“Show me the money!” (being smarter with your cash)

May 13, 2013 Categories: Investment Strategy

Russell Investments Wire - Smarter with money

A currency hedging programme can solve your exchange rate risk problem, but without adequate cash-flow planning it can also generate liquidity and asset allocation problems.

Watch your cash

The continuing Global Financial Crisis, and the resulting central bank addiction to QE, is making for volatile currency markets. Concerning shifts in major currencies are starting to develop, and serve to emphasise the value of a well-designed currency hedging programme.

Russell Investments Wire - Smarter with money graph

But it’s important to realise that the hedge on its own won’t solve all your problems. For instance, a sharp adverse movement in sterling could lead to a liquidity crunch when the unrealised losses on your hedging programme need to be realised. This scenario could mean that you are potentially faced with the problem of raising cash in a hurry, maybe liquidating your most easily traded assets and thus compromising your desired asset allocation (and incurring unnecessary trading costs on top).

Good cash-flow management, and a disciplined approach to asset allocation, can cover off all of these problems.

Being clever with your cash

One efficient way to manage liquidity is through a cash equitisation programme, in which frictional cash (that is, uninvested cash that is not part of your desired asset allocation) is equitised, or invested, through the use of derivatives such as index futures. For instance, using Pension Plans as a prime example, a Plan can relieve its liquidity concerns by holding adequate levels of cash and implementing an equitisation programme to “overlay” the cash with FTSE 100 or Gilt futures. Futures only require a fractional cash outlay (called margin) as opposed to physical securities, which need to be fully funded. This lower cash requirement allows investors to gain market exposure without the need to use up valuable cash reserves.

By holding adequate cash balances and implementing an equitisation programme, the desired asset allocation can be preserved, the equity premium captured, and the flexibility required for cash-flow planning maintained. Equitisation programmes can also help to relieve the administrative burdens that Plans experience when planning to liquidate assets to fund pension distributions to members.

Finding the right balance

An extension of a cash equitisation programme includes portfolio rebalancing. This is where an overlay manager equitises frictional cash and uses both long and short futures to manage the Pension Plan’s strategic or tactical asset allocation. This type of programme can benefit Pension Plans that are concerned about portfolio risks caused by drifts away from their asset allocation. Rebalancing overlays provide an efficient way for these Plans to rebalance their portfolios, without the need to liquidate physical securities or to reduce manager allocations.

More planning, fewer problems

Equitisation and rebalancing overlays are not new concepts, but have become increasingly important over the past several years, as Pension Plans have started to implement more de-risking programmes, which require flexible and efficient methods to disinvest from growth portfolios into matching portfolios. In addition, the increase in liquidity requirements arising from pending OTC legislation and from potential losses on derivatives in matching portfolios means that Pension Plans need more closely to manage Plan liquidity, or risk paying costly transaction charges when Plan assets need quickly to be liquidated. So better planning can help to control risks and avoid problems.


Yacine Zerizef – Portfolio Manager, Implementation Services, EMEA

Russell Investments Wire - Yacine Zerizef

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