Virginia GFOA May 4, 2016 Reid Andrews Government Treasury Management Vanessa Hubbard Fixed Income Market & Portfolio Strategy WFS and its investment representatives do not act as Municipal Advisors and only provide investment advice or recommendations with respect to bond proceeds as permitted by available exemptions
Table of Contents I. Overview of Cash Forecasting and Positioning II. III. IV. Monetary Policy, Rates Outlook Positioning on the Curve Cross Sector Relative Value V. Tactical Liquidity 2
Short-Term Overview of Cash Forecasting and Positioning 25-Apr 4-Mar 2.50 2.00 1.50 2Y FWD 1Y FWD 1.00 Spot 0.50 0.00 1 Mo 2 Mo 3 Mo 6 Mo 9 Mo 1 Yr 2 Yr 3 Yr 4 Yr 5 Yr 7 Yr 9 Yr 10 Yr Source: Federal Reserve Bank and Wells Fargo Securities, LLC 3
Short-Term Overview of Cash Forecasting and Positioning Wells Fargo & non- WFB accounts (domestic and international) 1-click print and export File upload of anticipated transactions Transaction matching Self-reporting also available 4
Short-Term Overview of Cash Forecasting and Positioning Daily balances 57 weeks into future Forecast created daily by use of rules View by day, week, month, quarter or year Save time and increases accuracy 1-click print and export of data Easy set-up 5
Monetary Policy, Rates Outlook
Rate (%) How much will Rates Rise? According to Policymakers The expected pace of firming has changed. The 2016 median appropriate Fed funds rate decreased to 0.88 percent from 1.38 percent and the 2017 median appropriate rate is now projected at 1.02 percent. Fed Fund futures are pricing at the lower end of 2016 and 2017 forecasts. September December Dot Plot Comparison 4.500 4.000 3.500 3.000 2.500 2.000 1.500 1.000 0.500 December Projection March Projection Fed Funds Futures 0.000 2016 2017 2018 Longer Run Source: Federal Reserve Board and Wells Fargo Securities, LLC 7
Economists When will the Fed Raise Rates next? Depends on Who You Ask Bloomberg Survey Estimates of Expected Fed IOER Apr-16 Jun-16 60 50 40 The consensus economist estimates show that many are calling for the FOMC to remain on hold in April, waiting until June to raise interest rates once again. 30 20 10 0 50 75 100 Source: Federal Reserve Bank and Wells Fargo Securities, LLC 8
Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Yield (%) When will the Fed raise rates again? Markets see rates remaining low in the near-term Short Term Rates Remain Low 1.6 3M Tbill 3M LIBOR 1.4 Short-term cash markets have responded to the first rate hike, though t-bill rates remain at either the lower end or below the Fed s target range. 1.2 1.0 0.8 0.6 This is likely to remain the case for the foreseeable future as demand for short-term government assets is at an alltime (non-crisis) high. 0.4 0.2 0.0 Fed funds target range Source: ICE, Bloomberg an d Wells Fargo Securities, LLC 9
When will the Fed raise rates? Markets continue to trade Cash and Futures-Implied Yields Recent global economic data has caused Eurodollar and Fed funds futures contracts to oscillate, though they are currently at or slightly above trend for 2016. Dec '16 Futures Dec '17 Futures 3M LIBOR Dec '16 FF Futures Dec '17 FF Futures Fed Effective 3.0 3.0 3.0 3.0 2.5 2.5 2.5 2.5 2.0 2.0 2.0 2.0 1.5 1.5 1.5 1.5 1.0 1.0 1.0 1.0 0.5 0.5 0.5 0.5 0.0 Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar 0.0 0.0 Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar 0.0 Source: CBOT, ICE, Bloomberg and Wells Fargo Securities, LLC 10
Positioning on the Curve when rates rise?
