Fixed Income Portfolio Management

Transcription

1 Fixed Income Portfolio Management Presented By: Marty Hammond, Managing Director Samantha Myers, Senior Analyst February 2019 PFM Asset Management LLC 821 Alexander Road Suite 110 Princeton, NJ pfm.com PFM 1

2 Building Blocks for a Strong Investment Program How do we communicate results? Communication & Reporting How should we implement our strategy? Strategy Execution How much / how should we invest? Strategy Development Cash Flow Analysis and Investment Policy What is our risk tolerance? Goals and Objectives PFM 2

3 Establish Goals & Objectives PFM 3

4 Establish Goals and Objectives Budget Risk Tolerance Revenue Goals Time Horizon View of Losses Earnings Liquidity PFM 4

5 Strategy Development PFM 5

6 Define Investment Objectives For Operating, Operating Reserves, and Bond Proceeds: Protect principal To meet ongoing and uncertain needs Maximize earnings While simultaneously providing safety and liquidity PFM 6

7 Investment Policy Statement Develop, Review, Amend, Improve Then Review, Amend and Improve again Objectives Belts and Suspenders Standard of Prudence Diversification Ethics & Conflicts Sector Delegation of Authority Issuer Competitive Selection Maximum Maturity Safekeeping and Custody Security Downgrades Authorized Investments Performance and Reporting Standards PFM 7

8 Example: Defining Your Investment Parameters Sector Type Sector Max (%) Issuer Max (%) Ratings Requirement 1 Max Maturity US Treasury 100% N/A N/A 10 Years Federal Agency 75% N/A 10 Years 35% 3 Agency MBS 15% N/A 10 Years 2 Corporate Notes 5% Top Three Ratings Categories 10 Years Commercial Paper 25% 5% Highest Ratings Category 270 Days Negotiable CDs 5% Top Three Ratings Categories 10 Years Municipals 30% 5% Top Three Ratings Categories 10 Years 1 By a Nationally Recognized Statistical Ratings Organization ( NRSRO ) 2 Agency MBS securities shall have a maximum weighted average life of 10 years 3 Federal Agency and Agency MBS securities are limited to a combined 35% maximum issuer allocation Sample Downgrade Language If a security(ies) in the Investment Portfolio is downgraded to a level below the quality required by this Policy, the Investment Officer shall consult with the Investment Advisory Firm to review the credit situation of the security(ies). Upon completion of such review, the Investment Officer shall make a determination as to whether to sell or retain such security(ies) in the Investment Portfolio and provide a written report to the Committee, informing the Committee of the situation, the investment decision, and the justification for a such a decision. If a decision is made to retain a downgraded security in the Investment Portfolio, its presence in the Investment Portfolio will be monitored and reported monthly, in writing, to the Investment Officer and the Committee. PFM 8

9 Addressing Liquidity Thanks, make mine a double! What you need is liquidity. PFM 9

10 Cash Flow Analysis Helps to Define Strategy Provides confidence in liquidity position Seasonality How much can be invested, how much needs to remain liquid When and where are your stress points Investable Funds Assists with investment strategy development Potentially increase investment income while managing risk Tier Structure PFM 10

11 Illustrative Cash Flow Analysis: Review Historical Balances Aggregate Portfolio Monthly Balances (January 2016 December 2017) $180 $160 $140 $120 Maximum monthly balance = $155.1 million (09/30/16) Minimum monthly balance = $103.4 million (07/31/17) $100 $80 $60 $40 $20 $0 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Millions Nov-17 Dec-17 Average monthly balance = $131.2 million PFM 11

12 Illustrative Cash Flow Analysis: Analyze Seasonality of Cash Flows $30 $25 $20 $15 Average Change in Balances Cash Flow Analysis # Negative # Positive Average Monthly Month Cash Flow Cash Flow Change Months Months January 11,645, February 15,464, March (6,088,405) 2 0 Millions $10 $5 $0 April (12,706,410) 2 0 May (3,460,021) 2 0 June (16,341,643) 2 0 July (9,852,441) 2 0 ($5) August 21,117, ($10) ($15) September 25,554, October (8,228,410) 2 0 November (14,780,085) 2 0 ($20) December (9,171,337) 2 0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec PFM 12

