Washington Finance Officers Association

Transcription

1 Washington Finance Officers Association Comprehensive Review of the Public Sector Investment Program September 12, 2017 Scott Prickett, CTP Executive Vice President, Portfolio Strategist Julie Hughes Senior Vice President, Portfolio Strategist nd Avenue, Suite 800, Seattle, Washington 98104

2 Table of Contents Section 1 Section 2 Section 3 Section 4 Determining Liquidity and Core Fund Investment Components Economic and Market Update Portfolio Strategies for Managing Risk and Return Benchmark Development and Implementation Chandler Asset Management 1

3 Section 1 Determining Liquidity and Core Fund Investment Components

4 Why a Cash Flow Analysis? GFOA Best Practice The analysis is intended to measure and assess the government s ability to meet its needs, to negate the need for any short-term borrowing or liquidation of long-term investments before maturity, and to identify any idle funds, and the duration of that idle period, to determine whether those funds could be invested over that time frame. Cash flow analysis is therefore an essential tool for informed management decision making. Source: GFOA Chandler Asset Management 3

5 What is a Cash Flow Forecast Projection of anticipated cash receipts Projection of anticipated cash disbursements To create an estimate of investable cash balances Liquid funds Reserve funds Cash is the operative word in cash flow forecasting. It is not accruals or budgeted funds Only cash is spendable or investable! Chandler Asset Management 4

6 Identify Liquid & Reserve Balances Total balances are trending higher But balances fluctuate throughout the year The Liquid Balances" are established to meet cash needs The Core/Reserve Balances" are generally stable and available for longer-term more diversified investing Entity s Balances 5 Year Period Liquid Balances Core/Reserve Balances Chandler Asset Management 5

7 Objectives of Cash Flow Forecasting Ensure sufficient liquidity for 6-12 month disbursements Improve investment earnings by Matching sources and uses of funds Investing reserve/core funds longer-term and more diversified Managing investment risks o Liquidity risk o Market risk Identify short-term cash deficits Warn of impending budget problems Chandler Asset Management 6

8 Annual Cash Flow Forecasts Estimates monthly cash position Determines cash available for investments of more than 30 days Provides a useful monthly overview for investment decision-making Prepared for this fiscal year and next one to three fiscal years Chandler Asset Management 7

9 Creating Annual Cash Flow Forecast Beginning balance of cash and investments Monthly revenue projections Monthly expenditure projections Projected net change Projected cumulative balance of cash and investments Schedule of current investments and coupon payments Chandler Asset Management 8

10 Identify Revenues and Expenditures Major revenues Major expenditures Property tax Payroll and benefits Sales and use tax Operating expenses User fees Debt service Shared revenues Capital projects Non-recurring Draw-down schedule Bond proceeds Non-recurring Other Other Chandler Asset Management 9

11 Sources of Information Historical data from general ledger Historical data from bank and pool statements Current year budget Capital project spending projections Schedule of investment maturities and coupon payments Chandler Asset Management 10

12 Annual Cash Flow - Example Beg. Balance Jan-16 Feb-16 Mar-16 Apr-16 May-16 Liquid Fund Balance 95,542, ,422, ,301, ,180, ,060, ,939, Inflow Sales Tax Collections 3,516,116 3,516,116 3,516,116 3,516,116 3,516,116 Property Tax Collections 10,507,259 10,507,259 10,507,259 10,507,259 10,507,259 Intergovernmental 10,264,623 10,264,623 10,264,623 10,264,623 10,264,623 Other Revenues 7,919,282 7,919,282 7,919,282 7,919,282 7,919,282 Outflows Personnel (12,778,319) (12,778,319) (12,778,319) (12,778,319) (12,778,319) Operating & Maintenance (1,199,030) (1,199,030) (1,199,030) (1,199,030) (1,199,030) Charges for Services (1,597,717) (1,597,717) (1,597,717) (1,597,717) (1,597,717) Debt Service (1,093,706) (1,093,706) (1,093,706) (1,093,706) (1,093,706) Other Expenses (6,659,210) (6,659,210) (6,659,210) (6,659,210) (6,659,210) Actual/Projected Net Change (1,120,702) (1,120,702) (1,120,702) (1,120,702) (1,120,702) Projected Liquid Balance 94,422,259 93,301,557 92,180,855 91,060,153 89,939,451 Projected Invested Balance 141,565, ,565, ,565, ,565, ,565,000 Total Projected Balance 235,987, ,866, ,745, ,625, ,504,451 Actual Liquid Balance 85,562, ,231, ,216, ,625, ,181,434 Actual Invested Balance 141,565, ,645, ,645, ,645, ,645,000 Total Actual Balance 227,127, ,876, ,861, ,270, ,826,434 Difference (8,859,794) 115,010,016 37,115, ,645,277 68,321,983 This sample illustration is being provided to demonstrate the tools on how we analyze cash balances. Chandler Asset Management 11

13 Funds Balance Cash Flow Consolidated Cash Flow Fund Balance Month Beg Balance Cash Inflows Cash Outflows Net Change January-16 95,542, ,572,384 (253,257,765) (9,685,381) February-16 85,857, ,962,217 (26,607,427) 117,354,790 March ,212,370 41,584,603 (119,098,784) (77,514,181) April ,698,189 94,526,488 (17,116,990) 77,409,498 May ,107,687 33,277,738 (84,727,349) (51,449,611) June ,658, ,278,132 (76,404,216) 25,873,916 July ,531,992 2,747,874 (36,416,262) (33,668,388) August ,863,604 32,888,804 (39,493,932) (6,605,128) September ,258, ,833,487 (251,697,780) 135,707 October ,394, ,834,825 (242,187,729) 647,096 November ,041, ,485,117 (239,719,807) (7,234,690) For Period Low Balance $85,857,580 High Balance $259,994,231 Average Balance Prior 12 Months $155,641,677 Prior 36 Months $159,324,198 This sample illustration is being provided to demonstrate the tools on how we analyze cash balances. Chandler Asset Management 12

