January 2024 - Drags on Cash Performance

Dear Investors and Friends,

In prior letters we articulated why savvy investors invest their cash in short term US Treasury bonds. Specifically:

1. In Active Cash Management we provide an overview of what it means, at least for RCM, to actively manage US Treasuries and what the actual benefits have been since we have started our US Treasury Cash Management Composite,
2. In The Silver-Lining in Today’s Market we discuss how Treasuries are safer than other cash products while providing better returns and higher liquidity,
3. In CDs, Cash Management and the Benefits of U.S. Treasuries we do a deep dive into bank CDs and compare them to short duration US Treasuries, and
4. In How to Protect Your Cash from the Risk of Bank Failure we demonstrate that there are better ways to protect cash, for amounts more than $250,000, than a bank account (whether checking, savings or certificates of deposits).

In this letter we address two related and significant “drags” on cash performance and how RCM avoids them.

Drag #1: Allowing cash to sit in default sweep products

Financial instruments generate cash - equities pay dividends and fixed income products have coupon payments and redemptions. Whether they are aware of it or not, investors typically allow their custodians to “sweep” this cash to the custodian’s default income generating product. We have found that many investors have a false sense of security, believing that their cash is earning a reasonable interest. Exacerbating this, many investors do not pay attention to the cash sitting in their accounts and allow significant time to go by before moving their cash to better alternatives. Whatever the case may be, the result is tremendous opportunity cost incurred as the yield on these default sweep products pales in comparison to short duration Treasuries. For instance, Schwab currently pays 0.45% on its sweep products and Fidelity pays 2.60%. Compare these rates to yields on short duration US Treasuries well in excess of 5.00%.

Drag #2: When “rolling” Treasuries, not doing so until there is cash in the account

We have found that many investors who are following the best practice of investing cash in short duration US Treasuries are still unnecessarily leaving cash on the table because they do not roll Treasuries until there is cash in the account. “Rolling” is the process of buying a new Treasury when the one you own matures.

Let’s walk through an example. Assume you own $1 million face of a Treasury bill that matures on Wednesday, February 7^th. You will not see the $1 million of cash from the T-bill maturity in your account until Thursday, February 8^th. Many Treasury investors wait until this cash shows up to redeploy the $1 million into a new Treasury. Critically, this trade does not settle until Friday, February 9^th. The result of waiting until cash is in the account is a loss of 2 days of interest. If the maturity were to fall on Friday, February 9^th, there would be a loss of 4 days of interest. On average, the lost days of interest each time a Treasury is rolled is 2.4 days (80% of the time * 2 days + 20% of the time * 4 days) if you wait until cash shows up in the account!

Over an entire year, the loss of interest for an investor that waits to see cash in the account can be very significant. Assuming a 5.00% interest rate and 18 trades per year (implied Treasury maturity of 20 days) there would be 43.2 days of impaired interest. Assuming a sweep rate of 0.45% (Schwab’s current rate), the result is that your actual interest would be 4.45%, not 5.00%.

Roosevelt Capital Management: Eliminating Drag on Cash

RCM eliminates the drag on cash on behalf of our clients. How do we do this?

• We eliminate sweep drag by having processes that monitor the cash in every client account every day. If a client account has cash, we move it out of the sweep account by getting it reinvested as expeditiously as possible.
• We eliminate roll drag by considering any position that matures in a business day to be cash. We can do this because we have proprietary systems that are developed internally for the benefit of our clients. Critically, we do this in cash (as opposed to margin) accounts.

Please reach out to us with questions and comments. Thank you for trusting RCM with your capital. It is a privilege for us to serve you.

David and Mike