13 Illustrative Cash Flow Analysis: Identifying Investable Funds Liquidity Contingency Core Manage liquidity needs Lower-risk investment strategy Lower expected earnings Cash and equivalents (0-1 year) Supplement to Liquidity funds Highly liquid Matched with potential liabilities High quality fixed income (1-5+ years) Reserve funds not expected to be spent for the foreseeable future More volatile Multi Asset Class $160 $140 $120 $100 $80 $60 $40 $20 $0 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 Dec-17 Millions Liquidity $37 million Contingency $32 million Core $44 million PFM 13

14 Strategy Execution PFM 14

15 Setting the Overall Strategy Index Changes DURATION Manage interest rate risk Disciplined approach to maintaining target duration Volatility Geopolitical Risks SECTOR Supply Central Bank Policy Macro Views Relative sector value analysis Increased income potential Sector Returns Yield Curve/ Trends CURVE PLACEMENT Credit Trends Identify attractive portions of the curve Roll Down for enhanced earnings PFM 15

16 Return Benefits of Diversification Example 1-5 Year Portfolio Sector Allocation Portfolio Returns 2018 Portfolio Returns 5-Year Portfolio Returns 15% 30% 25% 10% 10% 10% % 1.39% 15% 40% 25% 10% 10% % 1.37% 25% 40% 25% 10% % 1.53% 40% 50% 10% % 1.64% 50% 50% % 1.61% 100% 1.52% 1.09% % 0.25% 0.50% 0.75% 1.00% 1.25% 1.50% 1.75% Treasury Agency Corp A-AAA Mortgage-Backed Securities Supranationals Asset-Backed Securities Example portfolio returns are based on the ICE BofA Merrill Lynch 1-5 Year indices for all sectors except for Supranational which uses the 1-3 Year index and are annualized for trailing periods longer than one year. Source: ICE BofA Merrill Lynch PFM Indices, as of 12/31/18. 16

17 Interest Rate Risk Introduction to Duration Prices and interest rates are related Market values and rate movements are inversely related (normally) Longer maturity = Greater risk Interest Rates Portfolio Value Portfolio Value Interest Rates Duration = Inverse of Yield Movement times Years to Maturity PFM 17

18 Duration Explained (Part 2) Price Duration is tangent to the price/yield curve therefore, it is an estimate $100 Bond A Bond B Duration 5% Yield PFM 18

19 Duration Explained (Part 3) Think of it this way: Bonds are made up of future cash flows Coupons and Par Payment Future Cash Flows are discounted to today at the bond s current yield If today s yield increases today s price decreases Why? We are discounting cash flows at a larger factor 2-year U.S. Treasury Par Value: $1 million Coupon: 5% Current Yield to Maturity: 5% Issued and Bought November 1 st Coupon Paid Annually Receivables: Annual $50,000 coupon $50,000 Nov. 1, 2019 $50,000 Nov. 1, 2020 At Maturity: $1mm par Total Proceeds = $1,100,000 Cash Flows Discounted at 5% Yield = $1mm Present Values: Nov coupon: $47,619 Nov coupon: $45,351 Nov par: $907,029 PFM 19

20 Duration Explained (Part 4) Takeaways: Duration of cash flows matters As yields move, so do current values Longer cash flows have more price volatility than shorter ones The total price change is (3.6%) ($963k $1mm) / $1mm That s nearly (4%), which = (2yr Duration) x (2% Change in Yield) Cash Flows Discounted at 5% Cash Flows Discounted at 5% Yield = $1mm Present Values: Nov coupon: $47,619 Nov coupon: $45,351 Nov par: $907,029 Total: $1,000,000 Cash Flows Discounted at 7% Cash Flows Discounted at 7% Yield = $963,840 Present Values: Nov coupon: $46,730 Nov coupon: $43,672 Nov par: $873,438 Total: $963,840 PFM 20

21 Longer-Term Securities are More Sensitive* (*if bonds had feelings) $10 million Portfolio Changes in Market Value By Duration and Yield Portfolio Duration Simultaneous Change in Interest Rates -2% -1% No Change +1% +2% , ,000 - (100,000) (200,000) , ,000 - (200,000) (400,000) , ,000 - (400,000) (800,000) PFM 21

