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FLORIDA SCHOOL FINANCE OFFICERS ASSOCIATIONJUNE 2017 CONFERENCE
Thursday, Session II C: INVESTMENTS
Orrin Edwards, CPA [email protected]
888-424-0226
See Page 28 for Important Disclaimers & Disclosures
2
BACKDROP: WHERE HAVE YIELDS BEEN?
5Yr UST yield jumped after election but has fallen back as increased inflation expectations are diminishing
Market is “allowing” Fed to normalize Fed Funds rate which affects short term yields (see 2Yr UST yield tracking FFds)
3
FUTURE FED FUNDS PROJECTIONS
4
FUTURE FED FUNDS PROJECTIONS
People with a lot of information have continually “mis”-estimated where FF will be
5
INTEREST RATE PROJECTIONS
Projections per Scott J. Brown, Ph.D., Raymond James, as of May 8, 2017• 1-2 more 25bp hikes in 2017• 2-3 25bp hikes in 2018
6
SHORT TERM & MONEY MARKET OPTIONS
• Stable value investment funds (SVIF) typically yield near to slightly above Fed Funds
• SVIF-Limited risk, limited reward (that can be ok)
• SVIF-Return of principal is paramount, not income
• Short term bond funds (STBF) invest in securities you can invest directly in
• STBF example maturity: Florida Local Gov’t Investment Trust STBF average maturity 1.6 years at 3/31/17
• STBF typically yield slightly more than SVIF
• SVIF & STBF-Credit quality is typically high
7
OVERVIEW OF YIELDS
Important because, “Other Securities” are what you invest in either directly, or indirectly via investment funds/pools
• UST are the base, or reference, rate for other securities(they are the “credit free” option, thus, the starting point)
• Other securities are quoted at a “spread” over USTs(they have credit and/or option risk)
• Spread at xx bps (basis points) over a similar maturity UST
• Term fixed income securities all have interest rate risk
8
OVERVIEW OF YIELDS
Agency Bullet 2NC1Yr 2NC3Mo2 Yr UST Yield 1.29 1.29 1.29Security Spread +6 bps +9 bps +13 bpsSecurity Yield 1.35% 1.38% 1.42%
Optionality typically increases Spread, and therefore, Yieldand therefore, Income to your bottom line
Agency Debentures: FFCB, FHLB, FNMA, FHLMC, etc.
Example as of June 5, 2017 Source: Raymond James eFolio analytics & Bloomberg
9
OVERVIEW OF YIELDS
Agency Bullet 2NC1Yr 2NC3Mo2 Yr UST Yield 1.29 1.29 1.29Security Spread +6 bps +9 bps +13 bpsSecurity Yield 1.35% 1.38% 1.42%
• Bullets have certainty, thus rewarded less (less spread)• For greater uncertainty, investor is rewarded more• In the form of higher spread/Yield• Optionality, uncertainty as to exactly when investor will receive principal back, typically increases Spread/Yield• Principal is typically returned 100% at Call date or Maturity
Example as of June 5, 2017 Source: Raymond James eFolio analytics & Bloomberg
10
OVERVIEW OF YIELDS