Cost of Waiting Time in Cash Break-even Analysis, 3-year Agency at 1.090% Remaining Time Income Forgone Break-even Rate Over Remaining Term 6 months 2.5 years $45,500 1.272% 12 months 2 years $91,000 1.547% 18 months 1.5 years $136,500 2.004% Portfolio price volatility is a reality of fixed income investing, but there is also a cost to overweighting cash. Time in Cash Break-even Analysis, 5-year investment at 1.455% Remaining Time Income Forgone Break-even Rate Over Remaining Term 6 months 4.5 years $63,750 1.597% 12 months 4 years $127,500 1.775% 18 months 3.5 years $191,250 2.004% 24 months 3 years $255,000 2.310% Source: Wells Fargo Securities, LLC Amount invested: $10M Cash investment rate: 0.18% 12
Yield (%) 1M 6M 2Y 4Y 6Y 8Y 10Y 12Y 14Y 16Y 18Y 20Y Rates Treasury Curve 2.50 4/20/2015 4/20/2016 2.00 1.50 Short-term rates have risen recently, however longer-term Treasury rates remain unchanged, year-over-year. 1.00 0.50 0.00 Source: Federal Reserve Bank and Wells Fargo Securities, LLC 13
Rates Spot vs. Forward Curve 25-Apr 4-Mar 2.50 2.00 1.50 2Y FWD The forward curve has shifted higher versus a month ago, signaling that the market anticipates rates to begin to elevate. 1.00 0.50 0.00 1Y FWD Spot 1 Mo 2 Mo 3 Mo 6 Mo 9 Mo 1 Yr 2 Yr 3 Yr 4 Yr 5 Yr 7 Yr 9 Yr 10 Yr Source: Federal Reserve Bank and Wells Fargo Securities, LLC 14
Short-Term Rates Rate Comparison In response to the first rate move, most money market yields initially rose, but a number have since rallied. Asset Class Apr. 1 20-Apr _Change_ Fed RRP 25 25 0 Triparty (TSY) 28 27-1 GCF Repo (TSY) 50 35-15 Fed Funds 37 37 0 4-Week Bills 19 18-1 3-Month Bills 22 22-5 30-Day Discos 23 26 3 30-Day CP (Non-Fin) 33 33 0 30-Day CP (Tier-2) 77 75 1 1-Month LIBOR 44 44 0 3-Month LIBOR 63 64 1 1-Month OIS 36 36 0 3-Month OIS 38 39 1 Dec. '16 FF Fut. 56 56 0 Dec. '16 LIBOR Fut. 86 90 4 Crane 100 MMF YLD 22 22 0 2-Year TSY Note 72 79 7 3-Year TSY Note 86 97 11 1-3 Year IG Index 102 93-9 2YNC3M AGY Berm 99 106 7 2YNC1Y AGY Berm 96 101 5 Source: Bloomberg, Wells Fargo Securities, LLC 15
Cross Sector Relative Value 0 1 Year
Investment Landscape: Short-Term Rates Cross Sector Relative Value < 1 Year 1.6% 1.4% 1.2% 1.0% 0.8% A2/P2 CP Tier 2 CP, along with nontraditional repo are the highest yielding asset classes inside of one year. 0.6% 0.4% 0.2% 0.0% A1/P1 CP O/N 1 Mo 3 Mo 6 Mo 9 Mo 1 Yr Government Repo Non-Traditional Repo Prime Funds A1/P1 CP A2/P2 CP TE VRDNs TAX VRDNs AA Corps AAA TE AA TE AAA LGIP Net Yield Source: Wells Fargo Securities, LLC, Bloomberg, imoneynet, DTCC 17
Cross Sector Relative Value 1 5 Years
Investment Landscape: Annual Returns for Short Duration Sectors 6 5 4 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 5.33% Asset Backed Securities 2.74% Agencies, 2.18% 2.80% Asset Backed Securities 2.16% 1.82% Asset Backed Securities 2.60% 2.15% 1.89% Asset Backed Securities 4.73% 4.71% 4.64% Treasuries, 7.32% 6.95% Agencies 6.74% Agencies 7.05% Treasuries, 6.61% 5.27% 14.69% Asset Backed Securities, 13.80% 5.98% 5.42% 4.86% Asset Backed Securities, 3.35% 3.15% 2.37%, 1.76% 4.49% Asset Backed Securities, 1.88% 1.61% 1.78% 1.07% 0.91% 1.19% 1.10% Asset Backed Securities, 0.89% 3 2 1 0 2.08% Treasuries, 1.90% 1.83% 1.28% Agencies 1.18% Treasuries, 0.91% Agencies 1.77% Treasuries 1.67% 1.41% Agencies 4.52% Treasuries 3.96% 3.25% Source: Bloomberg, Federal Reserve, Wells Fargo Securities, LLC 5.67% Asset Backed Securities 4.84% 4.70% 5.16% Asset Backed Securities -1.22% -2.68% 4.21% Agencies 2.17% Treasuries, 0.79% Treasuries, 2.35% Agencies 2.32% 1.29% Treasuries, 1.55% Agencies 1.53% Asset Backed Securities, 1.49% 1.03% Agencies 0.85% Treasuries 