Investment Strategies for the Current Environment

Transcription

1 Investment Strategies for the Current Environment Presenters: QR Code Lunda Asmani, City of Newton, KS Tim Johnson, Piper Jaffray Jennifer Cooperman, City of Portland, OR Gary Ometer, Virginia College Savings Plan Date: 05/20/2014

2 Investment Strategies for the Current Environment

3 OVERVIEW ECONOMIC INDICATORS TREASURY YIELDS RELATIVE VALUE STRATEGIES 3

4 Economist s different views New neutral Economic growth globally will be converging toward lower, yet more stable top speeds and central bank interest rates will remain stuck below their precrisis equilibrium PIMCO The job market is gaining strength Mark Zandi, Moody s Analytics 4/30/14 5/13/14 Every leading indicator is signaling continued expansion David Rosenberg Glukin Sheff Associates Inc. 1/31/14 We re at the very beginning of a credit bubble Nouriel Roubini Roubini Global Economics 5/10/14 4

5 Economic Indicators Industrial Production Gross Domestic Product (GDP) Unemployment Rate Consumer Price Index (CPI) Consumer Confidence Conference Board Leading Economic Indicators 5

6 Economic Indicators Industrial Production month-over-month 6 Source: Bloomberg Finance L.P., Piper Jaffray

7 Economic Indicators Industrial Production year-over-year 7 Source: Bloomberg Finance L.P., Piper Jaffray

8 Economic Indicators Gross Domestic Product (GDP) chained quarter-over-quarter 8 Source: Bloomberg Finance L.P., Piper Jaffray

9 Economic Indicators Unemployment total labor in force, seasonally adjusted 9 = Lagging Market Indicator Source: Bloomberg Finance L.P., Piper Jaffray

10 Economic Indicators Unemployment total labor in force, seasonally adjusted 10 = Lagging Market Indicator Source: Bloomberg Finance L.P., Piper Jaffray

11 Economic Indicators Consumer Price Index (CPI) 11 Source: Bloomberg Finance L.P., Piper Jaffray

12 Economic Indicators Consumer Confidence 12 = Contrary Indicator Source: Bloomberg Finance L.P., Piper Jaffray

13 Economic Indicators Consumer Confidence 13 = Contrary Indicator Source: Bloomberg Finance L.P., Piper Jaffray

14 Economic Indicators Conference Board Coincident and Lagging Indicators Indices Source: Haver Analytics Number of Employees on Non Ag payrolls Personal income less Transfer payments Industrial Production Manufacturing and Trade sale Average duration of unemployment Value of commercial and industrial loans The change in CPI for services The change in labor cost per unit of output The ratio of manufacturing and trade inventories to sales The ratio of consumer credit outstanding to personal income The average prime rate charged by banks 14 Source: Conference Board, Piper Jaffray

15 Economic Indicators Top 25 Indicators ranked by Bloomberg Relevance Indicator Period Survey Actual Prior Revised Change in Nonfarm Payrolls May 288K Initial Jobless Claims 17 May GDP Annualized QoQ 1Q S 0.10% Consumer Confidence Index May 82.3 ISM Manufacturing May 54.9 Univ. of Michigan Confidence May P CPI MoM Apr 0.30% 0.20% MBA Mortgage Applications 16 May Durable Goods Orders Apr 2.60% 2.90% New Home Sales Apr 430K 384K Markit US Manufacturing PMI May P Retail Sales Advance MoM May Unemployment Rate May 6.30% Housing Starts Apr 981K 946K Industrial Production MoM Apr 0.00% 0.70% Existing Home Sales Apr 4.67M 4.59M PPI Final Demand MoM May U.S. Federal Reserve Releases Beige Factory Orders Apr 1.10% Personal Income Apr 0.50% Personal Spending Apr 0.90% Leading Index Apr 0.30% 0.80% Trade Balance Apr $40.4B Empire Manufacturing ADP Employment Change May May K 15 Source: Bloomberg Finance L.P., Piper Jaffray

16 Economic Indicators Top 25 Indicators ranked by Bloomberg Relevance Indicator Period Survey Actual Prior Revised Change in Nonfarm Payrolls May 288K Initial Jobless Claims 17 May GDP Annualized QoQ 1Q S 0.10% Consumer Confidence Index May 82.3 ISM Manufacturing May 54.9 Univ. of Michigan Confidence May P CPI MoM Apr 0.30% 0.20% MBA Mortgage Applications 16 May Durable Goods Orders Apr 2.60% 2.90% New Home Sales Apr 430K 384K Markit US Manufacturing PMI May P Retail Sales Advance MoM May Unemployment Rate May 6.30% Housing Starts Apr 981K 946K Industrial Production MoM Apr 0.00% 0.70% Existing Home Sales Apr 4.67M 4.59M PPI Final Demand MoM May U.S. Federal Reserve Releases Beige Factory Orders Apr 1.10% Personal Income Apr 0.50% Personal Spending Apr 0.90% Leading Index Apr 0.30% 0.80% Trade Balance Apr $40.4B Empire Manufacturing ADP Employment Change May May K = Leading Indicator 16 Source: Bloomberg Finance L.P., Piper Jaffray