14 Graphing Balances Over Time This sample illustration is being provided to demonstrate the tools on how we analyze cash balances. Chandler Asset Management 13

15 Millions Putting It Together and Forecasting Future Levels Assume future growth rates Factor in seasonality and known future budget events Forecast future liquid and longer-term balances Total Estimated Balances: $751 Million on June 2020 $800 Sample Invested Assets FY 2015 FY 2020 $700 $600 Historical Balances Forecast Balances $500 $400 $300 $200 $100 $0 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17 Jul-17 Jan-18 Jul-18 Jan-19 Jul-19 Jan-20 This sample illustration is being provided to demonstrate the tools on how we analyze cash balances. Chandler Asset Management 14

16 Challenges to Developing Forecasts Systems Limitations of computer systems for historical data or data management Physical structure Locations of people Political Elected officials agenda Inter-departmental communications Departments not understanding importance of information Chandler Asset Management 15

17 Review and Maintain Cash Flow Forecast Compare actual versus forecast Identify reasons for variances Adjust assumptions if warranted Follow up with department heads on capital project slippage Update database for accurate future projection Retain documentation for future reference Chandler Asset Management 16

18 Segmenting the Portfolio for Optimal Structure Total Portfolio Liquidity Portfolio Core/Reserve Portfolio Matching maturities to known expenditures Invests in short-term securities Average maturity short Very low volatility LGIPs and money market instruments Higher duration to enhance the potential to increase earnings Longer-term securities Normally not used for liquidity, but invested in highly marketable securities, in case Greater volatility Chandler Asset Management 17

19 Revised Code of Washington (RCW) Eligible Investments for Liquidity Portfolio (Typically 1 year and under) Local Government Investment Pools Treasury Bills Agency Discount Notes Commercial Paper CDs/Bank Deposits Chandler Asset Management 18

20 Revised Code of Washington (RCW) Eligible Investments for Core Portfolio (Typically 5 years and under) U.S. Treasury Obligations Federal Agency and Government Sponsored Enterprise Securities Municipal Bonds Corporate Notes Supranational Securities Chandler Asset Management 19

21 Section 2 Economic and Market Update

22 Major Indicators Employment report, (1st Friday of month) CPI: Consumer Price Index, (Mid-month) PCE: Personal Consumption Expenditures, (End of month) Retail Sales, (Mid-month) Institute for Supply Management (ISM) Survey, (1st day of new month) Quarterly GDP Chandler Asset Management 21

23 MOM Change In (000's) Rate (%) Employment Nonfarm Payroll (000's) 13.0% 12.0% 11.0% Unemployment Rate Underemployment Rate (U6) Unemployment Rate (U3) % % 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% Source: US Department of Labor Source: US Department of Labor Please see disclosures at the end of this presentation. Chandler Asset Management 22

24 YOY( %) Change YOY( %) Change Inflation 3.5% 3.0% 2.5% Consumer Price Index (CPI) CPI YOY % Change Core CPI YOY % Change 3.5% 3.0% 2.5% Personal Consumption Expenditures (PCE) PCE Price Deflator YOY % Change PCE Core Deflator YOY % Change 2.0% 2.0% 1.5% 1.5% 1.0% 1.0% 0.5% 0.5% 0.0% 0.0% -0.5% -0.5% Source: US Department of Labor Source: US Department of Labor Please see disclosures at the end of this presentation. Chandler Asset Management 23

25 YOY (%) Change Index Level Consumer 6.0% Retail Sales YOY % Change 130 Consumer Confidence 5.0% 4.0% % 2.0% 1.0% 0.0% Source: US Department of Commerce Source: Federal Reserve Please see disclosures at the end of this presentation. Chandler Asset Management 24

26 MOM ( %) Change 3 Month Average Economic Activity 0.7% 0.6% Leading Economic Indicators (LEI) 0.60 Chicago Fed National Activity Index (CFNAI) 0.5% 0.4% 0.3% % 0.1% % -0.1% % -0.3% % Source: The Conference Board Source: Federal Reserve Bank of Chicago Please see disclosures at the end of this presentation. Chandler Asset Management 25

27 MOM Change (In Thousands of Units) YOY( %) Change Housing Multi Family Housing Starts Single Family Housing Starts Housing Starts 6.5% 6.0% 5.5% 5.0% 4.5% 4.0% 3.5% S&P/CaseShiller 20 City Composite Home Price Index Source: US Census Bureau Source: S&P Please see disclosures at the end of this presentation. Chandler Asset Management 26

28 Rate (%) Manufacturing Institute of Supply Management Purchasing Manager Index Expanding 80.0% 79.0% Capacity Utilization % % 76.0% Contracting 75.0% 74.0% Source: Institute for Supply Management Source: Federal Reserve Please see disclosures at the end of this presentation. Chandler Asset Management 27

