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Companies with large cash balances can earn better yields by investing in unit trusts

18 February 2013 Gareth Johnson, Investment Solutions

South African companies sitting on large cash balances in banks may be missing out on the opportunity to potentially earn higher returns if they invested it with money managers via money market and income unit trusts, says experts at Investment Solutions.

Currently, yields on money market funds range between 5.75%-6.25% p.a. yet interest on positive balances in a corporate bank account are only between 4%-4.5% p.a. Gareth Johnson, Head of Client Services at Investment Solutions says, a company can earn an additional yield of between 1.25%-1.75% p.a. by using a money market unit trust. Even though fees on unit trusts are higher than those charged on a corporate bank account the additional yield mentioned above is net of the unit trust fees. “Typically, on a hypothetical balance of R500 million, this will equate to an additional amount of interest of R6,25m to R8.75m per year,” says Johnson.

He says while it is understandable that many corporates have adopted an overly conservative balance sheet in the face of market uncertainty, there are opportunities to capitalise more effectively on the potential returns their cash piles generate, and ensure they utilise cash balances effectively by selecting the investment vehicle best suited to their individual profile.

Corporate cash balances have been rising steadily since mid-2010 and figures released by the South African Reserve Bank (SARB) for September 2012 show that non-financial corporate cash balances were sitting at R542 billion (marginally down from their August 2012 peak of R549 billion). Such a steady rise represents an increase of 14% over the last year, double the growth rate of overall deposits.

In the US, estimates show that corporates hold a staggering $1.7 trillion in cash and other liquid assets, while in the euro zone area, estimates last year showed that cash on Eurozone- listed companies' balance sheets exceeded €770 billion.

“It comes as no surprise as to why this is the case. Since the global financial crisis hundreds of companies have been building up significant cash reserves as they seek to build a buffer against a rather tepid and fragile economic climate,” says Johnson.

In South Africa, he says hoarding cash on balance sheets is not surprising owing to concern by companies about local and global economic uncertainty. “SA corporates are no different to their international peers and in addition to the world’s economic woes, our current labour instability provides a toxic cocktail which is forcing most companies to delay any capital expenditure projects or acquisitions as they try to ride out the current political and economic storms,” says Johnson.

Another reason for hoarding cash is the perception by companies that bank credit might be difficult to obtain particularly as the banks are building additional capital and liquidity buffers in order to comply with Basel III requirements which are being phased in from 2013 to 2019.

Johnson warns, however, that in the current low interest rate environment in South Africa, while cash could be “king” in uncertain times, the truth is that surplus cash on balance sheets can create significant drag on earnings and return on equity. “In essence, corporate cash piling is counter-intuitive considering that interest rates are wallowing at near 40-year lows,” he says.

Amber Kirtley, Account Manager at Investment Solutions, says while there are always pros and cons to any strategy, hoarding vast sums of cash does come at a cost, however there are options available to corporates other than allowing these monies to lie idle in their bank accounts.

“In these uncertain times it is imperative that corporates optimise income and retain the ability to access their funds at short notice without compromising on the security of the assets,” says Kirtley. “Money Managers via money market and income unit trusts are ideally positioned to provide corporates with an appropriate investment solution by offering unit trust options that provide comparatively higher yields without incurring additional risk along with accessibility within 24 hours and peace of mind through the security of assets,” she says.

Johnson says during this period of continued uncertainty, defining the right investment strategy with an emphasis on access to liquidity will remain extremely important for corporates globally.

“In this environment, investing in secure, liquid and diversified instruments offered through money market and income funds will ensure your corporate cash works harder yielding better returns. We have no doubt that in time business confidence will be restored and that the current depressed economic climate will turnaround, but until then it would be wise for corporates to sweat their cash,” says Johnson.
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