0.43% Asset Backed Securities 0.78% Agencies 0.424% Treasuries 0.36% 0.72% Agencies 0.70% Treasuries 0.62% Returns shown are the annual total returns of select Bank of America Merrill Lynch indices. This Table of Short Duration Returns is a comprehensive representation of relative sector performance for a 10-year period through 12/31/2014. This material is offered compliments of Wells Capital Management to its clients. It is for your own personal information and we are not soliciting an action based upon it. Past performance is not indicative of future results. 19
Investment Landscape: Annual Returns for Short Duration Sectors 6 1994 1995 1996 5 4 3 2 1 0 2.184% Asset Backed Securities 1.625% 1.311% 1.182% Treasuries 0.569% Agencies 0.267% 12.486% 11.717% Treasuries 10.999% Agencies 10.935% Asset Backed Securities 9.945% 7.220% 6.156% Asset Backed Securities 5.882% 5.712% Agencies 5.377% Treasuries 4.979% 4.108% 7 1999 2000 2001 6 5 4 3 2 1 Asset Backed Securities 4.830% 4.677% 3.904% Agencies 3.508% Treasuries 3.063% 2.507% 8.992% Agencies 8.544% Asset Backed Securities 8.004% Treasuries 7.995% 7.608% 5.678% 9.585% Agencies 8.635% Treasuries 8.300% Asset Backed Securities 8.155% 7.792% 6.041% 6 2004 2005 2006 5 4 3 2 1 0 2.802% Asset Backed Securities 2.161% 1.820% Agencies 1.183% 1.275% Treasuries 0.907% Asset Backed Securities 2.602% 2.151% 1.888% Agencies 1.767% Treasuries 1.668% 1.406% Asset Backed Securities 4.725% 4.714% 4.638% Agencies 4.515% Treasuries 3.963% 3.253% Source: Bloomberg, Federal Reserve, Wells Fargo Securities, LLC Returns shown are the annual total returns of select Bank of America Merrill Lynch indices. This Table of Short Duration Returns is a comprehensive representation of relative sector performance for a 12-year period through 12/31/2006. 20
Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Basis Points Investment Landscape: Corporate Bonds () Corporate Bonds () 300.0 250.0 200.0 1 0.9 0.8 0.7 0.6 Corporate spreads have demonstrated stability during the three previous ratetightening cycles. 150.0 100.0 50.0 0.5 0.4 0.3 0.2 0.1 0.0 0 OAS Fed Rate Hike Source: Wells Fargo Securities, Bloomberg, Yield Book 21
Investment Landscape: Corporate Bonds () 2013 2016 1-3 Year HG OAS by Sector Median - 25th 75th - Median Last 1-3 Year corporate notes are trading in-line with their 3-Year median spread levels. The energy sector continues to be hampered by 12-year low commodity prices. 450.00 400.00 350.00 300.00 250.00 200.00 150.00 100.00 50.00 0.00 450.00 400.00 350.00 300.00 250.00 200.00 150.00 100.00 50.00 0.00 Source: Wells Fargo Securities, Bloomberg 22
Investment Landscape: Agency Bonds (1-5 Years) 2013 2016 1-5 Year Spread by Tenor 75th - Median Median - 25th Last 60.00 60.00 50.00 50.00 40.00 40.00 30.00 30.00 1-5 Year Agency Bonds are trading wide of their 3-Year median spread levels. 20.00 10.00 0.00 20.00 10.00 0.00-10.00 1-Year NC 3M 2-Year NC 3M 3-Year NC 3M 5-Year NC 3M -10.00 Source: Wells Fargo Securities, Bloomberg 23
Short-Term Rates Cross Sector Relative Value 0 5 Years 2.5% 2.0% 1.5% There are numerous investment options in the credit space, 1-5 years with the curve steepening between 2-5 years. 1.0% 0.5% 0.0% A2/P2 CP Non-Trad Repo O/N 1 Mo 3 Mo 6 Mo 9 Mo 1 Yr 18 Mo 2 Yr 30 Mo 3 Yr 4 Yr 5 Yr Government Repo Non-Traditional Repo Prime Funds A1/P1 CP A2/P2 CP TE VRDNs TAX VRDNs AA Corps AAA Taxable AA Taxable AAA TE AA TE AAA LGIP Net Yield Source: Wells Fargo Securities, Bloomberg, imoneynet, DTCC 24