29 GDP Statistical Data The most common indicator of economic growth measures the change in value of all final goods and services produced in the U.S. Two consecutive quarters of negative GDP indicates recession GDP averaged +3.1% from 1947 to 2016, although the -5.1% contraction rate during the Great Recession was the worst in seven decades GDP has yet to reach +2.5% in any single year during the 7-year recovery cycle, despite massive stimulus From , real GDP increased by at an annual rate of +2.0% Lagging indicator Source: U.S. Department of Commerce, Bureau of Economic Analysis Please see disclosures at the end of this presentation. Chandler Asset Management 28

30 Gross Domestic Product (GDP) Components of GDP 9/16 12/16 3/17 6/17 Gross Domestic Product (GDP) 6.0% Personal Consumption Expenditures 1.9% 2.0% 1.3% 1.9% 5.0% Gross Private Domestic Investment 0.4% 1.3% -0.2% 0.3% 4.0% 3.0% Net Exports and Imports 0.4% -1.6% 0.2% 0.2% 2.0% 1.0% Federal Government Expenditures 0.1% 0.0% -0.2% 0.2% 0.0% State and Local (Consumption and Gross Investment) 0.0% 0.1% 0.1% 0.0% -1.0% -2.0% GDP QOQ % Change GDP YOY % Change Total 2.8% 1.8% 1.2% 2.6% Source: US Department of Commerce Source: US Department of Commerce Please see disclosures at the end of this presentation. Chandler Asset Management 29

31 Potential Reduction in the Fed s Balance Sheet 4,500,000 Securites Held on the Fed's Balance Sheet 4,000,000 3,500,000 Federal Agency Debt Mortgage-Backed Securities US Treasuries $ millions 3,000,000 2,500,000 2,000,000 1,500,000 1,000, ,000 0 Source: Bloomberg Chandler Asset Management 30

32 Historical Perspective 9.00% 2 Year Treasury Note 8.00% 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% Source: Bloomberg Chandler Asset Management 31

33 Historical Perspective 9.00% US Federal Funds Rate 8.00% 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% Source: Bloomberg Chandler Asset Management 32

34 Incorporating Economic Data into Investment Strategy Watch for trends in the data, and how the market reacts to data releases Weigh current yields against future expectations to assist in determining optimal portfolio structure Irrespective of your interest rate outlook, stay disciplined and avoid significant inconsistencies with your portfolio s benchmark Risk is something to be managed, not avoided Diversify portfolio by sector, issuer, and maturity Please see disclosures at the end of this presentation. Chandler Asset Management 33

35 Section 3 Portfolio Strategies for Managing Risk and Return

36 Portfolio Management Is Risk Management The greater an investor s exposure to properly diversified risk, the higher the expected return over time The greater an investor s exposure to risk, the higher will be the volatility of return from period to period The objective of safety requires establishing risk constraints Chandler Asset Management 35

37 Risks Credit risk Will the investment be repaid by the issuer? Will the investment be downgraded? Are there potential administrative or headline risks? Liquidity risk Is there an active secondary market for the investment? Could the secondary market be affected by economic or market developments? Market risk - exposure to interest rate fluctuations Securities prices change as interest rates change - in the opposite direction Chandler Asset Management 36

38 How Does This Work? You purchase on 4/14/2017: Par Credit Quality Coupon Maturity Income Yield Price $1 million AAA 5% 4/14/2018 $50,000 5% Please see disclosures at the end of this presentation. Chandler Asset Management 37

39 Impact of Rising Rates Rates rise on 4/15/2017, and someone else purchases a newly-issued security similar to yours, but with a higher yield: Your Bond Credit Quality Coupon Maturity Income Yield Price $1 million AAA 5% 4/14/2018 $50,000 5% Their Bond Credit Quality Coupon Maturity Income Yield Price $1 million AAA 6% 4/14/2018 $60,000 6% Please see disclosures at the end of this presentation. Chandler Asset Management 38

40 Impact of Rising Rates Here is some math to contemplate: Par Income Yield Their Bond $1 million $60,000 6% Your Bond $1 million - $50,000 5% = $10,000 Your security would have to be sold at approximately $990K to make up for the rise in interest rates $1,000,000 -$10,000 $990,000 Please see disclosures at the end of this presentation. Chandler Asset Management 39

41 Snapshot of the Impact of Rising Rate Levels Maturities and new investments will be invested at higher yield levels increasing the earnings of the portfolio Budgets will benefit with increased cash flow Portfolio returns will be negatively impacted by rising rates Interest Rate Change 3 Month Horizon 12 Month Horizon US Treasury US Treasury 1 Year 2 Year 3 Year 1 Year 2 Year 3 Year - 10 BPs No Change BPs 0.51 (0.38) (1.22) BPs (0.23) (2.08) (3.85) BPs (1.69) (5.42) (8.99) (0.50) Source: Bloomberg Chandler Asset Management 40

42 Income is an Important and Dependable Source of Return - Acts as a cushion during periods of price decline 12.00% 11.00% 10.00% 9.00% 8.00% Yield (Income Return) vs. Total Return by Year 0-3 Yr BAML Treasury Income Return 0-5 Yr BAML Treasury Income Return 0-3 Yr BAML Treasury Total Return 0-5 Yr BAML Treasury Total Return 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% % Source: Bloomberg. Past performance is not indicative of future results. Index returns assume reinvestment of all distributions and do not reflect fees or expenses. It is not possible to invest directly in an index. Please see attached Bank of America Merrill Lynch index disclosures for details. Chandler Asset Management 41

