Estimating Future Investment Earnings Today

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1 CHANDLER A SSET MA N AGEMEN T Estimating Future Investment Earnings Today September 18, 2012 Martin Cassell, CFA CEO & Chief Investment Officer 6225 Lusk Boulevard San Diego, CA Phone Fax

2 Questions to Address How can future investment earnings be estimated? Why does the earnings rate matter? Does history matter? How can rolling time periods help manage results? Is there a disclosure statement? Of course - please see the statement at the end of this presentation for important disclosure information. 2

3 Forecasting Earnings Key components affecting an earnings forecast Forecast period Investment portfolio balance Purchase yield of investment portfolio Investments maturing Reinvestment rate of cashflows 3

4 Possible Forecasting Inputs Purchase Yield to Maturity Market Yield to Maturity Historical Returns Market Benchmark Return Inflation Rate Implied Forward Rates 4

5 Process for Current Year Forecast Portfolio beginning balance Expected contributions and withdrawals Portfolio current earnings rate or purchase yield Reinvestments over forecast period Reinvestment rate Expected period forecasted earnings 5

6 Investment Balance Investment Balance Establish the beginning investment balance Portfolio value Accrued Interest Include any potential contributions/withdrawals Interest Earnings Projection 06/30/12 to 06/30/13 Beginning Balance $ 10,000,000 Contribution / Withdrawal $ - Ending Balance $ 10,000,000 6

7 Current Portfolio Income Income from existing securities Sum the securities maturing after the forecast period. Calculate the weighted average purchase yield of the current portfolio. Purchase Yield = Yield to Maturity at time of purchase Multiply the securities remaining in the portfolio by the weighted average purchase yield to calculate the income forecast. Maturing After 06/30/13 $ 8,200,000 Purchased Yield 1.54% Income $ 126,280 7

8 Current Portfolio Income Income from existing securities Sum the securities maturing during the forecast period. Multiply the securities maturing in the portfolio by purchase yield to calculate the annual income. Multiple the above value by the holding period for the year. Maturing Before 06/30/13 $ 1,800,000 Purchased Yield 1.54% Average Maturity (days) of investments maturing by 6/30/ Income from maturities $ 15,873 8

9 Forward Rates US Treasury Forward Rates Tenors Current 1YR 2YR 3YR 5YR 10YR 3Mo Mo Yr Yr Yr Yr Yr Yr Source: Bloomberg, LLP 9

10 Reinvestment Income Income from reinvestment of maturities Calculate the average number of days until reinvestment of the maturity of securities. Forecast a reinvestment rate for security maturities Government forward rates Corporate forward rates Blended forward rates Multiply the dollar amount of the maturing securities by the reinvestment rate. Multiply the above value by the fractional time period left on the horizon period Maturing Before 06/30/13 $ 1,800,000 Reinvestment Rate 0.50% Average earning period of reinvestments 156 Income from reinvestments $ 3,808 10

11 Total Portfolio Income Total Portfolio Income Add existing portfolio income to the reinvestment income to calculate the total portfolio income forecast. Maturing After 06/30/13 $ 8,200,000 Purchased Yield 1.54% Income $ 126,280 Maturing Before 06/30/13 $ 1,800,000 Purchased Yield 1.54% Average Maturity (days) of investments maturing by 6/30/ Income from maturities $ 15,873 Maturing Before 06/30/13 $ 1,800,000 Reinvestment Rate 0.50% Average earning period of reinvestments 156 Income from reinvestments $ 3,808 Total Income Projection $ 145,961 11

12 Interest Earnings Forecast Estimated Portfolio Earnings Rate Divide the total income for the year by the average balance Weighted Average Balance $ 10,000,000 Total Income $ 145,961 Wt Avg Earnings Rate 1.46% 12

13 Interest Earnings Forecast Beginning Balance $ 10,000,000 Contribution / Withdrawal $ - Ending Balance $ 10,000,000 Maturing After 06/30/13 $ 8,200,000 Purchased Yield 1.54% Income $ 126,280 Maturing Before 06/30/13 $ 1,800,000 Average Maturity (days) of investments maturing by 6/30/ Income from maturities 15,873 Average earning period of reinvestments 156 Reinvestment Rate 0.50% Income from reinvestments $ 3,808 Total Income Projection $ 145,961 Weighted Average Balance $ 10,000,000 Total Income $ 145,961 Wt Avg Earnings Rate 1.46% 13

14 The Earnings Rate Matters The earnings rate helps to estimate the growth of the portfolio The growth of the portfolio helps to pay for future liabilities Underestimating the earnings rate can create a funding shortfall What is the appropriate time period for earnings? Does history have a roll in forecasting future returns? 14

15 Rolling Return Estimates Historical yield for the Constant Maturity 5 Year US Treasury 8.00% 5 Yr US Treas Yield 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% Thru August 0.00% 5 Yr Treas CM Yld to est future return 15

