PUTTING LEARNING INTO PRACTICE: PORTFOLIO MANAGEMENT FOUNDATIONS & AN INVESTMENT SIMULATION

Transcription

1 PUTTING LEARNING INTO PRACTICE: PORTFOLIO MANAGEMENT FOUNDATIONS & AN INVESTMENT SIMULATION FENIL PATEL Senir Vice President Prudent Man Advisrs, Inc. JAIME SANTANA Assciate Prtfli Manager Prudent Man Advisrs, Inc. April 7, 2017

2 TAKEAWAYS Public fund investrs ften stay t liquid fr varius reasns...timing interest rates is ne reasn. There is an pprtunity cst in liquidity Betting n interest rates has never been a cnsistent surce f return But diversificatin in a fixed incme prtfli is anther way t buffer rate changes 2

3 INVESTMENT STRATEGIES AND EXECUTION

4 INVESTMENT DECISIONS Peridically Review & Update Yur Investment Plicy Authrized investments Diversificatin Maturity Asset class

5 INVESTMENT DECISIONS Assess Yur Needs Determine yur bjectives Assess yur expertise Cnsider yur time Utilize investment prfessinals

6 INVESTMENT STRATEGY 1) Prtect Principal D yur hmewrk Wrk with peple yu trust D yur due diligence

7 INVESTMENT STRATEGY 2) Maintain Liquidity Cash flw analysis Keep it simple Be realistic Remember unusual expenditures

8 INVESTMENT STRATEGY 3) Generate Incme Understand market realities Yu can t beat the market ver time Extending maturity increases yield and interest rate risk Match assets and liabilities t reduce risk and prvide efficient investing Remember, the market is efficient Seek best executin thrugh cmpetitive bids

9 INVESTMENT STRATEGY Evaluate Call Risk Typically seen in Agency Securities and Municipal Bnds Issuer has right t redeem the security n a given date r dates call date(s) The value f the call ptin varies depending n the fllwing factrs: Current market rates relative t the security s cupn rate Time remaining t the call date Call type What are the risks? Issuers exercise call ptins in perids f declining interest rates Issuers d nt exercise call ptin when rates rise reducing yur ability t reinvest at higher yields

10 YIELD CURVE STRATEGIES $10 Millin Prtfli Average Maturity: 5 Years Prtfli Yield: Bullet: 1.45% Barbell: 1.24% Ladder: 1.46% U.S. Treasury Curve $15,000,000 $10,000,000 $5,000,000 $ $6,000,000 $4,000,000 $2,000,000 $ Bullet Years t Maturity Barbell Years t Maturity $1,500,000 $1,000,000 $500,000 Ladder M3M6M1Y2Y3Y 5Y 7Y 10Y 15Y 20Y 30Y $ Current Week ag Mnth ag Years t Maturity

11 YIELD CURVE STRATEGIES 1. Pwer f a Ladder Reinvest ver time Similar t dllar cst averaging in stcks Wrks in all rate envirnments Rates Fall: Lcked in higher yields in lnger maturities Rates Stable: Lnger maturities will enhance yield Rates Rise: Reinvest at higher yields as bnds mature

12 YIELD CURVE STRATEGIES 2. Rlling Dwn the Yield Curve In a psitively slped yield curve envirnment, as the bnd ages, it will be re priced at a lwer yield which leads t a higher price This enhances the price cmpnent f return leading t a ttal return that is greater than the purchase yield Example: 5 year UST yield 1.45% Price: Next year this bnd will be a 4 year yielding 1.30% Price: Price change: +.61 Ttal return: +1.98% Find the steepest part f the yield curve t maximize the rll dwn strategy 3.00% Yield Curve 2.00% 1.00% UST Yields 0.00% Years t Maturity