43 Historic Rising Interest Rate Cycles January 1, 1994 February 28, 1995 Time Period: 14 Months Cumulative Performance BAML 0-3 Year US Treasury Index BAML 0-5 Year US Treasury Index Source: Bank of America Merrill Lynch Indexes; Bloomberg. Past performance is not indicative of future results. Index returns assume reinvestment of all distributions and do not reflect fees or expenses. It is not possible to invest directly in an index. Please see attached Bank of America Merrill Lynch index disclosures for details. Chandler Asset Management 42

44 Historic Rising Interest Rate Cycles June 1, May 31, 2000 Time Period: 12 Months Cumulative Performance BAML 0-3 Year US Treasury Index BAML 0-5 Year US Treasury Index Source: Bank of America Merrill Lynch Indexes; Bloomberg. Past performance is not indicative of future results. Index returns assume reinvestment of all distributions and do not reflect fees or expenses. It is not possible to invest directly in an index. Please see attached Bank of America Merrill Lynch index disclosures for details. Chandler Asset Management 43

45 Historic Rising Interest Rate Cycles June 1, June 30, 2006 Time Period: 25 Months Cumulative Performance BAML 0-3 Year US Treasury Index BAML 0-5 Year US Treasury Index Source: Bank of America Merrill Lynch Indexes; Bloomberg. Past performance is not indicative of future results. Index returns assume reinvestment of all distributions and do not reflect fees or expenses. It is not possible to invest directly in an index. Please see attached Bank of America Merrill Lynch index disclosures for details. Chandler Asset Management 44

46 How To Begin What are the goals of the investment program? What are investment constraints? What are risk tolerances? How can investments be structured to meet those goals? What experience does staff have? Chandler Asset Management 45

47 Considerations Sources of return Coupon income Reinvestment income Capital gains and losses Factors that affect gains and losses Changes in interest rates Changes in the shape of the yield curve Changes in spreads between sectors Changes in the spread for a particular bond Changes in OAS for bonds with options Passive & Active strategies Chandler Asset Management 46

48 Passive Management Passive Management Requires Low to no market analysis Minimum resources Strategies Liquidity pool Cover next disbursement Asset/liability matching Maturity ladder Objective Buy and Hold Routine discipline to meet cash flow needs Chandler Asset Management 47

49 Active Portfolio Management Strives to achieve a return equal to or in excess of market return by building and maintaining a portfolio structure with optimal exposure to risk through: Duration management Yield curve placement Sector weighting decisions Individual security selection Portfolio rebalancing and realignment Active management requires resources and expertise to perform market analysis such as: Yield Curve Analysis Credit Analysis Spread Analysis Chandler Asset Management 48

50 Benefits of a Strategy Decision Making Strategy Tools Improved Process Improved Communication Monitoring & Accountability Duration is the primary contributor for portfolio returns Asset (Sector) Allocation Yield Curve Positioning Efficient Pre-determined strategy Accountable Same Vocabulary Board, Committee and Staff Consistent over interest rate cycles Understand outcome of decisions Tracking of decisions Value added can be measured Chandler Asset Management 49

51 Portfolio Strategies for Managing Risk and Return Portfolio Duration Constraining portfolio duration relative to the benchmark Sector Allocation Strategic allocations to key sectors, with value-based rotation Term Structure Positioning securities along the yield curve to capture value across maturities Security Selection Selecting bonds that we believe are undervalued and offer the greatest potential for risk-adjusted return Chandler Asset Management 50

52 Facts About Duration Duration is a direct measure of exposure to market risk in a fixed maturity bond Duration is a better measure of the sensitivity to changes in interest rates than term-to-maturity Duration is a close approximation of the percent change in the price of a bond for a given change in yield Securities with equal maturity dates may not have equal interest rate risk - duration quantifies the difference Chandler Asset Management 51

53 Market risk is best measured as Modified Duration for bullet securities Invest in $1MM Tsy. 0.75% 2/15/19 $1,003,750 $3.750 $3.750 $3.750 $3.750 $3.750 Years Duration 2.95 yrs. Please see disclosures at the end of this presentation. Chandler Asset Management 52

54 Impact of Duration Portfolio #1: $50 million and 2.0 duration If rates increase 2.25%, then ($2,250,000) Loss $50 million x 2 x 2.25% x -1 = $50 million x -4.5% = ($2,250,000) If rates decrease 2.25%, then $2,250,000 Gain $50 million x 2 x 2.25% x 1 = $50 million x 4.5% = 2,250,000 Portfolio 2 = $50 million and 1.0 duration If rates increase 2.25%, then ($1,125,000) Loss $50 million x 1 x 2.25% x -1 = $50 million x -2.25% = ($1,125,000) If rates decrease 2.25%, then $1,125,000 Gain $50 million x 1 x 2.25% x 1 = $50 million x 2.25% = $1,125,000 Please see disclosures at the end of this presentation. Chandler Asset Management 53

55 Duration Management Targeting duration of benchmark within a range (e.g. + 10% of benchmark) Bank of America Merrill Lynch 0-3 Year US Treasury Index Index duration approximately 1.40 years Bank of America Merrill Lynch 0-5 Year US Treasury Index Index duration approximately 2.20 years Source: Bank of America Merrill Lynch Indexes. Please see attached Bank of America Merrill Lynch index disclosures for details. Chandler Asset Management 54

