The Meaning of Cash

One of the great aspects of my job is that I get to pick the brains of some very smart and passionate investors. It is their generosity with ideas and time that helps me produce relevant content.

We try to give back to the industry by creating a confidential environment for open discussion between peers at our forums, but it is especially rewarding to see that on occasion we can do more for the industry.

Last year, when I spoke to investors in preparation for our Fixed Income, Credit & Currency Forum, one of them vented his frustration about the discrepancies in reported returns of pension fund cash options.

Being true to label, this investor’s cash portfolio contained, what you might call, plain vanilla cash instruments, meaning nothing more fancy than a few short-dated term deposits. But that also meant it didn’t score particularly well in the league tables.

At the top of the tables were a handful of cash options that seemed to produce some, well, ‘uncash-like’ returns.

Trying to find out more about this issue, I was pointed in the direction of Debbie Saunders, Principal Adviser at asset consultant Whitehelm Capital. Saunders had just concluded a review of a $2 billion cash portfolio for a client and as such had a good grasp of the current landscape of cash options.

She agreed to delve further into the issue and found that not only were there a handful of options that produced unexpectedly high returns, but also that they did so with much higher standard deviations. In short, they were taking more risk.

Saunders presented her findings at the forum in November 2017 and we published an article on the back of an interview in our December edition of [i3] Insights.

And we thought that would be the end of this story.

But the Australian Prudential Regulation Authority (APRA) had taken note and in May 2018, APRA Member Helen Rowell appeared before the Senate Economics Legislation Committee to answer questions from Labor Senator Chris Ketter about the returns of cash options.

Rowell revealed APRA was in the midst of conducting a review of cash options and had found some unusual returns indeed.

“One is that some cash options seem to be returning much higher than we would expect from what you might call a pure cash option and there are others that are returning much less,” she told Senator Ketter.

“Our initial work seems to suggest that part of it goes to the types of instruments, if you like, which are in those. They are not just term deposits; they may be enhanced cash, RMBSs (residential mortgage-backed securities) or other types of securities that are cash-like but
not cash.”

Asked if Rowell thought the current regulatory arrangements were appropriate and sufficient, she replied:

“I would say that there is room to strengthen the regulatory framework both in terms of putting tougher requirements on funds in terms of how they look at and assess member outcomes and what they are delivering at a fund, product and investment option level, but also in terms of the reporting and disclosure and the information that is available that enables us and other stakeholders to get more visibility of these types of issues more quickly.”

She proved to be true to her word and on 29 June, APRA issued guidance to all registrable superannuation entity licensees on cash option holdings, banning any credit instruments.

“Assets that APRA has observed forming part of cash options’ underlying investments include
asset-backed and mortgage-backed securities, commercial bonds and hybrid debt instruments, credit default swaps, loans and other credit instruments,” the prudential regulator said in a letter to licensees.

“These assets do not typically exhibit the characteristics necessary to be considered as cash or cash equivalent.”

APRA pointed to the definition of cash under Superannuation Reporting Standard 530 Investments, which spells out that not only do cash holdings need to be liquid, they also need to be “subject to an insignificant risk of changes in value”.

The regulator urged super funds to review and restructure cash investment options that have exposure to non-cash assets and said it would continue to monitor the situation.

With this guidance, the superannuation system has become just that little bit more stable.

So we would very much like to thank our investor network for the time and effort they have put in to educating us and we hope we’ll have many more great conversations going forward.

Thank you,

Wouter Klijn

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[i3] Insights is the official educational bulletin of the Investment Innovation Institute [i3]. It covers major trends and innovations in institutional investing, providing independent and thought-provoking content about pension funds, insurance companies and sovereign wealth funds across the globe.