Efficiently Managing and Deploying Unencumbered Cash

For buy-side firms, maximizing alpha hinges on one crucial factor: cash management. Unencumbered cash, or funds that are readily available for investment, enables firms to capitalize on market opportunities and maximize returns. Managing this valuable resource effectively, however, can be a complex endeavor for funds and asset managers. In this blog, we’ll explore strategies buy-side firms can employ to optimize unencumbered cash balances, ensuring access to the right amount of cash on hand to meet operational needs as well as maximize returns on idle cash holdings.

Striking the Right Balance: Assessing Unencumbered Cash

The first step in optimizing unencumbered cash is determining the appropriate level to maintain. This is a delicate balance, because buy-side firms need to have sufficient cash on hand to fund daily operations, cover settlement obligations, and meet client redemption requests. At the same time, firms also want to avoid accumulating excessive idle cash that could be better deployed.

To arrive at the optimal unencumbered cash balance, treasury teams should consider the following factors:

1. Operational cash forecasting: Develop robust cash forecasting models that accurately predict the firm’s short-term liquidity needs. This involves analyzing historical patterns, anticipated investment activities, and potential market events that could impact cash inflows and outflows.
2. Regulatory requirements: Ensure the firm maintains unencumbered cash reserves that meet or exceed any regulatory capital or liquidity ratio requirements.
3. Client redemption risk: Assess the potential for client redemptions, particularly during periods of market volatility. Hold sufficient unencumbered cash to meet these obligations without disrupting investment strategies.
4. Counterparty risk management: Consider the firm’s exposures to various counterparties, such as prime brokers and trading venues, and maintain unencumbered cash buffers to mitigate potential settlement risks or margin calls.
5. Contingency planning: Build an additional cushion of unencumbered cash to address unforeseen events or emergencies, ensuring the firm has the financial flexibility to respond quickly to market disruptions or unexpected liquidity needs.

By carefully analyzing these factors, treasury teams can determine the appropriate level of unencumbered cash to hold, striking the right balance between operational needs and maximizing returns on idle cash.

Minimizing Idle Cash and Maximizing Returns

Once the ideal unencumbered cash balance is known, buy-side firms can use multiple strategies to achieve it, including all of the following.

1. Short-term investment

• Invest unencumbered cash in high-quality, low-risk, and highly liquid instruments, such as money market funds (MMFs), short-term treasuries, or repurchase agreements (repos).
• Continuously monitor and evaluate the performance and risk profiles of these short-term investment vehicles to ensure they align with investment objectives and risk tolerance.
• Leverage treasury management systems (TMS) and analytics to automate the decision-making process and optimize the firm’s short-term cash portfolio.

2. Cash pooling and centralization

• Consolidate unencumbered cash holdings across various bank accounts, entities, or geographical locations into a centralized cash pool.
• Cash pooling allows for more efficient cash management, improved visibility, and the ability to better deploy excess cash into higher-yielding investments.
• Ensure any cash pooling arrangements comply with regulatory requirements and do not inadvertently encumber the firm’s cash holdings.

3. Interest rate risk management

• Monitor interest rate trends and actively manage the duration of the firm’s unencumbered cash investments to mitigate interest rate risk.
• Consider implementing strategies like barbell portfolios or laddered maturity structures to maintain liquidity while capturing higher yields as interest rates rise.
• Leverage interest rate derivatives, such as interest rate swaps or futures, to hedge against adverse interest rate movements.

4. Bank relationship management

• Cultivate strong relationships with the firm’s banking partners to negotiate more favorable deposit rates on unencumbered cash holdings.
• Explore opportunities to participate in bank-sponsored cash investment programs that may offer enhanced yields compared to standard deposit accounts.
• Regularly benchmark the firm’s cash deposit rates against market averages to ensure optimized bank relationships.

5. Cash forecasting and automation

• Implement advanced cash forecasting models that leverage historical data, market intelligence, and predictive analytics to accurately anticipate short-term cash needs.
• Automate cash management processes, such as daily cash position monitoring, funds transfers, and investment allocations, to reduce manual interventions and optimize efficiency.
• Integrate treasury management systems and cash management tools to streamline data collection, analysis, and decision-making around unencumbered cash management.

By implementing these strategies, buy-side firms can effectively minimize the amount of idle unencumbered cash while ensuring sufficient liquidity to meet operational requirements. This, in turn, allows firms to maximize returns on unencumbered cash holdings, ultimately enhancing your overall financial performance and competitive position.

When selecting a treasury and cash management solution, it is important to choose one that is easy to customize for your fund’s unique needs. IVP Treasury Management is an industry-leading solution that is designed for customization and can help buy-side firms efficiently manage and deploy unencumbered cash while optimizing treasury operations.

Learn more about IVP Treasury Management or contact us at sales@ivp.in to schedule a live or online demo.