56 Update Benchmarking Study BofA ML 0-3 and 0-5 Year US Treasury BofA ML 0-3 Year US Treasury BofA ML 0-5 Year US Treasury 0-6 months 15.30% 10.16% 6-12 months 17.37% 11.53% 1-3 years 67.33% 44.69% 3-5 years 33.63% 5-10 years Treasury % % Agency Corporate Modified Duration 12/31/ Year Annualized Total Return 1.78% 2.37% 10 Year Standard Deviation 2.28% 2.76% Sharpe Ratio Qualitative Risk Objective 12/31/ /31/ /30/ /31/2016 Negative Quarterly Return Occurrences Negative Return For Year Occurrences 0 2 Worst Year Total Return 0.00% -0.12% Source: Bank of America Merrill Lynch Indices. Please see Benchmark disclosures; Past performance is not indicative of future results. Index returns assume reinvestment of all distributions and do not reflect fees or expenses. It is not possible to invest directly in an index. Chandler Asset Management 55

57 Yield Curve and Term Structure Strategies Bullet: Bond maturities in a portfolio are concentrated at one point on the curve. Strategy utilized when expectations are for a steepening curve Barbell: Bond maturities are concentrated at extreme maturities on the curve. Typically on the short and long end of a portfolio strategy range. Strategy utilized when expectations are for the curve to flatten Ladder: Equal amounts at each maturity. Typically equal amounts maturing each month. Neutral relative to yield curve expectations Chandler Asset Management 56

58 Portfolio Structure - Bullet Portfolio Structure - Bullet $4,000,000 $3,500,000 $3,000,000 $2,500,000 $2,000,000 $1,500,000 $1,000,000 $500,000 $0 This sample illustration is being provided to demonstrate the Bullet portfolio structure. Chandler Asset Management 57

59 Portfolio Structure - Barbell Portfolio Structure - Barbell $4,000,000 $3,500,000 $3,000,000 $2,500,000 $2,000,000 $1,500,000 $1,000,000 $500,000 $0 This sample illustration is being provided to demonstrate the Barbell portfolio structure. Chandler Asset Management 58

60 Portfolio Structure - Laddered Portfolio Structue - Laddered $4,000,000 $3,500,000 $3,000,000 $2,500,000 $2,000,000 $1,500,000 $1,000,000 $500,000 $0 This sample illustration is being provided to demonstrate the Ladder portfolio structure Chandler Asset Management 59

61 Duration Distribution Portfolio Compared to the Benchmark as of April 30, % 30.00% 25.00% 20.00% 15.00% 10.00% 5.00% 0.00% Sample Client BAML 1-5 Yr US Treasury/Agency Index Portfolio 3.4% 3.0% 13.8% 18.4% 20.4% 21.2% 19.8% 0.0% Benchmark* 0.1% 0.1% 1.9% 31.9% 28.5% 22.0% 15.5% 0.0% *BAML 1-5 Yr US Treasury/Agency Index Based on a representative portfolio as of 4/30/17. This sample illustration is being provided to demonstrate the tools on how we segment duration distribution versus its benchmark. Please see disclosures for BAML 1-5 Yr US Treasury/Agency Index. Past performance is not indicative of future results. Chandler Asset Management 60

62 Yield Rolling Down the Curve U.S. Treasury Yield Curve 2.00% One year later, it is a 2-YR UST, but new UST in the 2-YR range only yield 1.20% 1.50% 1.20% 1.31% 1.00% Purchase a $3MM, 3- Year UST on 12/31/2015 at Par 0.50% 12/31/ /30/ % Years Source: Bloomberg. Chandler Asset Management 61

63 Roll Down - Doing the Math Purchase UST on 12/31/2015 One Year Later Total Return After One Year Par Value: 3,000,000 UST Now a 2-YR Security Earned Income: $39,300 Maturity: 12/31/18 (3 Years) Purchase Yield: 1.31% Price Appreciation: 9,690 Price: $ Market Yield: 1.20% Total $ Return: $48,990 Yield to Maturity: 1.31% Market Price: $ Total % Return: 1.63% Chandler Asset Management 62

64 Break-Even Analysis (GAP Analysis) Yields expected to rise in coming months. What should you buy? Which would you buy? 1-year investment at 1.20% 3-year investment at 1.46% Chandler Asset Management 63

65 Break-Even Analysis What rate do you need to earn for the last two years to break even? 1.46% for 3 years 0 1 year 2 years 3 years 1.20% for 1 year?? for 2 years Chandler Asset Management 64

66 Break-Even Analysis 1.46% for 3 years 0 1 year 2 years 3 years 1.20% for 1 year?? for 2 years 1.46 * 3 years = (1.20% * 1 year) + (x * 2 years) 4.38 = x 3.18 = 2x X = 1.59 Chandler Asset Management 65

67 Break-Even Analysis Will rates rise enough to get a 2 year investment at 1.59% one year from now? 1.46% for 3 years 0 1 year 2 years 3 years 1.20% for 1 year 1.59% for 2 years Chandler Asset Management 66

68 Your Turn Which would you buy? 1-year U.S. Treasury at 1.20% 2-year U.S. Treasury at 1.34% Chandler Asset Management 67

69 Break-Even Analysis 1.34% for 2 years 0 1 year 2 years 1.20% for 1 year?? for 1 Year Chandler Asset Management 68

70 1 Year vs 2 Year GAP Analysis Source: Bloomberg. Chandler Asset Management 69

71 Eligible Investments for Washington Public Funds Local Government Investment Pools U.S. Treasury Obligations Federal Agency and Government Sponsored Enterprise Securities Commercial Paper CDs/Bank Deposits Municipal Bonds Corporate Notes Supranational Securities Chandler Asset Management 70

72 Sector Allocation Sample Portfolio Allocation Municipal Bonds 5.4% Agency 65.9% US Treasury 28.7% Sector Allocation is based on a representative portfolio as of 6/30/17. Chandler Asset Management 71

