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The B-Side Of Capital Preservation – PIMCO Spotlight

  • ?Regulatory and market forces have made traditional capital preservation strategies, including money market funds, less appealing or simply less available.
  • Many traditional approaches have also failed to preserve purchasing power: Near-zero returns have trailed inflation.
  • Global investors need to consider more active approaches to cash management that aim to preserve purchasing power, including short-term and low duration strategies.

Vinyl single records have two sides: The A-side is always the well-known hit song by the musician, and the other, called the “B-side,” is often a lesser known (or unknown) work. When it comes to cash management, the hit song on the A-side – “Capital Preservation Is King” – has been played over and over since the financial crisis. Amid episodes of stress and illiquidity, continuing central bank action and changing regulatory frameworks, investors sought refuge through three traditional avenues to capital preservation: investing cash with depository banks, buying U.S. Treasury bills directly and buying shares in regulated 2a-7 money market funds.

Until now, these strategies mostly succeeded in preserving capital. However, regulatory and market forces are changing the landscape, and these traditional schemes have become less appealing or simply less available. In addition, many have failed to preserve purchasing power: Their near-zero returns have trailed even recent modest levels of inflation. As monetary stimulus in the U.S. winds down, global investors need to consider turning the record over to the B-side and listening to the new tune for cash management: “Purchasing Power Preservation.”

Traditional strategies: played out?
Of the three traditional strategies, regulated money market funds have been the vehicle of choice for investors looking to manage liquidity while preserving capital. Over the past few years, investors have even forgone attractive returns, with money funds yielding a mere 0.01% at the end of June, according to Crane’s Money Fund Index. With bond yields low overall and inflation expectations benign, the opportunity cost of this strategy has been small over the past five years.

But things are changing.

First, all three traditional methods of seeking to preserve capital are becoming increasingly curtailed. In general, banks are not encouraging deposits as these are no longer shareholder friendly, T-bill supplies have diminished as the fiscal outlook has improved, and money market reform in 2016 will likely bring floating net asset value (“FNAV”) share classes and the...