22 Reporting PFM 22

23 Appropriate Benchmark and Detailed Reporting are Key What are the Purposes of a Benchmark? Help evaluate your investment strategy for funds Help to measure & evaluate relative investment performance Be an independent representation of the market or a particular market segment Considerations When Choosing a Benchmark Is information about the benchmark readily accessible? Is the composition of the benchmark similar to the funds it is being compared to? Monthly Reports Investment holdings & positions Transaction detail Detailed security characteristics Quarterly/Annual Reports Economic review and outlook Trading strategy Compliance with policy Return vs. benchmark Portfolio composition and duration Do the benchmark s characteristics correspond to your investment objectives? PFM 23

24 Current Markets PFM 24

25 Short-Term Yield Increases Outpace Longer-Term Yields U.S. Treasury Yield Curve Tenor Current 1/31/19 Year-End 12/31/18 Year-End 12/31/17 3.5% 3 month 2.38% 2.35% 1.38% 3.0% 6 month 2.45% 2.48% 1.53% 2.5% 1 year 2.54% 2.60% 1.73% 2 year 2.46% 2.49% 1.88% Yield 2.0% 1.5% 3 year 2.43% 2.46% 1.97% 5 year 2.44% 2.51% 2.21% 10 year 2.63% 2.68% 2.41% 1.0% 0.5% 0.0% 3 M 1 Y 2 Y 3 Y Maturity January 31, 2019 December 31, 2018 December 29, Y Source: Bloomberg, as of 1/31/2019. PFM 25

26 What We re Watching Spread Between 10-Year and 2-Year Treasury Yields Spread 10-Year 2-Year 3.5% Current: 17bps 3.0% 2.5% 2.0% Yield 1.5% 1.0% 0.5% 0.0% Sep-16 Dec-16 Mar-17 Jun-17 Sep-17 Dec-17 Mar-18 Jun-18 Sep-18 Dec-18 Source: Bloomberg, as of 1/31/2019. PFM 26

27 What We re Watching 100% Market Implied Fed Rate Hike Probability 80% Implied Probability 60% 40% 20% Target Rate % % % % % 0% Mar '19 Jun '19 Sep '19 Dec '19 Fed Meeting Dates Source: Bloomberg, as of 1/31/2019. PFM 27

28 Yield Environment as of January 31, 2019 Maturity Treasury Federal Agency AA Corporate A Corporate 3-Month 2.38% 2.38% 2.56% 2.66% 6-Month 2.47% 2.40% 2.63% 2.64% 1-Year 2.56% 2.54% 2.64% 2.79% 2-Year 2.46% 2.56% 2.71% 2.94% 3-Year 2.43% 2.55% 2.75% 3.02% 5-Year 2.44% 2.65% 2.93% 3.19% Source: Bloomberg BVAL yield curves for Treasury and Corporate. TradeWeb for Federal Agency yields. 3 and 6 month corporate yields from commercial paper; A-1+ for AA and A-1 for A. Yields are for indicative purposes only; actual yields may vary by issue. PFM 28

29 Presented by: Marty Hammond, Jr. Managing Director Samantha Myers Senior Analyst PFM 29

30 PFM Disclaimer This presentation is only intended for institutional and/or sophisticated professional investors. This material is intended for informational purposes only and should not be relied upon to make an investment decision, as it was prepared without regard to any specific objectives, or financial circumstances. It should not be construed as an offer or to purchase/sell any investment. Any investment or strategy referenced may involve significant risks, including, but not limited to: risk of loss, illiquidity, unavailability within all jurisdictions, and may not be suitable for all investors. To the extent permitted by applicable law, no member of the PFM Group, or any officer, employee or associate accepts any liability whatsoever for any direct or consequential loss arising from any use of this presentation or its contents, including for negligence. This material is not intended for distribution to, or use by, any person in a jurisdiction where delivery would be contrary to applicable law or regulation, or it is subject to any contractual restriction. No further distribution is permissible without prior written consent. The views expressed within this material constitute the perspective and judgment of PFM 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 of 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 30