16 Rolling Return Estimates Historical rolling 5 year Total Rate of Return 8.00% Actual 5 Yr TRR 7.00% 6.00% 5.00% 4.00% Thru August 3.00% 2.00% 1.00% 0.00% Actual 5 yr TRR 16

17 Rolling Return Estimates Using the 5 year US Treasury constant maturity yield does not provide a very accurate estimate of the 5 year rolling Total Rate of Return. 8.00% Actual 5 Yr TRR, 5 Yr US Treas Yield 7.00% 6.00% 5.00% 4.00% Thru August 3.00% 2.00% 1.00% Thru August 0.00% 5 Yr Treas CM Yld to est future return Actual 5 yr TRR 17

18 Developing A Rolling Return Estimate Incorporating historical return information and future earnings estimate Seeking an effective estimate of future returns Portfolio 1 Yr Total Rate of Return 2.87% 3 Yr Total Rate of Return 3.29% 5 Yr Total Rate of Return 5.06% Purchase Yield 2.09% Market Yield 0.83% Future Earnings Estimate 1.46% 18

19 Required Future Return For a given discount rate, what do we need to earn in the future? What rate of return do we need to earn for a given discount rate? Discount Rate 3.50% 2.50% 1.50% 3 Year Historical Total Rate of Return 3.29% 3.29% 3.29% Required 2 year return to meet discount rate 3.82% 1.33% -1.13% 19

20 Finding an Reasonable Discount Rate The 3 year historical return and the 2 year future return estimate have an expected return of about 2.50% Historical 3 Year TRR 3.29% Future Return Estimate 1.46% 5 year Rolling Return Estimate 2.55% Reasonable Discount Rate 2.50% 20

21 Rolling Return Estimates Estimate of the future 5 year rolling Total Rate of Return using a combination of Purchased Yield, Market Yield, and historical 3 year Total Rate of Return. 8.00% Estimated 5 year TRR 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% 2 Yr Est Portfolio avg Purch/Mkt Yld & 3 yr TRR 21

22 Rolling Return Estimates Using the combination of historical returns and estimated future earnings provides a very accurate estimate of the 5 year rolling Total Rate of Return. 8.00% Estimated 5 year TRR, Actual 5 Yr TRR 7.00% 6.00% 5.00% 4.00% Thru August 3.00% 2.00% 1.00% 0.00% 2 Yr Est Portfolio avg Purch/Mkt Yld & 3 yr TRR Actual 5 yr TRR 22

23 Rolling Return Estimates The combination of historical returns and estimated future earnings may help provide a relatively stable and effective tool to help a pool manage funding estimates for future liabilities. 8.00% Estimated 5 year TRR, Actual 5 Yr TRR, 5 Yr US Treas Yield 7.00% 6.00% 5.00% 4.00% Thru August 3.00% 2.00% 1.00% Thru August 0.00% 2 Yr Est Portfolio avg Purch/Mkt Yld & 3 yr TRR 5 Yr Treas CM Yld to est future return Actual 5 yr TRR 23

24 Conclusions Forecasting is an estimate, not an absolute Known facts can help improve your forecast - better than a SWAG It is always prudent to be conservative in your forecast Past performance does not guarantee future results 24

25 The Future is Clear 25

26 Biographies Martin Cassell, CFA CEO, Chief Investment Officer Martin Cassell is the chief executive and investment officer at Chandler Asset Management and is a principal of the firm. Mr. Cassell is responsible for defining, planning, and directing company programs. He heads implementation of the firm s investment strategies and portfolio risk management. He designed the proprietary quantitative models that drive our investment process, establishing duration, structure, and asset allocation throughout client portfolios. Mr. Cassell joined Chandler Asset Management in 1991 from the City of San Diego where he managed a $1 billion fixed income portfolio. He began his investment career in 1987 managing portfolios at World Savings and Loan. Mr. Cassell received his B.S. in finance from California State University, Hayward. He is a member of the CFA Society of San Diego and holds the designation of Chartered Financial Analyst. He is also a member of the California Association of Joint Power Authorities (CAJPA) finance committee. 26

27 Disclosures DISCLOSURES Past performance is not indicative of future results, which may vary. There is no guarantee that any opinion, forecast, or objective will be achieved. The information herein is provided for informational purposes only and should not be construed as a recommendation of any security, strategy or investment product, nor as an offer or solicitation for the purchase or sale of any financial instrument. The financial model described in this presentation has been prepared using a hypothetical portfolio and assumptions provided by the author for the purposes of demonstrating the model. References to specific securities, issuers and market sectors are for solely illustrative purposes of the model presented herein. This presentation contains the current opinions of the author, which are subject to change without notice. Any statements concerning financial market trends are based on current market conditions, which will fluctuate. Forecasts and assumptions are inherently limited and should not be relied upon as an indicator of future results. Unless otherwise noted, Chandler is the source of the tables, graphs, performance data and characteristics contained in this presentation. 27

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