Portfolio Managers
Cash and collateral management has always been regarded as a peripheral activity for many portfolio managers. In an ever more competitive environment, customers must extract the maximum possible value from their portfolio.
Yield Enhancement
Bond portfolios can boost their portfolio yield via the specials market. Either they lend bonds for a fee (See Securities Lending: Bond vs Fee section) or they put out the special bonds on repo and reinvest the cash proceeds at a higher rate. The reinvestment can be done by buying
general collateral, lending cash through deposits or other short term money market instruments, depending on the portfolio's investment criteria.
Another way of enhancing the yield of a security is by buying a particular bond and financing it by repo-ing it for a particular duration. This is described in the forward pricing analysis below.
EXAMPLE: The US treasury 2.75% 07/06 is bought on the 2 August and repo-ed on the same day for a duration of a month. The yield of the bond before the repo is 2.677%. Since the rate at which the bond is being financed, in this case the repo rate, is 2.00%, the net yield of the bond increases to 2.706%. Hence, the portfolio yield has been enhanced.
Used with permission for illustrated purposes only
Portfolio Financing
A customer utilises a portfolio of bonds in order to raise an amount of funds for a required duration. For example, a fund manager could repo an entire € 500 million portfolio for one year with quarterly resets of the repo rate. The financing rate would be dependent on the quality of the collateral. If the collateral is in demand in the specials market, rates below EONIA may be obtained, even for sub-investment grade collateral.
There are several advantages for portfolio managers using repo transactions for financing:
- Stable cash flow over repo duration
- Increased leverage for their portfolio
- Reduction in clearing and operation's risk relative to financing portfolio piecemeal with several dealers
- Provides customer value for a larger portion of portfolio than just the current specials
Market Intelligence
Portfolio managers also use repo transactions to establish direct relationships with major repo houses. This means that the customers are much more likely to have their securities lent out at the best possible rate. In addition, direct dialogue with trading firms can give customers a much better insight into why securities are in demand and how long that demand is likely to continue. Repo market activity often explains apparent anomalies in the market price of the underlying securities. This information is of practical value to fund managers regardless of the extent to which they lend securities.
