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Members of TIMPG contemplate cash levels, external investment managers and artificial intelligence at recent meeting.
The TIMPG 2018 fall meeting sponsored and hosted by Franklin Templeton Investments in San Mateo, CA, was chock-full of valuable insights on the outlook for interest rates and the economy, portfolio optimization and other topics of interest to investment managers confronting new decisions about cash levels and deployment post tax-reform. Here are a few of the meeting’s key takeaways.
Find your spot on the spectrum. As members look to define the steady state of their cash levels, they must ask anew where they will position themselves on an investment spectrum ranging from conservative—traditional short-duration investments and few external managers—to sophisticated, meaning those with more expansive mandates and more extensive use of external managers. Several members noted that they will be looking to invest more in traditional money-market funds and in-house managed SMAs going forward and most said that they are looking to consolidate their list of external managers.
Define the steady state of your cash balances. A big question for most member companies is what their steady-state cash levels will be once they have allocated their excess cash that is no longer trapped offshore and rejiggered their capital structure. This question will get answered over the next several months for most companies and there is wide variance of opinion, even within some companies: “Our debt guy talking hundreds of millions and I’m thinking billions.” What framework will be used, what level of risk appetite and how much weight will be given to R&D, tangible vs. intangible assets and rating agency concerns?
External managers: How to keep score. Many members will be consolidating managers due to expected lower, steady-state cash levels and all seem to want to scrutinize them more. So there was keen interest in one member’s discussion of external manager scorecards and how they’re used to communicate performance to external managers—and even justify firing them. What goes into such scorecards: “credit, credit, credit,” which emphasizes the importance of using external managers’ credit research capabilities to supplement a firm’s own. Beyond credit, the scorecards note the number of good ideas the manager comes up with vs. your own and how many winning picks in the portfolio are yours vs. theirs, plus how many losers are theirs and how many they insisted on keeping after you questioned holding them.
Prepare for the new asset management ecosystem with machine learning and AI. Roger Bayston, director of investment grade bonds at Franklin Templeton, urged members to look out for the new asset management ecosystem, including a bond market built on tech platforms. One area tech-based ecosystems are showing promise is in the bank loan market, where marketplace lending is taking off. As much as $1 trillion in loans may be originated by marketplace lending (non-banks like Lending Club, Prosper, OnDeck, Marcus ad Enova) by circa 2025, Franklin Templeton predicts.
- Less Prescriptive, More Flexible. The member described the new framework as less prescriptive than the previous approach that had a specific cadence but had given up some flexibility. Now, the company is not announcing when it will execute buybacks. The company’s goal is to “embed flexibility” in timeline parameters, measuring in years, not months or quarters.
- No KPI Magic Bullet. In response to a question, the treasurer said, “I don’t think there’s a magic bullet for KPI” when evaluating the success of a share repurchase program. No matter what the size of the program, a “broader framework” is necessary to measure the program.
- Designing the Framework. The member suggested a three-point framework that included: 1. Achieving stated capital structural goals; 2. Updating the valuation thesis regularly, validating repurchase decisions through retrospective analysis and adjusting for market conditions or changing business conditions or other; and 3. Execution: taking advantage of multiple buyback tools to manage through open markets, and blackouts, while considering volatility, ADTV, VWAP and other factors to measure program success, bank execution and other factors.
- Leverage Questions Give Treasury a Bigger Seat at the M&A Table. The wide spectrum of leverage involved in the various scenarios meant treasury played a much bigger role than in most deals and was heavily involved in the negotiations. Under one scenario, the company’s leverage ratio could have reached over 4x leverage, considerably more than its target of 2. This brought “a lot of credit implications and financing possibilities,” the treasurer explained.
- Multiple Scenarios Mean Lots of Work. The huge size of the deal and the subsequent bidding for the stake in the third company meant treasury had to detail the leverage implications of three different scenarios each time it met with the board. All the work done gave the company the confidence to proceed without running scenarios by the rating agencies before bids were structured. “We thought we had a good handle on it,” the treasurer said, noting that the company always talked to the rating agencies shortly before any announcement.
- Tax reform and its implications for treasury
- What investors and activists are demanding and how global treasury and shared service centers are beginning to change in response to tax reform
- How new technologies like robotic process automation and artificial intelligence are deployed
- Leveraging blockchain technology and what to do about cryptocurrencies.
Are you missing something important as treasurers when it comes to Brexit?
At recent peer group meetings, members have been asking each other about Brexit. The gist of the question is: Has anyone discovered something to be concerned about regarding Brexit? From a treasury standpoint, few have heard anything meaningful in response.
Given that Brexit is scheduled to go down on March 29, 2019, whether the UK has an exit deal with the EU finalized or not, we thought it would be good to get some added expertise in the mix.
Enter BNP Paribas’ UK Economist Paul Hollingsworth, who joined them this summer from Capital Economics, where he also opined on Brexit. Paul will be addressing our Treasurers’ Group of Thirty Large-Cap Edition meeting in New York, via video link, which BNP Paribas is hosting on October 11.
We hope that with Paul’s perspective and his responses to the questions from T30 LC members, we will help shed light on this question and see if there is something that MNC treasurers should be worried about. He may also help members assess if it’s true that Paris is set to become the new center of trading for Europe.
- Key Takeaway: Bigger Savings with Bigger Trades. The presentation demonstrated that the savings gained by using algos vs a risk-transfer trade on $200 million notional far outpaced savings on a $50 million trade. The presenting company therefore has a $100 million minimum for EUR trades.
- Key Takeaway: Algos Take More Work. The difference in savings matters in part because the passive algos favored by the member can take up to 30 minutes to execute a $200 million trade (meaning the user is exposed to market risk) and require monitoring. One member said, “It sounds like a lot of work to me,” and asked if the extra time spent on algos negated the benefits. The presenter said the choice whether to spend 5-10 minutes of your time on an algo versus 1 minute for risk transfer comes down to how much you value the savings. He said $2-$3 million in savings is worth it to him.
- Key Takeaway: Price maker or price taker? Market position, price elasticity and margins matter in risk management. Premium brands like Cartier (to take a French example) have an ability to pass through significant FX moves to consumers and they have the higher margins to unlock budget for options premiums. Lower margin brands operate in a much more competitive landscape; they often prefer the certainty of outcome that comes with a forwards-based strategy.
- Key Takeaway: More dynamic, please! Benefits of not being totally static. In a hedge program, the hedge ratio, tenor and instrument choice are the levers that allow flexibility (or not). In their presentation, the presenters noted that they refer mainly to instrument choice when they talk about static vs. dynamic hedging. A static hedge program is consistently applied regardless of market conditions. A dynamic systematic program is a rules-based framework using mainly forwards and collars and where the hedge ratio is determined by market-based triggers like volatility and forward premiums. This kind of program can result in considerable savings in hedge cost (or more risk reduction for the same cost) over time, while still having the guardrails of a well-defined framework. A dynamic opportunistic program allows decision making on a case-by-case basis based on currency, exposure, timing and market levels and can include options and option combinations.
- How do companies prioritize capital allocation between growth investment, return of capital, and improving balance sheet, and what are the strategic and capital market implications?
- On what basis are internal and external investment decisions made (e.g., variants of NPV, IRR, ROIC, etc.) and how are appropriate hurdle rates for different jurisdictions set and managed over time?
- How should these change with tax reform and market conditions, and how can the choice of evaluation framework and/or hurdle rate impact strategic decision-making?