Agency Bullet 2NC1Yr 2NC3Mo2 Yr UST Yield 1.29 1.29 1.29Security Spread +6 bps +9 bps +13 bpsSecurity Yield 1.35% 1.38% 1.42%
• Increasing Maturity typically increases Spread & Yield• Increasing Optionality typically increases Spread & Yield
Agency Bullet 5NC1Yr 5NC3Mo5 Yr UST Yield 1.72 1.72 1.72Security Spread +12 bps +29 bps +38 bpsSecurity Yield 1.84% 2.01% 2.10%
Example as of June 5, 2017 Source: Raymond James eFolio analytics & Bloomberg
11
OVERVIEW OF YIELDS & AVERAGE LIFE
Agency Mtg Bk’d Sec 10Yr MBS 15Yr MBSReference UST Yield 1.44/3 Yr 1.72/5 YrSecurity Spread +18 bps +41 bpsSecurity Yield 1.62% 2.13%Avg. Life 3.63 yrs 5.62 yrsAvg Life Change from Base: -50 / +100
-.9 / +.64 yrs -.69 / +.30 yrs
• Optionality for MBS: uncertainty as to exactly when investor will receive principal back, average life varies, but cash flow always comes in monthly at a reasonably predictable pace• Yield/Income also may vary, especially as Price diverges from Par
Example as of June 5, 2017 Source: Raymond James eFolio analytics & Bloomberg
12
BLOOMBERG SCREENSHOTS: 15 YEAR MBS
Example as of June 9, 2017Source: Bloomberg
13
RJ eFolio SCREENSHOTS: 15 YEAR MBS
Example as of June 9, 2017Source: Raymond James eFolio
14
COMPARATIVE ANALYSIS: RISK vs REWARD
* $1Mil invested, constant balance
PV +100 Unrealized Loss Base Yield 1 Year Income *
2 Yr UST -1.94% -$19,419 1.29% 12,9003 Yr UST -2.91% -$29,095 1.44% 14,4005 Yr UST -4.61% -$46,085 1.72% 17,2002NC3Mo -2.45% -$24,502 1.42% 14,2005NC3Mo -5.88% -$58,774 2.10% 21,00010 Yr MBS 3.6AL -3.18% -$31,773 1.62% 16,20015 Yr MBS 5.6 AL -4.46% -$44,607 2.13% 21,300
• Unrealized Loss is ONLY RECOGNIZED IF YOU SELL SECURITY
• PV (Price Volatility) and Unrealized Loss “erode” as security ages & approaches maturity, while income is earned/recognized
Example as of June 5, 2017 Source: Raymond James eFolio analytics & Bloomberg
15
SECURITY OPTIONS
• Proper Cash Flow planning prefers Certainty
• Paying the Bills prefers greater Yield/Income
• Use a combination of Bullets and Securities with Optionality for Optimal Results
The Big Dilemma: Yield vs Certainty
16
OPTIONS FOR INCREASES YIELD/INCOME
• Break-even analysis
• Step-Up Agencies
• Agency CMBS (commercial mortgage backed securities from GNMA, FHLMC & FNMA) as higher yielding “bullet” alternative
But Don’t Miss Out On Extra Potential Income
17
OPTIONS FOR INCREASES YIELD/INCOME: BREAK-EVEN ANALYSIS
If you believe rates are increasing:
• Option A: Invest in 2 year Agency bullet at 1.35% and then in a 3 year Agency bullet
• Option B: Invest in a 5NC1Yr Agency callable at 2.01%
• To be “neutral” the 3 Year Agency 2 years from now needs to yield 2.45%
• That’s 94bps more than 3 year Agency bullet currently yields
• Do you believe the 3 Year Agency yield is increasing 94bps in 2 years?
