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© PFM 1
Presenter:
Steven Alexander, CTP, CGFO, CPPTManaging [email protected](407) 406-5750
June 19 2019 | 3:40 p.m. – 4:30 p.m.Tools for Developing a Successful Investment Program Learning Objective: When you complete this session, you should be able to: Recognize and discuss components that are essential in constructing and managing investment programs, including: month end statements, asset allocation reports, third-party custody statements, investment transaction reports, cash flow modeling, and investment policies
© PFM 2
Tools for Developing a Successful Investment ProgramJune 19, 2019
PFM Asset Management LLC
407.648.2208pfm.com
300 South Orange Ave,Suite 1170Orlando, FL 32801
Steven Alexander, CTP, CGFO, CPPTManaging Director
© PFM 3
Properly identifying assets for long-term
investment
• Maintaining purchasing power of assets
Properly diversifying assets
Manageable oversight of investment program
Challenges Public Entities Face
3
© PFM 4
• Does investing outside of a money market or pool make sense for me?• If yes, what components do I need to have a successful investment program?
• Do I have an investment policy in place?
• What securities should be used in these portfolios? • How much risk am I comfortable taking to achieve my goals?
• How much is available for investment? • Am I investing appropriately for my cash flow needs/maximizing investment
income?
• I have an investment portfolio, what do I do now?
Questions to Ask Yourself
3
© PFM 5
Policy should be structured to place the highest
priority on the:
• Safety of principal
• Liquidity of funds
The optimization of Returns shall be secondary
(yet important - maximize earnings through
diversification)
Compliance with legal restrictions/regulations
Flexibility/Simplicity
Provides a road map during periods of volatility
Developing an Investment Policy
© PFM 6
An Investment Policy Allows for Greater Diversification
Investment Options Without an Investment Policy
Investment Options With a written Investment Policy
• Local Government Investment Pools • Local Government Investment Pools
• SEC registered Money Market Funds • SEC registered Money Market Funds
• Interest-bearing time deposits or savings accounts • Interest-bearing time deposits or savings accounts
• U.S. Treasury Securities • U.S. Treasury Securities
• Federal Agency/GSE
• Supranationals
• Corporate Bonds
• Municipal Obligations
• Government Agency Mortgage-Backed Securities
• Asset-Backed Securities
• Certificates of Deposit
• Commercial Paper
© PFM 7
Sector Allocation Changes
State Pool
© PFM 8
Investment Policy Review Framework
S t a t e S t a t u t e s
A s s o c i a t i o n o f P u b l i c Tr e a s u r e r s o f
U S a n d C a n a d a G F O A
B e s t P r a c t i c e s
© PFM 9
APT US & C* Investment Policy Requirements
• Policy/Purpose• Scope• Prudence• Objective (Safety, Liquidity, Yield)• Delegation of Authority• Ethics and Conflict of Interest• Authorized Financial Dealers and Institutions• Authorized & Suitable Investments• Investment Pools/Mutual Fund Questionnaire • Collateralization• Safekeeping and Custody • Diversification• Maximum Maturities• Internal Control• Performance Standards• Reporting• Investment Policy Adoption• Glossary
© PFM 10
GFOA Investment Policy Best Practices
• Scope and investment objectives
• Roles, responsibilities, and standards of care
• Suitable and authorized investments
• Investment diversification
• Safekeeping, custody, and internal controls
• Authorized financial institutions, depositories, and broker/dealers
• Risk and performance standards
• Reporting and disclosure standards
© PFM 11
Cash Flow AnalysisCash Flow Analysis
© PFM 12
Cash Flow Analysis
• Determines your liquidity needs
• Identify short term vs. long term
• Short-term assets should be the primary source for near term disbursements
• Long-term/core assets are designed as a last resort for liquidity needs
• Enhances cash management - better understanding of timing of revenues and expenditures
• Results in more effective cash flow management, e.g. stretching out accounts payables and speeding up collection of receivable to finance part of the operations internally
• Identifies an optimal allocation of funds to maximize investment income
• Investment selection
• Purchasing power
© PFM 13
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
7/15 9/15 11/15 1/16 3/16 5/16 7/16 9/16 11/16 1/17 3/17 5/17 7/17 9/17 11/17 1/18 3/18 5/18 7/18 9/18
Erosion of Purchasing Power - $100 Million Portfolio
Inflation Rate(Core PCE)
3 Month T-Bill Index
$2.9 millionlost purchasing
power
Bloomberg is the source of Inflation data. Loss is based on a starting portfolio size of $100,000,000. The 3 Month Treasury Bill Index is sourced from Bloomberg utilizing monthly data from 7/31/2015 –9/30/2018.