13 IN SUMMARY Safety, liquidity and then yield Invest with a plan D yur due diligence

14 INTRODUCTION TO OUR SIMULATION GAME 14

15 INVESTMENT BUCKETS Successful Investment Plan Aligns Apprpriate Strategy fr Purpse Immediate Reserves: <12 mnths T bills/agency Discunt Ntes/CD s Cmmercial Paper LGIPs Semi Permanent Reserves: 1 5 Years Treasury Ntes/Agency Ntes Investment Grade Crprate Bnds Taxable Municipal Bnds Agency Mrtgage Securities Permanent Reserves: 5+ Years Investment Grade Crprate Bnds Mrtgage Pass Thrugh Bnds Taxable Municipal Bnds Treasury Ntes / Agency Ntes Pensin / OPEB : Lng Hrizn Crprate Bnds Zer Cupn Treasury/Agency Bnds Equities / Stcks 15

16 INVESTMENT CONSIDERATIONS Safety f Principal Credit Risk Interest Rate Risk (Price Vlatility) Liquidity Needs Yield, Incme, and Return Objectives 16

17 INVESTMENT GOALS AND OBJECTIVES ASSUMPTIONS FOR TODAY Fcused n Lng Term Reserves High Quality Emphasis; AA Overall Credit Quality Prtfli Duratin Matching Yur Gals & Objectives Eligible Investments: Mney Market Funds & Lcal Gvernment Investment Pls U.S. Treasury Ntes U.S. Agency Ntes and Agency Securitized Municipal Securities (Rated AA/A) Crprate Securities (Rated AA/A) 17

18 INVESTMENT GOALS AND OBJECTIVES IMPLEMENTING OUR GAME We will be investing in indices instead f individual securities. DEFINITION Index: Attempts t replicate the perfrmance f a given investment type. It can als be called a benchmark. 18

19 INVESTMENT ALTERNATIVES INDICES imneynet A cmpsite f dmestic taxable mney market mutual funds BfA Merrill Lynch 1 3 Year US Treasury & Agency Index BfA Merrill Lynch 1 3 Year US Crprate Index BfA Merrill Lynch 1 5 Year AAA AA Municipal Securities Index BfA Merrill Lynch 3 5 Year US Mrtgage Backed Securities Index BfA Merrill Lynch 1 10 Year US Treasury & Agency Index 19

20 INVESTMENT ALTERNATIVES KEY TERMS Current Yield: Annual incme (cupns and interest) divided by the current market price f the security. This measure f yield uses the market price f a bnd instead f its face value r cst. When a bnd sells at par, the current yield will equal the stated interest rate (cupn) f the bnd. When the bnd sells fr a premium, the current yield will be lwer than the stated interest rate n the bnd. The current yield will be higher fr a discunt bnd. 20

21 INVESTMENT ALTERNATIVES KEY TERMS Duratin: The apprximate percentage change in price fr a 100 basis pint change in rates. Clsely related t time t maturity Generally, lnger maturity bnds have a greater sensitivity t changes in interest rates. Apprximate Percent Price change = duratin x change in rates x 100 EXAMPLE Using a duratin f 3.00, let's see the apprximate change fr a small mvement in rates such as a 50 basis pints increase. Apprx. Percentage Price Change = 3.00 x ( ) x 100 = 1.50% 21

22 INVESTMENT ALTERNATIVES KEY TERMS Ttal Return: The actual rate f return f an investment r a pl f investments ver a given time perid. Ttal return includes interest and capital gains earned ver a given perid f time. Excess Return: Additinal return f an investment abve a Treasury security f similar duratin. Standard Deviatin: A measure that is used t quantify the amunt f variatin r dispersin f a set f data values. A lw standard deviatin indicates that the data pints tend t be clse t the mean. A larger standard deviatin is an indicatr f greater vlatility. 22

23 INVESTMENT ALTERNATIVES KEY TERMS Sharpe Rati: A measure fr calculating risk adjusted return. The Sharpe rati is the average return earned in excess f the risk free rate per unit f vlatility r ttal risk. Generally, the greater the value f the Sharpe rati, the mre attractive the risk adjusted return. This rati has becme the industry standard fr such calculatins. Sharpe rati = (Mean pr li return Risk free rate)/standard deviatin f prtfli return 23

