Making your short-term cash reserves work harder

The right weighting in cash is a balancing act. It needs to be sufficiently large to manage any necessary liabilities, but not so large as to compromise long-term investment returns. Long-term cash returns are still below those of stock markets or fixed income portfolios, so there will be an opportunity cost to holding cash.

At the same time, cash rates will vary, so it is important to ensure that this cash is working as hard as it can be. The returns available from shorter-term deposits have improved as global interest rates have risen. Nevertheless, cash savings accounts have not always kept pace with central bank rate rises.

Liquidity portfolios can be used to generate a stronger return than that available in a cash savings account with a commercial bank. They can also bring diversification and help with risk management. Rather than holding large amounts with a single bank, or smaller amounts spread across multiple banks, liquidity portfolios will have a range of exposures, reducing default risk.

Any cash portfolio needs to be managed with a keen understanding of an organisation’s short and long-term liabilities. Building a portfolio starts with the broader cashflow context of the organisation’s operations, and the associated liquidity requirements. This helps us understand how much should be held in cash and when that cash needs to be available.

Liquidity portfolios will comprise a variety of assets, depending on the risk profile and time horizons. However, the ‘core’ assets for most liquidity portfolios will be short-term government debt, combined with cash funds, usually managed by the large fund groups.

For UK charities, we make extensive use of T-bills. These are UK government bonds with a maturity of 6 months or less. The Bank of England’s Debt Management Office currently issues bills with a 1 month, 3 month and 6-month maturity. Each T-bill is issued at a discount to its maturity value of £100, so the return is made up purely of capital growth back to that maturity value over the term of the bill.

They have some notable advantages over cash deposits with a commercial bank. For example, there is typically no secondary market for cash deposits, and many require a lock-in period until maturity. Interest rates are often higher than most cash deposits. Equally, the different maturities of a T-bill portfolio allow us to build a portfolio round a charity’s liquidity needs.

At the same time, while the default risk for the major UK commercial banks is low, it is even lower for the UK government. Small investors with commercial bank deposits are protected by government guarantee systems, but the value of the organisation’s assets exceed these limits.

Liquidity portfolios are flexible and can take advantage of shifting market opportunities. Today, for example, we find the majority of opportunities are in shorter-dated bonds, but if the shape of the yield curve were to change, we would revisit this assessment. Likewise, if a charity’s cashflow needs change, the structure of the portfolio can be adapted accordingly.

Liquidity portfolios can be established as a separate portfolio, segregated from the primary investment portfolio. They are an efficient way for a charity to manage its short-term cash needs and liabilities.

By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.