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Jerome M. Schneider
The properties of pyrite – fool’s gold, as it’s commonly known – are worryingly similar these days to the characteristics of many short-term portfolios investors are using these days for maintaining defensive liquidity-minded cash positions. Investors have in recent weeks sought refuge from volatility by delving into the mines of “cash equivalent” portfolios in search of greater stability. While many money-market strategies, especially those that favor credit, look like valuable commodities, their appearances may prove deceiving and may even, like pyrite, blow up if left unmonitored in the wrong environment.
We believe investors need to be more cautious than ever when considering allocations to short-term strategies. Traditional money market liquidity strategies often advertise easy access to the cash in the portfolio. However, investors need to dig a little deeper to accurately determine whether the minerals they hold will be valuable – both in terms of liquidity and credit performance – over a range of market scenarios.
Just as minerals show up on a periodic table, money market securities provide relative levels of liquidity across a broad spectrum. However, when market conditions change, the liquidity embedded within securities can change, too, as liquidity preferences themselves change. The recent volatility over the past two months has supported this dynamic again, as dealers and investors become more defensive in bidding for securities in an ever more stressed marketplace. Securities that are perceived to have high value because of liquidity or relative yield can look a lot different once investors start worrying about, say, the possibility of Greek default or broader credit concerns in Europe.
The latest volatility – and volatility looks to be with us for a while – has investors asking questions about the securities they own, in particular probing any exposures to European issuers. Since 2010, some investors have migrated from strategies containing commercial paper (CP) and certificates of deposit (CDs) to those focused on only purchasing government debt. Yet, as we saw in the 2008 and other recent crises, there has tended to be less willingness to provide liquidity to holders of commercial paper – the bid-ask spreads for financial and other high-beta issuers have widened greatly – so what typically might be deemed money-market worthy instruments in better times may be anything but sources of marketable liquidity.
In times of stress, we believe only Treasury securities, over-collateralized repurchase obligations and insured demand bank deposits will be able to withstand the stress of a liquidity vacuum and continue to provide portfolios with adequate access to cash in a variety of market environments. The cost of this “purity” can be quite expensive though: near zero percent yields, currently.
Cash Equivalents are defined as any security with a duration less than one year.
Past performance is not a guarantee or a reliable indicator of future results. Investing in the bond market is subject to certain risks including market, interest-rate, issuer, credit, and inflation risk. Investing in foreign denominated and/or domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Sovereign securities are generally backed by the issuing government, obligations of U.S. Government agencies and authorities are supported by varying degrees but are generally not backed by the full faith of the U.S. Government; portfolios that invest in such securities are not guaranteed and will fluctuate in value. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market.
No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. Pacific Investment Management Company LLC, 650 Newport Center Drive, Newport Beach, CA 92660, 800-387-4626. ©2015, PIMCO.
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