17 Economic Indicators Components of the Conference Board s Leading Index Average weekly hours, manufacturing Average weekly initial claims for unemployment insurance Manufacturers' new orders, consumer goods and materials ISM new order index Manufacturers' new orders, non defense capital goods excl. aircraft Building permits, new private housing units Stock prices, 500 common stocks Leading Credit Index Interest rate spread, 10 year Treasury bonds less federal funds Avg. consumer expectations for business and economic conditions Source: The Conference Board, Piper Jaffray 17

18 Economic Indicators Leading Economic Indicators (Leading Index) YOY 18 = Leading Indicator Source: Bloomberg Finance L.P., Piper Jaffray

19 Economic Indicators Key takeaways Graph economic indicators over a long period of time (i.e. 25 years). Graph the most recent recessions Try to understand how the indicator behaves before, during and after a recession. Graph the indicator on a year-over-year basis rather than month-over-month, if possible. Focus on leading indicators, be cognizant of coincident indicators and understand 19

20 Treasury Yields 20

21 Treasury Yields 10 year Treasury yields % average over past 25 years = Average 21 Source: Bloomberg Finance L.P., Piper Jaffray

22 Treasury Yields 5 year Treasury yields % Average over past 25 years = Average 22 Source: Bloomberg Finance L.P., Piper Jaffray

23 Treasury Yields Normal ands Flat Yield Curves 23 Source: Bloomberg Finance L.P., Piper Jaffray

24 Treasury Yields Fed Funds and 30 year Treasury yields on top and spreads below. 24 Source: Bloomberg Finance L.P., Piper Jaffray

25 Treasury Yields Fed Funds and 30 year Treasury spreads 25 Source: Bloomberg Finance L.P., Piper Jaffray

26 Treasury Yields Fed Funds and 5 year Treasury yields on top and spreads below. 26 Source: Bloomberg Finance L.P., Piper Jaffray

27 Treasury Yields Fed Funds and 5 year Treasury spreads below. 27 Source: Bloomberg Finance L.P., Piper Jaffray

28 Treasury Yields Forward Treasury Curves 1yr, 2yr, 3yr, 4yr, and 5yr forward 28 Source: Bloomberg Finance L.P., Piper Jaffray

29 Relative Value Multi-sector yields 5 yr maturity Yield Comparison Agency spread -5yr maturity Corporate spread 5 yr maturity Taxable Municipal spread 5 yr maturity Mortgage spread 15 yr current coupon versus 5 yr maturity Opportunity Matrix Opportunity Matrix table 29

30 Relative Value Yield comparison 5yr maturity tough to digest 30 Source: Bloomberg Finance L.P., Piper Jaffray

31 Relative Value 5 year Agency bullet spreads 0 percentile = Mean = Current value Source: Bloomberg Finance L.P., Piper Jaffray 31

32 Relative Value 5 year Corporate Composite spreads 0 percentile = Mean = Current value Source: Bloomberg Finance L.P., Piper Jaffray 32

33 Relative Value 15 year current coupon FNMA Mortgages vs 5 year Treasury spreads 5 percentile = Mean = Current value Source: Bloomberg Finance L.P., Piper Jaffray 33

34 Relative Value 5 year Taxable A-rated Municipal bond spreads - 43 percentile = Mean = Current value Source: Bloomberg Finance L.P., Piper Jaffray 34

35 Relative Value Opportunity Matrix 5 year maturity 35

36 Relative Value Opportunity Matrix - 5 year table Current Spread Current Risk Adjusted Percentile Combined Std Dev Rank RAS Z Score Rank Z Yield Median High Low Spread Spread (RAS) Rank Rank Health Care AA (0.12) 45% 1 1 Materials BBB (0.61) 27% 19 2 Energy BBB (0.56) 29% 17 3 FHLMC 15Y Curr Cpn (0.87) 19% 24 4 Utilities BBB (0.49) 31% 10 5 Industrials BBB (0.51) 31% 12 6 FNMA 15Y Curr Cpn (0.94) 17% 26 7 Technology BBB (0.66) 26% 22 8 GNMA 15Y Curr cpn (0.67) 25% 23 9 Energy A (0.37) 35% 5 10 Consumer Staples BBB (0.44) 33% 8 11 Materials A (0.38) 35% 6 12 Industrials A (0.35) 36% 2 13 Utilities A (0.46) 32% 9 14 Health Care A (0.38) 35% 7 15 Consumer Disc BBB (0.64) 26% Financials BBB (0.54) 30% Technology A (0.36) 36% 4 18 Health Care BBB (0.62) 27% Consumer Staples A (0.36) 36% 3 20 Financials A (0.54) 29% Consumer Disc A (0.55) 29% Communication A (0.58) 28% Financials AA (0.50) 31% Consumer Staples AA (0.53) 30% Tax Exempt Muni AAA (Tax Equiv) (30) (0.92) 18% Agency 5Y Bullet (1) (1) 23.5 (0.0) 27 (1.25) 11% Year Maturity Ten Year History