February 2017 Difference of 1.34%
© PFM 14
100,000,000
200,000,000
300,000,000
400,000,000
500,000,000
600,000,000
Jan-
13
May
-13
Sep-
13
Jan-
14
May
-14
Sep-
14
Jan-
15
May
-15
Sep-
15
Jan-
16
May
-16
Sep-
16
Jan-
17
May
-17
Sep-
17
Jan-
18
May
-18
Sep-
18
Jan-
19
Total - All FundsAnalysis of Core Portfolio
Cash Flow Analysis
Liquid Funds
Core Portfolio $146 million
Projected
Immediate Liquidity
Liquidity Reserve
Short-Term Liquidity
Core Portfolio
For illustrative purposes only
© PFM 15
Portfolio Segmentation and Strategy Considerations
Portfolio Segment Strategy Consideration Potential Characteristics
Immediate Liquidity Daily Liquidity• Bank operating cash• Money Market Funds • Local Government Investment Pools (LGIPs)
Short-Term LiquidityMaturity matched to
expenditures (3-6 Months)
• Maturities matched to know cash flow needs (i.e. debt service, construction, etc.)
• Commercial paper
Liquidity Reserve Short Duration Target(6 Months-2 Year Duration)
• Highly liquid securities- Securities/sectors with active secondary markets- Limited structure/optionality risk
• Allocation to high-quality, diversified credit securities to maximize the income potential of short duration needs
• Commercial paper, ABS, corporate notes
Core Portfolio Longer Duration Target(1-3, 1-5 years)
• Diversified across high-quality asset classes• Realize the benefits of a positively sloped yield curve• Greater focus on income generation (lower liquidity
profile)- Corporate notes, MBS, federal agencies
© PFM 16
Improving Diversification to Maximize IncomeCurrent Allocation Sample Allocation
Balance Yield Liquidity Tier Balance YieldBank
Account $6,000,000 0.07%
ImmediateLiquidity
Bank Account $6,000,000 0.07%
State LGIP 15,000,000 2.04% State LGIP 25,000,000 2.04%
Money Market Fund 5,000,000 0.47% Money Market
Account/LGIP 50,000,000 1.99%
Short Term Liquidity
Enhanced Cash Portfolio 147,000,000 2.27%
Liquidity Cushion Long Term Pool 40,000,000 1.64%
Long Term Pool 388,000,000 1.64% Core
Reserves Core Portfolio 146,000,000 2.46%
Total $414,000,000 1.62% Total $414,000,000 2.20%
Estimated Annual Earnings $6,696,900 Estimated Annual Earnings $9,093,700
For illustrative purposes only
Difference $2,396,800
© PFM 17
50
100
150
200
250
300
Jan-
15
May
-15
Sep-
15
Jan-
16
May
-16
Sep-
16
Jan-
17
May
-17
Sep-
17
Jan-
18
May
-18
Sep-
18
Milli
ons
Total - All FundsAnalysis of Core Portfolio
Historical Short-term Portfolio Historical Core Projected Short-term PortfolioSeries2 Projected Core
Total Core $222.8 Million
Projected
Immediate Liquidity
Liquidity Reserve
Core Portfolio
Liquidity Reserve
Cash Flow Analysis
For illustrative purposes only
© PFM 18
Improving Diversification to Maximize Income
Existing Allocation Sample AllocationBalance Yield Liquidity Tier Balance Yield
Bank Account $214,046,099 0.57%Immediate Liquidity
Bank Account $25,462,290 0.57%
Enhanced Cash Investments 41,995,405 1.56% Local LGIP 49,943,673 1.30%
Liquidity Reserves
Enhanced Cash Portfolio 155,448,439 1.79%
Core Portfolio 22,892,870 1.65% CoreReserves Core Portfolio 48,079,972 1.93%
Total $278,934,374 0.80% Total $278,934,374 1.62%
For illustrative purposes only
Estimated Annual Earnings $2,221,157 Estimated Annual Earnings $4,504,873 Difference $2,283,716
© PFM 19
In Summary
Short-term Portfolio
• Highly liquid funds to meet daily disbursements needs and unforeseen expenditures
• Funds to cover specific, predictable cash flows (i.e. payrolls, debt service)