73 12/1/1998 6/1/ /1/1999 6/1/ /1/2000 6/1/ /1/2001 6/1/ /1/2002 6/1/ /1/2003 6/1/ /1/2004 6/1/ /1/2005 6/1/ /1/2006 6/1/ /1/2007 6/1/ /1/2008 6/1/ /1/2009 6/1/ /1/2010 6/1/ /1/2011 6/1/ /1/2012 6/1/ /1/2013 6/1/ /1/2014 6/1/ /1/2015 6/1/ /1/2016 6/1/2017 Historical Treasury vs Agency Spreads Year US Treasury Index vs 1-3 Year US Bullet Agency Index Year US Treasury vs 1-3 Year US Bullet Agency Source: Bloomberg. Chandler Asset Management 72

74 Current Treasury Agency Curves 2.50% Difference in Yield at Historic Lows 2.00% 1.50% 1.00% US Agency US Treasury 0.50% 0.00% Source: Bloomberg. Chandler Asset Management 73

75 Historical Credit Spreads to U.S. Treasuries 250 BAML 1-5 AAA-AA Foreign Govt and Supranational BAML 1-5 AAA-A U.S. Corporate BAML 1-5 Bullet Agency BAML 1-5 AAA-AA Municipal /31/ /31/ /31/ /31/ /31/ /31/ /31/ /31/2016 Source: Bloomberg. Past performance is not indicative of future results. Index returns assume reinvestment of all distributions and do not reflect fees or expenses. It is not possible to invest directly in an index. Please see attached Bank of America Merrill Lynch index disclosures for details. Chandler Asset Management 74

76 Revised Code of Washington (RCW) Eligible Investments for Liquidity Portfolio (Typically 1 year and under) Local Government Investment Pools Treasury Bills Agency Discount Notes Commercial Paper CDs/Bank Deposits Chandler Asset Management 75

77 Local Government Investment Pool Pooling Public Funds State-operated pool County-operated pool Benefits Professional Management Daily Liquidity Normally constant NAV (Net Asset Value) of $1.00 Economies of scale Diversification Services Enrollment Prospectus Resolution Procedures for deposits and withdrawals Chandler Asset Management 76

78 Money Market Instruments Discount securities (no coupon) Treasury bills Agency discount notes Commercial paper Certificates of deposit Treasury and Agency Notes/Bonds whose remaining maturity is 13 months or less Chandler Asset Management 77

79 Discount Securities (T-Bills, Agency Discount Notes, CP, BAs) $1,000,000 {$1,459} $998,541 6 Month 0.29% Disc 0.295% BEY Chandler Asset Management 78

80 Treasury Bills Considered the risk-free investment Zero coupon; trade at discount to par Maturities of 1 year or less 4-week; 3- & 6-month; 1-year; cash management Auctions 3 & 6-month auctioned every Monday* 4-week auctioned every Tuesday 1-year auctioned every 4 weeks Cash management bill auctioned as needed Settlement & maturities Thursdays (unless a holiday then next business day) Chandler Asset Management 79

81 Treasury Bill Quotes Source: Bloomberg as of August 28, Chandler Asset Management 80

82 Government Sponsored Enterprises (Agencies) Chandler Asset Management 81

83 Discount Note Window Source: Bloomberg as of August 28, Chandler Asset Management 82

84 Commercial Paper Unsecured promissory note Maximum maturity 270 Days Discounted (most common) or coupon security Typically held to maturity Washington State Investment Board Guidelines Highest short-term credit rating category of any two NRSROs at time of purchase (highest rating from all who rate) Maturity longer than 100 days must have underlying long-term senior unsecured credit rating in one of the three highest rating categories of an NRSRO Maximum 3% per issuer Purchased in the secondary market Chandler Asset Management 83

85 Commercial Paper Ratings Source: Bloomberg as of August 28, Chandler Asset Management 84

86 Certificates of Deposit Restrictions on CDs - Public Depositories Issued by financial institutions qualified by the Washington Public Deposit Protection Commission Non-Negotiable Interest calculations 360 or 365 day years Compounding Sold at par or at a discount Illiquid Early Redemption Penalties Chandler Asset Management 85

87 Revised Code of Washington (RCW) Eligible Investments for Core Portfolio (Typically 5 years and under) U.S. Treasury Obligations Federal Agency and Government Sponsored Enterprise Securities Municipal Bonds Corporate Notes Supranational Securities Chandler Asset Management 86

88 U.S. Treasury Coupons Notes Original maturity 10 years & under 2, 3, 5, 7 & 10 year notes Bonds Original maturity greater than 10 years 30 year bond Structure Mature either the 15th or last day of the month Fixed coupons Semi-annual payments Coupons multiples of 1/8 Chandler Asset Management 87

89 Partial Two to Four Year Treasuries Source: Bloomberg as of August 28, Chandler Asset Management 88

90 GSE ( Agency ) Securities GSE s - Government Sponsored Enterprises Federal National Mortgage Association ( Fannie Mae ) Federal Home Loan Mortgage Corp ( Freddie Mac ) Federal Home Loan Banks (FHLB) Federal Farm Credit Banks (FFCB) Usually simply referred to as Agencies No explicit government guarantee Issued: Auctions, Syndicates, Reverse Inquiry Senior debt: Aaa/AA+ Various structures Bullets, discount notes, callables, step-ups Liquidity considerations for small issues Chandler Asset Management 89