24 SIMULATION 1 RISING RATE ENVIRONMENT 24

25 RISING RATE ENVIRONMENT 12/31/04 Yield Curve Surces: Blmberg 25

26 RISING RATE ENVIRONMENT MARKET INFORMATION DECEMBER 31, 2004 Yield Duratin Mney Market Treas Crp Mrt Muni Treas Surces: Blmberg, imneynet

27 SIMULATION GAME WHAT DO WE DO? Break int grups f 5 7 As a grup, discuss yur strategy Cnsider data regarding each Index Yield Duratin Cnsider market envirnment Assign an allcatin t each index (yu can assign 0%) What are yur gals/bjectives? What is yur risk tlerance? Share yur grup s strategy and asset allcatin with the rm 27

28 RISING RATE ENVIRONMENT SUMMARY RESULTS Cumulative Avg. STRATEGY Mney Ttal Excess Standard Sharpe Market Treas Crp Mrt Muni Treas Return Return Deviatin Rati Diversified 10% 20% 20% 20% 20% 10% 12.3% 0.03% I think I knw 40% 30% 30% 0% 0% 0% 12.3% 0.03% Extreme betting 100% 0% 0% 0% 0% 0% 12.3% 0.01% Mney Market 70% 10% 10% 0% 10% 0% 11.9% 0.01% Surces: Blmberg, imneynet, Prudent Man Advisrs, Inc. Mnthly returns used t calculate Excess Returns and Standard Deviatin

29 SIMULATION 2 FALLING RATE ENVIRONMENT 29

30 FALLING RATE ENVIRONMENT 12/31/07 Yield Curve 30 Surces: Blmberg

31 FALLING RATE ENVIRONMENT MARKET INFORMATION DECEMBER 31, 2007 Yield Duratin Mney Market Treas Crp Muni Mrt Treas Surces: Blmberg, imneynet

32 FALLING RATE ENVIRONMENT SUMMARY RESULTS Cumulative Avg. STRATEGY Mney Ttal Excess Standard Sharpe Market Treas Crp Muni Mrt Treas Return Return Deviatin Rati Diversified 10% 20% 20% 20% 20% 10% 13.0% 0.28% I think I knw 0% 0% 0% 30% 30% 40% 15.0% 0.33% Extreme betting 0% 0% 0% 0% 0% 100% 15.4% 0.33% Mney Market 70% 10% 10% 10% 0% 0% 5.9% 0.09% Surces: Blmberg, imneynet, Prudent Man Advisrs, Inc. Mnthly returns used t calculate Excess Returns and Standard Deviatin

33 SIMULATION GAME RESULTS AND SUMMARY 33

34 GAME RESULTS AND SUMMARY CHANGES IN INTEREST RATES 34

35 GAME RESULTS AND SUMMARY SUMMARY Rates may nt mve as expected Strng market and Fed tightening in 2005 reversed by the end f 2007 Financial Crisis: Falling Treasury Rates Rising Credit Spreads Diversificatin acrss allwable sectrs reduces risk Financial Crisis results n sectr perfrmance: Treasuries utperfrmed (flight t safety) Credit prducts such as crprates and munis underperfrmed 35

36 GAME RESULTS AND SUMMARY 6 YEAR RESULTS STRATEGY Mney Ttal Avg. Excess Standard Sharpe Market Treas Crp Muni Mrt Treas Return Return Deviatin Rati Diversified 10% 20% 20% 20% 20% 10% 26.0% Stay Shrt 40% 30% 30% 0% 0% 0% 22.0% G lng 10% 0% 0% 20% 20% 50% 27.7% Surces: Blmberg, imneynet, Prudent Man Advisrs, Inc. Annual returns used t calculate Excess Returns and Standard Deviatin 36

37 GAME RESULTS AND SUMMARY INVESTMENT LESSONS Match yur investment plan t Gals and Objectives Measure perfrmance based n: Ttal Return (incme and price return) Risk Adjusted Return (Sharpe rati) Diversificatin reduces risk ver time Avid market timing 37

