Managing Corporate Cash: Benefits and Risks of Liquidity Funds

As businesses navigate an uncertain economic environment, the need for efficient, low-risk cash management solutions has never been greater. Liquidity funds have emerged as a vital tool for corporate treasurers seeking to preserve capital, maintain access to cash, and generate modest returns. But alongside the benefits, it is crucial to understand the associated risks.

Liquidity funds—often referred to as money market funds (MMFs)—are mutual fund vehicles that invest in short-term, high-quality, and low-risk debt instruments

What Are Liquidity Funds?

Liquidity funds—often referred to as money market funds (MMFs)—are mutual fund vehicles that invest in short-term, high-quality, and low-risk debt instruments such as Treasury bills, commercial paper, certificates of deposit, and repurchase agreements.

They are designed to provide daily liquidity, capital stability, and modest income, making them ideal for managing operational and reserve cash.

Key Benefits for Corporates

1. Preservation of Capital

Liquidity funds are typically composed of investment-grade, short-maturity instruments, helping to minimize price volatility and credit risk. This makes them well-suited for companies that prioritize capital protection.

2. Same-Day Liquidity

Most liquidity funds offer same-day settlement, allowing corporates to quickly access cash when needed. This is essential for managing day-to-day operational needs or unexpected funding requirements.

3. Diversification and Professional Management

Unlike holding individual instruments, liquidity funds provide instant diversification across issuers and sectors. They are managed by professional fund managers who monitor credit quality and manage interest rate risk.

4. Higher Yield vs. Deposits

In many interest rate environments, liquidity funds may offer higher yields than traditional bank deposits, while still maintaining a low-risk profile.

5. Transparency and Reporting

Corporate treasurers benefit from daily NAV reporting, performance tracking, and portfolio disclosures, which support strong governance and compliance practices.

6. Regulatory Compliance

In many jurisdictions, MMFs are regulated to ensure high standards of safety and liquidity (e.g., under SEC Rule 2a-7 in the US or ESMA guidelines in the EU), enhancing their reliability as a cash management tool.

Risks to Take Note

Despite their advantages, liquidity funds are not without risks. Treasurers must remain vigilant and assess the following:

1. Credit Risk

Although funds invest in high-quality debt, default by any issuer could affect the fund’s NAV. Treasurers should monitor the fund’s credit exposure and issuer concentration.

2. Liquidity Risk

In times of market stress, funds may face redemption pressures, making it harder to meet withdrawal demands without selling assets at a loss. This was highlighted during the 2020 pandemic liquidity crunch.

3. Interest Rate Risk

While typically short-duration, liquidity funds are still sensitive to interest rate changes. Rising rates may lead to mark-to-market losses or lagging yield adjustments.

4. Fund Structure Risk

Different funds have different structures—some maintain a constant NAV (CNAV), while others are variable NAV (VNAV). VNAV funds may experience minor fluctuations in value, which could affect accounting treatment or investor confidence.

5. Regulatory and Policy Changes

Changes in liquidity fund regulations or central bank policies can impact fund composition, risk profile, and returns. Treasurers should monitor these developments and stay aligned with internal investment policies.

Best Practices for Corporates Using Liquidity Funds

• Define internal investment criteria, including credit ratings, asset types, and counterparties

• Segment cash pools by liquidity needs (operational vs. reserve vs. strategic)

• Set diversification limits across funds and asset managers

• Perform due diligence on fund managers, historical performance, and risk controls

• Integrate fund reporting into treasury dashboards for better visibility

Conclusion

Liquidity funds offer corporate treasurers an efficient, flexible, and relatively safe way to manage excess cash. Their ability to preserve capital, offer daily liquidity, and generate incremental returns makes them a valuable addition to the corporate cash toolkit.

However, careful fund selection, ongoing risk monitoring, and alignment with corporate policies are critical to unlocking their full potential.