91 Agency Bullet Screen Source: Bloomberg as of August 28, Chandler Asset Management 90

92 Callable Agency Securities Issuer has right to redeem the security on a given date or dates - call date(s) The value of the call option varies depending on the following factors: Current market rates relative to the security s coupon rate Time remaining to the call date Call type What are the risks? Issuers exercise call options in periods of declining interest rates causing you to reinvest proceeds at lower yields Issuers do not exercise call option when rates rise reducing your ability to reinvest at higher yields Chandler Asset Management 91

93 Corporate Securities A security obligation of a corporation, either secured or unsecured that pays interest periodically (usually semi-annually), and returns principal at maturity A direct loan from an investor to a corporation Investing in corporate obligations can improve income from investments BUT as with all investments, the potential for increased return goes hand-inhand with the assumption of more risk Credit Research and Analysis Fundamental Analysis (balance sheet, income statement, ratios, competitive strategy, management strength, etc.) Relative Value Analysis spread levels Diversification between sectors and issuers Chandler Asset Management 92

94 Resources Necessary for Investing in Corporate Bonds Independent pricing source Access to several corporate dealers for competitive transactions Timely, independent access to ratings and rating services actions Credit analysis capabilities Independent sources for credit research Policy regarding sales due to credit downgrades Chandler Asset Management 93

95 Elements of Credit Methodology The 4 C s of Credit Evaluation Capacity ability to pay debt obligations Character willingness to pay debt Collateral - assets that back the issuer s debt. Covenants legal protections provided to bondholders. Chandler Asset Management 94

96 Sample Corporate Security Source: Bloomberg as of August 28, Chandler Asset Management 95

97 Sample Corporate Security Source: Bloomberg. As of August 28, Chandler Asset Management 96

98 Municipal Obligations Taxable and non-taxable issuers Various structures - Serial, term, discounts, premiums Credit and liquidity issues Arbitrage safe haven Chandler Asset Management 97

99 Who are AAA Supranationals? Source: The World Bank and Inter-American Development Bank Supranationals 2016 WFOA Presentation Chandler Asset Management 98

100 What is a Supranational? Supranationals are international institutions that provide development financing, advisory services and/or other financial services to their member countries. Their goal is to achieve improving living standards through sustainable economic growth. A supranational entity is formed by two or more central governments with the purpose of promoting economic development for the member countries. Supranational institutions finance their activities by issuing debt, such as supranational bonds. Similar to the government bonds, the bonds issued by these institutions are considered very safe and have a high credit rating. Example of Supranational organizations are: The World Bank International Bank of Reconstruction and Development Bank International Finance Corporation Inter-American Development Bank European Bank of Reconstruction and Development Bank Chandler Asset Management 99

101 Supranationals for Local Governments RCW permits supranationals with the U.S. government as the largest shareholder*: Inter-American Development Bank International Bank for Reconstruction and Development International Finance Corporation Asian Development Bank The opportunities these securities provide: High quality AAA issuers to further diversify the portfolio A potential replacement for shrinking supply of US Agency securities Yield pickup of approximately 5-15 basis points to similar US Agency securities *As of December 31, Chandler Asset Management 100

102 Supranational Facts International Bank for Reconstruction and Development (IBRD) International Finance Corporation (IFC) Inter-American Development Bank (IADB) Development purpose Global source of funding to member governments Global source of finance for private enterprise in developing countries. Regional source of development finance for Latin America and the Caribbean. Membership Global 188 members Global 184 members Regional(Latin America and the Caribbean) -48 Year established Largest shareholder United States 16% United States 24% United States 30% Balance Sheet USD 359 billion USD 84.1 billion USD 97 billion Annual Funding Program USD billion USD 18 billion USD 21 billion SEC exemption* Yes Yes Yes, but still required to file certain information with SEC under SEC Regulation IA Act of Congress Authorizing US membership Bretton Woods Act 22 USC 286 et. Seq. International Finance Corporation Act 22 USC282 et. Seq. Inter-American Development Act 22 USC 283 et. seq. Type of Lending Preferred Creditor Status (PCS) Lending to Sovereigns or Sovereign guaranteed only Lending to or equity investment in Emerging Market private sector entities PCS Lending to Sovereign or Sovereign guaranteed (approximately 94%) plus Lending to private sector Part of World Bank Group Yes Yes No Source: and Please see disclosures at the end of this presentation. Chandler Asset Management 101

103 Section 4 Benchmark Development and Implementation

104 What is a Benchmark? An unmanaged portfolio that includes the types and maturities of securities that are permitted in the investor s policies The benchmark represents the appropriate level of risk for the portfolio Examples: S&P 500 Index for stocks 0-3 year Treasury Index of 1-3 year government notes Index of 1-5 year government and corporate securities rated AA or higher Chandler Asset Management 103

105 Why Benchmark? Compare Returns: How is your portfolio performing relative to the benchmark? Compare Risk: Is your portfolio s volatility within expectations versus benchmark? Accountability/Guidelines Improves Communication Chandler Asset Management 104

106 What Makes a Good Benchmark? Representative of assets in which the fund may invest: Includes only real securities that are available for sale Constructed in a disciplined and objective manner Formulated from publicly available information Exhibit similar risk characteristics as the investment objectives The information derived from both the benchmark and the portfolio should use the same calculation methods Known in advance Chandler Asset Management 105

107 What a Benchmark Does Provides discipline and guidance to portfolio manager in making investment decisions Helps control risk exposure in the portfolio Portfolio structure properly reflects risk tolerance of agency as defined by selected benchmark o o Duration Credit Manages the returns to expectations: Performance will be close to the benchmark return Variance of return will be due to variance in duration, sector weighting and maturity structure Provides clarity of strategy in communication to board Chandler Asset Management 106