• Can be lower during periods of net cash inflow
Core Portfolio
• Funds not expected to be spent, but may be disbursed in extraordinary circumstances
• Can be invested in longer-term securities to generate a higher expected return
© PFM 20
Investment Program Building Blocks
© PFM 21
Building Blocks of Portfolio Construction Process
Issuer & Industry Selection
Yield Curve
Sector Allocation• Focused sector allocation
• Identify attractive portions of the curve
• Manage interest rate risk
Duration
• “Roll down the curve” for enhanced earnings
• Increased income potential
• Thorough review of issuer-specific trends and credit profile
• Macroeconomic factors unique to the industry
• Disciplined approach to maintaining target duration
Interest rates are the headline, but they are not the foundation
© PFM 22
100%
70%
40%
30%
20%
20%
30%
30%
30%
30%
20%
30%
30%
30%
30%
10%
10%
10%
10%
10% 10%
Example 1-5 Year Portfolio Sector Allocation
Treasury Agency Corp A-AAA Mortgage-BackedSecurities
Asset-BackedSecurities
Corp BBB
Benefits of Diversification
Sample portfolio returns are based on the ICE BofAML 1-5 Year indices for all the sectors shown. Source: ICE BofAML Indices
0.0% 0.5% 1.0% 1.5% 2.0%
2017 Portfolio Returns
+0.50%
© PFM 23
Long-Term Performance Correlations
Correlations of sector indices from Sep, 1997 – Sep, 2017.
Correlation Matrix
Column1 Treasury Agency CorpAAA-A MBS Municipal ABS Corp
BBB
Treasury 1.00 0.94 0.59 0.79 0.62 0.56 0.32
Agency 1.00 0.70 0.87 0.68 0.68 0.44
Corporate AAA-A 1.00 0.66 0.62 0.76 0.84
MBS 1.00 0.68 0.63 0.48
Municipal 1.00 0.59 0.48
ABS 1.00 0.75
Corporate BBB 1.00
© PFM 24
$95
$100
$105
$110
$115
$120
Sep 08 Sep 09 Sep 10 Sep 11 Sep 12 Sep 13 Sep 14 Sep 15 Sep 16 Sep 17 Sep 18
Mill
ions
Risk/Return of Various Treasury Investment Strategies
Source: Bloomberg, Bank of America Merrill Lynch Indices, based on quarterly returns.
Risk/Return of Various Investment Strategies10 Years Ended September 30, 2018
Bank of America Merrill Lynch Index
Duration(years) Yield Annualized
Total ReturnCumulative Value of
$100 Million
1-Year Treasury 0.98 2.67% 0.71% $107,309,524
1-3 Year Treasury 1.87 2.81% 1.09% $111,432,388
1-5 Year Treasury 2.64 2.86% 1.63% $117,555,071
1-Year Treasury
1-3 Year Treasury
1-5 Year Treasury
Growth of $100 Million PortfolioSeptember 30, 2008-September 30, 2018
© PFM 25
Cash/Securities Information
Investment strategyTrade execution
Competitive biddingTrade coordination
Approved Broker-Dealers
The Entity’s Custodian
Bank
Trad
e Ex
ecut
ion
Investment Advice
Cash TransactionsCash only moves between the
Entity and custodian bank
Trade SettlementVia Federal Reserve “Delivery
versus Payment” system
Best Practice Discretionary Trade Process
City, Town, County,
Authority, School District
Investment Manager
© PFM 26
Monitoring Your Investment Program
Investment Advisor
Investment Committee
Quarterly Performance Report
Monthly Statement
Custody Statement
© PFM 27
Quarterly Performance Report
© PFM 28
Performance Reporting
© PFM 29
Total Return and Yield
Returns shown could be:
• Total Return
• Yield
Returns are retrospective
Yields are prospective
Total Return takes into account
• Interest earnings
• Realized gains/losses
• Unrealized gains/losses
Total Return =
𝐸𝐸𝐸𝐸 − 𝐵𝐵𝐸𝐸 − 𝑁𝑁𝑁𝑁𝑁𝑁𝐵𝐵𝐸𝐸 + 𝑊𝑊𝑁𝑁𝑁𝑁
© PFM 30
Total Return – Income + Price Return
-10%
-5%
0%
5%
10%
15%
20%Series2 Price ReturnIncome Return
9.95%
6.84%
4.46%
0.75%
Source: Bloomberg, BofA Merrill Lynch 1-5 Year U.S. Treasury Index, as of 12/31/17.