37 Strategies Core Focus Asset / Liability Management cash flow Duration Management Structure Yield Curve Strategies Business Cycle Strategies Money Market Fund Yields 37

38 Strategies Core Focus Objectives Safety Liquidity Yield Constraints Fish Bowl Maintaining Public trust Local Laws 38

39 Strategies Asset / Liability management Cash Flow $ 39 Time

40 Strategies Duration Management Bond Market Rally (bond prices rise interests rates fall) Longer durations will outperform short duration bonds Bullets will outperform callables Given the same maturity, lower coupon bonds will outperform higher coupons Bond Market Sell-off (bond prices fall interest rates rise) Shorter duration bonds will outperform longer duration bonds Callables will tend to outperform bullets Given the same maturity, higher coupon bonds will outperform lower coupons 40

41 Strategies Duration Management Duration a concept to measure the volatility of a bond by measuring the weighted average term to maturity of the bond s cash flow. Duration is the approximate percentage change in the price for a 100 basis point change in yields. Given small changes in yields Assuming interest rates move in a parallel manner. However, the yield curve typically does not move parallel. Yields 3-month 5yr 10yr 30yr 41

42 Strategies Duration Management Price Duration Price/Yield Relationship Error in estimating price using duration For small changes in yield, the straight line (estimated price using duration) and the curved line (actual prices) are fairly similar. As yields change by larger amounts, the gap increases between the straight line and the curved line - hence making duration less useful as a predictor of price. Yield 42

43 Strategies Duration Management Bond Market Rally (bond prices rise interests rates fall) Longer durations will outperform short duration bonds Bullets will outperform callables Given the same maturity, lower coupon bonds will outperform higher coupons Bond Market Sell-off (bond prices fall interest rates rise) Shorter duration bonds will outperform longer duration bonds Callables will tend to outperform bullets Given the same maturity, higher coupon bonds will outperform lower coupons 43

44 Strategies Duration Management Positive Convexity is good when rates rise or fall Price Even when rates increase positive convexity is a Good Thing. $1,000 Bond B - $900 Bond A - $800 Yield Increases Bond B Bond A Bond B has greater Convexity than Bond A. Why? Because if yield decrease by the same amount, the price of Bond B increases more than the Price of Bond A. 44

45 Strategies Duration Management Negative convexity Investors receive more yield to purchase callable bonds (munis, agencies, corps, or mortgages). Prices Callable Bond Noncallable Bond Callable bonds have negative convexity. Negative convexity can hurt price appreciation when yields fall. Negative convexity can introduce extension risk when interest rates rise Yield 45

46 Strategies Structure Coupon Weighted Average Coupon & Coupon Type Matters 46

47 Strategies Structure Diversification Agency Treasury Agency Muni Mortgage Corporate MM 47

48 Strategies Structure General tendencies in a rising rate environment Total Extension Effective Yield Return Risk Duration Bullet Med Low Low High Floater Low High Low Low Callable High Med High Med 48

49 Strategies Yield curve strategies: Steep Yield Curve 49 Source: Bloomberg Finance L.P., Piper Jaffray

50 Strategies Yield curve strategies: 2 year to 5 year Treasury spread 83 percentile 50 Source: Bloomberg Finance L.P., Piper Jaffray

51 Strategies Yield curve strategies: $5 M 10 yr Bullet $1M $1M $1M $1M $1M $2.5 M $2.5M 6yr 8yr 10yr 12yr 14yr Ladder 3 month 20yr Barbell 51

52 Strategies Yield curve strategies: Steepening Curve Laddered & Bullet strategies Flattening Curve Barbell strategies Bull Market Lengthen Duration Decrease (Low) coupon Positive convexity Bear Market Shorten Duration Increase (High) coupon Negative convexity (if paid) 52

53 Strategies Yield curve strategies: Forward Curve Forward Table Treasury Spot Forward Yrs Treasury Maturity year yield 1.65% 3 year yield 0.89% 2 year yield, 3 years forward = 2.79% 53