38 APPENDIX 38

39 RETURN DATA 6 YEAR MONTHLY DATA SUMMARY Mney Market Treas Crp Muni Mrt Treas Cumulative Return 15% 25% 32% 24% 36% 32% Annual Return 2.3% 3.9% 4.7% 3.7% 5.3% 4.8% Standard Deviatin Number f Perids with Lsses Surces: Blmberg, imneynet, Prudent Man Advisrs, Inc. Mnthly returns used t calculate Cumulative Return and Standard Deviatin 39

40 Disclaimer Prudent Man Advisrs, Inc. ( Prudent Man ) is an investment adviser registered with the U.S. Securities and Exchange Cmmissin. The infrmatin presented herein is fr general infrmatin purpses nly and is nt a specific/buy sell recmmendatin. The analysis r infrmatin presented in this presentatin is based upn hypthetical prjectins and/r past perfrmance that may have certain limitatins and is slely intended t suggest/discuss ptentially applicable financing applicatins r investment strategies with yu. Any terms discussed herein are preliminary until cnfirmed in a definitive written agreement. Investment in securities invlves risks, including the pssible lss f the amunt invested. In additin, past perfrmance is n indicatin f future perfrmance and the price r value f investments may fluctuate. Asset allcatin des nt assure r guarantee better perfrmance and cannt eliminate the risk f investment lsses. Yu shuld cnsider certain ecnmic risks (and ther legal, tax, and accunting cnsequences) prir t entering int any type f transactin with Prudent Man Advisrs, Inc. Prudent Man and its emplyees d nt ffer tax r legal advice. Yu shuld cnsult with yur tax and/r legal advisrs befre making any tax r legal related investment decisins. Securities, public finance and institutinal brkerage services are ffered thrugh PMA Securities, Inc. PMA Securities, Inc. is a brker-dealer and municipal advisr registered with the SEC and MSRB, and is a member f FINRA and SIPC. Prudent Man Advisrs, Inc., an SEC registered investment adviser, prvides investment advisry services t separately managed accunts and lcal gvernment investment pls. All ther prducts and services are prvided by PMA Financial Netwrk, Inc. PMA Financial Netwrk, Inc., PMA Securities, Inc. and Prudent Man Advisrs (cllectively "PMA") are under cmmn wnership. Securities and public finance services ffered thrugh PMA Securities, Inc. are available in CA, CO, FL, GA, IL, IN, IA, KS, MI, MN, MO, NE, OH, OK, PA, SD, TX and WI. This dcument is nt an ffer f services available in any state ther than thse listed abve, has been prepared fr infrmatinal and educatinal purpses and des nt cnstitute a slicitatin t purchase r sell securities, which may be dne nly after client suitability is reviewed and determined Prudent Man Advisrs, Inc. All rights reserved. Fr institutinal use nly. 40

41 Rising Rate Envirnment 12/31/04 Indices Yield Duratin Allcatin Mney Market Treas Crp Mrt Muni Treas FENIL PATEL Senir Vice President, Senir Relatinship Officer PMA Financial Netwrk, Inc. Prudent Man Advisrs, Inc CityGate Lane, 7th Fl, Naperville, IL (630) JAIME SANTANA Assciate Prtfli Manager Prudent Man Advisrs, Inc CityGate Lane, 7th Fl, Naperville, IL (630)

42 Falling Rate Envirnment 12/31/07 Indices Yield Duratin Allcatin Mney Market Treas Crp Muni Mrt Treas FENIL PATEL Senir Vice President, Senir Relatinship Officer PMA Financial Netwrk, Inc. Prudent Man Advisrs, Inc CityGate Lane, 7th Fl, Naperville, IL (630) JAIME SANTANA Assciate Prtfli Manager Prudent Man Advisrs, Inc CityGate Lane, 7th Fl, Naperville, IL (630)