© PFM 31
Using Benchmarks in Portfolio Management
Identification and Explanation• Specifically identified and explained before implementing the
proposed portfolio strategy Comparability
• Be representative of the policy guidelines and investment strategy
Direction• Provide PM with an understanding of investment goals and
objectives Investable & Unambiguous
• Data should be available with the names and weights of the securities comprising the benchmark
• Security type can be purchased in the Market Measurable
• The benchmark return is readily available through 3rd party sources (WSJ, Bloomberg)
• Independent representation of the market
Typical Benchmarks* include:
• Merrill Lynch 1 Year T-Note Index
• Merrill Lynch 1-3 Year Treasury and Agency Index
• Merrill Lynch 1-5 Year Corporate and Government Index
• Barclays Capital 1-3 Year Government Index
*This is a partial listing of available benchmarks
© PFM 32
Duration ComparisonComparing portfolio duration to
prior period and benchmark show investment managers strategy with regard to the direction of
interest rates
© PFM 33
Deconstructing Duration
Duration BehaviorLower Higher
Factor Duration Duration
Term to maturity shorter longerCoupon rate higher lowerMarket yield level higher lowerFrequency of coupon quarterly annual
Simply defined, duration is a measure of a security’s or portfolio’s interest-rate sensitivity.
Duration is similar to, but more precise, than average life or average maturity. The longer the duration of a security or portfolio, the more sensitive it is to changes in interest rates.
© PFM 34
Portfolio Maturity vs. Benchmark
Comparing portfolio maturity distribution to benchmark
confirms managers interest rate strategy as well as value
along the yield curve
© PFM 35
Active Duration ManagementAv
erag
e D
urat
ion
Time
LowerLimit
Target
UpperLimit
Neutral
Expect LowerRates
Expect HigherRates
© PFM 36
Portfolio Characteristics
© PFM 37
Transaction Reports
© PFM 38
Transaction Reports
© PFM 39
Investment Policy Compliance
© PFM 40
Investment Policy Compliance
© PFM 41
Reconcile Month-End Statements
Coupon Rate
Maturity Date
CUSIP Par Value Settlement Date Original Cost Accrued Interest Market Value
© PFM 42
Custody Statement vs. Investment Manager Statement
© PFM 43
Different Financial Companies Use Different Pricing Sources
Pricing sources can vary from third party vendors such as Bloomberg, ICE Data Services and Thomson Reuters to a custodian’s internal pricing group.
© PFM 44
Important Disclosures
This material is based on information obtained from sources generally believed to be reliable and available to the public, however PFM Asset Management LLC cannot guarantee its accuracy, completeness or suitability. This material is for general information purposes only and is not intended to provide specific advice or a specific recommendation. All statements as to what will or may happen under certain circumstances are based on assumptions, some but not all of which are noted in the presentation. Assumptions may or may not be proven correct as actual events occur, and results may depend on events outside of your or our control. Changes in assumptions may have a material effect on results. Past performance does not necessarily reflect and is not a guaranty of future results. The information contained in this presentation is not an offer to purchase or sell any securities.
The views expressed within this material constitute the perspective and judgment of PFMAM at the time of distribution and are subject to change. Any forecast, projection, or prediction of the market, the economy, economic trends, and equity or fixed-income markets are based upon current opinion as of the date if issue, and are also subject to change. Opinions and data presented are not necessarily indicative of future events or expected performance. Information contained herein is based on data obtained from recognized statistical services, issuer reports or communications, or other sources, believed to be reliable. No representation is made as to its accuracy or completeness.
© PFM 45
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