is no planned operational use, and which the treasurer feels can be safely invested for at least one year. The priority for this tranche shifts more in favor of a higher return on investment, with an attendant potential for higher levels of volatility and perhaps short-term capital loss, with a reduction in the level of liquidity.

The corporate cash balance should rarely decline into the long-term tranche, with occasional forays into the medium-term tranche, while the cash level will vary considerably within the short-term tranche.