108 Selection of Appropriate Benchmark Primary criteria: Compliance with policy and statutes Risk tolerances; risk profile Growth objectives Additional criteria: Allowable types of securities Time horizon of portfolio- Core Fund Maturity constraints of portfolio- Investment policy Chandler Asset Management 107

109 Evaluating Return How is return measured? Yield Income Realized Return/Book Value Return Income +/- realized gains (losses) Total Rate of Return All income earned +/- realized and unrealized gains and losses Chandler Asset Management 108

110 Yield and Realized Return/Book Value Return Yield: income from current and new investments + projection of income from reinvestment Used to project income for line item in next year budget To update income projection in current budget And often, to compare portfolio return to a yield benchmark Realized Return/Book Value Return Adds realized gains and losses No traditional or standardized realized return benchmark Chandler Asset Management 109

111 Total Rate of Return Total Rate of Return (TRR) measures the outcome of the portfolio Incorporates all three elements of return: Interest income Market value gains and losses realized and unrealized Reinvestment of interest Agreed upon industry standard Uniformly applied to all portfolios To provide comparable, consistent results Chandler Asset Management 110

112 Total Rate of Return: A Tool for Risk Management Total rate of return in a vacuum does not tell us much The appropriate level of risk must be established Cash flow needs Tolerance for market value fluctuations Need for return The characteristics of that level of risk is represented with a benchmark Chandler Asset Management 111

113 Total Rate of Return Aids Performance Management Always put your performance in perspective, given market conditions Can manage the governing body s expectations Demonstrates how the interest rate environment is impacting the portfolio Measures the financial health of the portfolio Our objectives in alignment with our tolerance for market volatility/risk Chandler Asset Management 112

114 Yield and Return Reference Guide Chandler Asset Management 113

115 Yield and Return Reference Guide Chandler Asset Management 114

116 Disclosures 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 an offer or solicitation for the purchase or sale of any financial instrument. References to investment indices are for informational purposes and do not imply that managing portfolios to those styles will achieve comparable returns. Indices do not reflect the deduction of transaction and/or custodial charges or the deduction of an investment management fee, the incurrence of which would have the effect of decreasing historical performance results. Indices are unmanaged, and one cannot invest directly in an index. Past performance is not indicative of future results. Any forecasts, forward-looking statements and assumptions are inherently limited and should not be relied upon as an indicator of future results. Any opinions and views constitute judgments made by the author at the date of this presentation and may become outdated or superseded at any time without notice. Any statements concerning financial market trends are based on current market conditions, which will fluctuate. Economic factors, market conditions and investment strategies will affect the performance of any portfolio and there are no assurances that it will match or outperform any particular benchmark. The data contained in this presentation is the property of those providers, which were obtained from sources believed to be reliable, but are subject to change at any time at the provider s discretion. Fixed Income investments are subject to interest, credit and market risk. Interest rate risk: the value of fixed income investments will decline as interest rates rise. Credit risk: the possibility that the borrower may not be able to repay interest and principal. Low rated bonds generally have to pay higher interest rates to attract investors willing to take on greater risk. Market risk: the bond market in general could decline due to economic conditions, especially during periods of rising interest rates. Chandler Asset Management 115

117 Disclosures Bank of America Merrill Lynch 0-3 Treasury Index The Bank of America Merrill Lynch Treasury 0-3 Year Index is comprised of U.S. Treasury securities issued by the U.S. Government. All securities in the index must have fixed coupon rates and a maturity not greater than three years regardless of any call features. Bank of America Merrill Lynch 0-5 Treasury Index The Bank of America Merrill Lynch Treasury 0-5 Year Index is comprised of US Treasury securities issued by the US Government. All securities in the index must have fixed coupon rates and a maturity not greater than five years regardless of any call features. Bank of America Merrill Lynch 1-5 Year US Treasury & Agency Index The Bank of America Merrill Lynch 1-5 Year US Treasury & Agency Index is comprised of securities issued by entities of the US Government, including the US Treasury and Agencies such as Fannie Mae, Resolution Trust Funding and the Federal Home Loan Bank. Corporate or foreign debt guaranteed by the US Government, such as USAID securities, may also be included in the index. All securities in the index must be investment grade, have fixed coupon rates or rates that change according to a predetermined schedule, and have at least one year but not greater than five years to maturity regardless of any call features. Bank of America Merrill Lynch US Corporate 1-5 Year AAA-A Index The Bank of America Merrill Lynch US Corporate 1-5 Year AAA-A Index is comprised of securities issued by Corporations having a rating of no less than A by a NRSRO (National Recognized Statistical Ratings Organization). All securities in the index must have a fixed coupon rate or rates that change according to a predetermined schedule, and must have at least one year but not greater than five years to maturity regardless of any call features. Bank of America Merrill Lynch 1-5 Year US Treasury & Agency Index (1-5 Year Government Benchmark) The BofA/ML 1-5 Year US Treasury & Agency Index is comprised of securities issued by entities of the US Government, including the US Treasury and Agencies such as Fannie Mae, Resolution Trust Funding and the Federal Home Loan Bank. Corporate or foreign debt guaranteed by the US Government, such as USAID securities, may also be included in the index. All securities in the index must be investment grade, have fixed coupon rates or rates that change according to a predetermined schedule, and have at least one year but not greater than five years to maturity regardless of any call features. Chandler Asset Management 116