54 Strategies Business cycles strategies 4 PEAK 1 Contractio n 3 Expansion PEAK 2 Trough 54

55 Strategies Business cycle strategies: o o Contraction o Flight to Quality o Transition to: o Consumer Staples/Food/Beverage/Tobacco o Drugs/Utilities/Supermarkets/Drug Stores o Treasuries Trough o Consumer Staples/Food/Beverage/Tobacco o Drugs/Utilities/Supermarkets/Drug Stores o Expansion o Increase risk exposure o Transition to: o Interest rate sensitive sectors o Consumer discretionary o Lower quality credits 55

56 Strategies Money Market Fund Yields 56 Source: Bloomberg Finance L.P., Piper Jaffray

57 Strategies Money Market Fund Yields tend to underperform in rising rate environments Spread to 3 month T-Bill 57 Source: Bloomberg Finance L.P., Piper Jaffray

58 Portfolio and Balance Sheet Strategies Contact information: Tim Johnson, CFA Managing Director Senior Fixed Income Strategist (612)

59 Disclosures In providing information contained herein to a municipal entity or obligated person, Piper Jaffray is not recommending an action to the municipal entity or obligated person recipient; is not acting as an advisor to any municipal entity or obligated person and does not owe a fiduciary duty pursuant to Section 15B of the Exchange Act to any municipal entity or obligated person with respect to the information and material contained in this communication. Piper Jaffray is acting for its own interests, and any municipal entity or obligated person recipient of this information should discuss any information and material contained in this communication with any and all internal or external advisors and experts that the municipal entity or obligated person deems appropriate before acting on this information or material. 59

60 Investment Strategies for the Current Environment

61 Characteristics o Average $1.08 billion o Self directed o Rate forecasts o Net earnings distributed to all City funds

62 Investment Goals/Limits o Safety, liquidity, yield o Diversification Only ORS approved investment types Issuer, rating, and maturity limits o Limits on portfolio maturity 0 2 years, % of funds 2 10 years, 0 50% of funds 18 month portfolio WAM

63 ORS approved investments* US Treasury debt US Agency debt Oregon municipal bonds California, Idaho, Washington municipal bonds Interest bearing deposits Banker s acceptances Corporate debt (commercial paper and bonds) Repurchase agreements Local Government Investment Pool (LGIP) *Various limits apply

64 Investment Approach o Economic analysis and rate expectations o Cash flow forecasting o Identify time horizons/liquidity gaps o Relative value within investment policy limits Holding cash FRN Carry and roll down the curve Step up coupons

65 Investment Strategies for the Current Environment

66 Defined Benefit Plan - Fixed Income Considerations for the Long-Term Investor o Gary s Rules on Investments Rule No. 3: Never bet on interest rates o Portfolio asset allocation drives long term returns o Strategic moves / changes, not tactical o No need to panic salesmen will try to sell you the flavor du jour!

67 Defined Benefit Plan - Fixed Income Considerations for the Long-Term Investor The future isn t what it used to be Yogi Berra

68 What Went Up, Came Down THE ESTABLISHED HISTORY OF LOW LONG TERM U.S. TREASURY RATES 1873 to September 2013 Source: Prudential Securities Fixed Income Perspectives September 2013

69 Annual Net Cash Flows Into Total Equity and Total Bond Mutual Funds $500,000 Annual Net Cash Flows into Total Equity and Total Bond Mutual Funds $400,000 $300,000 $200,000 $100,000 $ $(100,000) $(200,000) $(300,000) Total Equity Total Bond Source: Investment Company Institute

70 Corporate Credit Cycle Source: Amundi Smith Breeden Asset Management 2014

71 Leveraging the Best of Active v. Passive Strategies Source: Morningstar Direct Mutual Fund Data is exclusive of Money Markets and Fund of Funds All data provided is year end data as of 12/31/2013

72 Factors Favoring Fixed Income Active Management o Most credit spreads are below historical averages o Call protection is being reduced o Covenant protections are waning o Markets continue to experience sporadic volatility o M&A deals are big and may become bigger o Mortgage backed securities market future (GSE s) o Federal Reserve actions short term rates, QE4? o Duration, duration, duration; and cash flow

73 VA529 prepaid Portfolio Asset Allocation

74 VA529 prepaid Core Fixed Income Portfolio Stable Value 20% December 31, 2012 Barclay's Aggregate Index Fund 40% Stable Value 20% TIPS 20% December 31, 2013 Senior Secured Bank Loans 36% TIPS 40% Mortgage- Backed Securities 12% Core Fixed Income: Active vs. Passive as of December 31, 2013 Intermediate Term Corporates 12% Strategy Manager Active/Passive Senior Secured Bank Loans Shenkman Capital Management Active Intermediate Term Corporates Vanguard Passive Mortgage-Backed Securities* Vanguard* Passive* TIPS SSgA Passive Stable Value Invesco Advisers Active *Transitioning to active manager

75 Investment Strategies for the Current Environment