Short-Term Rates Government Cross Sector Relative Value 0 5 Years 1.80% 1.60% Agency Callables 1.40% 1.20% 1.00% In the government space, the highest yielding alternative is the FDIC insured Brokered CD market. 0.80% 0.60% 0.40% 0.20% 0.00% O/N 1 Mo 3 Mo 6 Mo 9 Mo 1 Yr 18 Mo 2 Yr 30 Mo 3 Yr 4 Yr 5 Yr Govt Money Funds AAA LGIP Net Yield T-Bills T-Notes Agency Discos Agency Bullets Agency Callables Brokered CDs - Program Brokered CDs Source: Wells Fargo Securities, Bloomberg 25
Tactical Liquidity Portfolio Segmentation to Optimize Investment Objectives
Positioning Corporate Cash Portfolios Curve steepening in the current environment is causing investors to look at their strategic cash allocations to see if there are opportunities to extend or introduce new asset classes. Segmentation of the Corporate/Public Cash Portfolio (for illustrative purposes only) Liquidity, stability Stability of principal of Principal Operating Cash (Horizon - daily) Reserve Cash (Horizon - Quarterly) Restricted Cash (Horizon - longer-term) Strategic Cash (Horizon - longer-term) Less liquidity, higher yields, more price Less liquidity, volatility higher yields, more price volatility Source: ICI, Wells Fargo Securities, LLC Q1 Q2 Q3 Q4 27
Positioning Corporate Cash Portfolios- Your Bucket List Corporate Cash Portfolio Segments/Buckets have different Durations, Objectives, Strategies and Return Expectations Operating Cash Reserve/Core Cash Strategic Cash Investment Horizon 0 6 months 6 months 2 years 1 5 years Portfolio Duration 30-90 Days 6 18 months 2 3 years Cash Flow Volatility High Low/Maturity Matched Very Low/Maturity Matched Strategy Money Market/Cash Equivalents Incremental Duration and Credit Risk Incremental Duration and Credit Risk Benchmark N/A Treasury-based LIBOR + -based Index-based (strategy-specific) Source: Wells Fargo Securities, LLC 28
Yield Positioning Corporate Cash Portfolios Product Segmentation Across Liquidity Buckets Money Markets < 12M S/T Investments > 12M Products can be placed in multiple buckets. However, certain products are more suited to certain investment styles based on relative liquidity and duration profiles. Operational Cash Bank Deposits Sweep Accounts Money Market Funds Treasury Bills Discount Notes Repo Commercial Paper Certificates of Deposit TE/Taxable VRDNs Reserve Cash Commercial Paper Certificates of Deposit Short Corporate Bonds Treasury Bills/Notes Agency Discos/Bullets Agency Municipal Securities Floaters Restricted/Strategic Cash Certificates of Deposit Brokered CDs Corporate Bonds Treasury Notes Agency Callables Agency Bullets Municipal Securities Duration Source: Wells Fargo Securities, LLC 29
Portfolio Construction Approaches Basic Approach $30 $30 $25 $25 The Basic Approach manages all expected cash outflows through existing cash balances, represented by the grey area. The cash balances represented by the light and dark blue areas are not anticipated to be used and can be invested further out on the curve to augment yield. $20 $15 $10 $5 $4M Short-term inv. (6 12M) $9M Short-term inv. (1-3Y) MMFs, LGIP, O/N Inv. $20 $15 $10 $5 $0 7-Jan 7-Feb 7-Mar 7-Apr 7-May 7-Jun 7-Jul 7-Aug 7-Sep 7-Oct 7-Nov 7-Dec $0 Cash Balance Forecast Source: Wells Fargo Securities, LLC 30
Portfolio Construction Approaches Maturity Matching Approach $30 $30 MMFs, LGIP, O/N Inv. $25 $25 The Maturity Matching Approach identifies the size and dates of known cash outflows and invests an equivalent amount of cash to those dates. Liquidity is partially managed through maturity matching, allowing short-term investments to constitute a larger part of the overall portfolio. $20 $15 $10 $5 Short-term inv. (1-3Y) Short-term inv. (6-12M). $20 $15 $10 $5 $0 $0 Cash Balance Forecast Source: Wells Fargo Securities, LLC 31
Investment Policy Samples 32
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