18
OPTIONS FOR INCREASES YIELD/INCOME: BREAK-EVEN ANALYSIS
It’s just math:5NC1Yr Agency Callable yields 2.01%2 Yr Agency Bullet yields 1.35%3 Yr Agency Bullet currently yields 1.51%3 Yr Agency Bullet need to yield 2.45% 2 years from now
On the other hand, if 5NC1 is called, you would only need the 4 Yr Agy bullet to yield 1.80% for years 2-5 to have equal income with a 5 Yr Agy bullet yielding 1.84% today
If 5NC1Yr NOT CALLED If 5NC1Yr IS CALLED5NC1Yr 5Yr Bullet
Current 2 Yr Agy 1.35 2.01 2.01 1.84Current 2 Yr Agy 1.35 2.01 1.80 1.84Current 3 Yr Agy 2.45 2.01 1.80 1.84Future 3 Yr Agy 2.45 2.01 1.80 1.84Future 3 Yr Agy 2.45 2.01 1.80 1.84
5 Yr Income 10.05 10.05 9.20 9.20
3Yr Agy 2 years from now to BE 2.45Current 3Yr Agy Bullet 1.51Needed Increase in 3 Yr Agy 0.94
Source: see RJ FI Research Public Funds Investor Insights May 24, 2017
19
OPTIONS FOR INCREASES YIELD/INCOME: STEP UP CALLABLE AGY
• Cash & SVIF have lower yields near the rate of Fed Funds• STBF have slightly higher yields, but they have a built in reset lag as the bonds mature and are reinvested in “higher” levels
If you’re holding Cash or in SVIF or STBF in anticipation of Rising Rates, consider Callable AGY w/ Step Up Coupons w/ frequent steps
Coupon schedule of Step Up AGY vs representative short term “future” yields• FHLMC 1.625% for 1 year, then semi-annual steps to 1.75%, 2.00%, 2.25%, 2.50%, 2.75%, 3.00%, 3.50% & 4.00%
• Price: 100.00• YTM: 2.47%• Qtly call
Source: see RJ FI Research Public Funds Investor Insights May 24, 2017
20
BLOOMBERG SCREENSHOTS: STEP UP CALLABLE AGY
Bloomberg pages:
Bloomberg screenshots:DESYTCCoupons
21
RJ eFolio SCREENSHOTS: STEP UP CALLABLE AGY
Raymond James eFolio screenshots:DescriptionYield/Shock TableCash Flow Shocks
22
OPTIONS FOR INCREASES YIELD/INCOME: AGENCY CMBS
Typically, higher yielding alternative to Agency debentures (bullet maturities and callables)
Issued by GNMA, FNMA and FHLMC, each w/ unique structures
Collateral is larger commercial “bank” loans, typically to apartments
“Hard” final similar to Agency debentures
Monthly cash flow, usually with a larger balloon payment at maturity
Many structures have prepayment disincentives that if incurred may be passed through to investor as yield boost
23
BLOOMBERG SCREENSHOTS: AGENCY CMBS
Bloomberg pages:
Bloomberg screenshots:DESYTCCoupons
WHAT’S IMPORTANT: INCOME / YIELD
25
WHAT’S IMPORTANT: CASH FLOW
26
WHAT’S IMPORTANT: RISK
27
WHAT’S IMPORTANT: IT IS ALL IMPORTANT
MAKE SURE YOU ARE OPTIMIZING YOUR AVAILABLE OPTIONS
28
DISCLAIMERS & DISCLOSURES
This communication is from Raymond James & Associates, Inc. fixed income Portfolio Strategy Group; it is not research.This communication is directed exclusively to institutional investors, for informational purposes only. The informationprovided herein is not complete and may not be relied on as such. We are only providing this communicationon the condition that it will not form the basis for any investment decision or strategy you may make.
You must independently determine the appropriateness of an investment in any securities or strategy referred to hereinbased on the array of information available to you, applicable legal, tax, and accounting considerations, as well as yourown investment strategy and risk tolerance. Raymond James & Associates, Inc. disclaims responsibility for any suchinvestment decision.
You should assume Raymond James & Associates, Inc. that has a position and will transact in any of the securitiesmentioned in this communication. Raymond James & Associates, Inc. may provide investment-banking services to anyof the issuers mentioned in this communication.
The data and values described herein are calculated based on historical information and should not be relied upon topredict future values or prices. Raymond James & Associates, Inc. has used sources it considers reliable. Any and alldata, calculations or expressions reflect the judgment of the Portfolio Strategy Group employee at the time of writing andare subject to change without notice. Raymond James & Associates, Inc. does not represent that this material isaccurate, current or complete, and you should not rely upon it as such.
Slide Number 1Backdrop: where have yields been?Future fed funds projectionsFuture fed funds projectionsInterest rate projectionsShort term & money market optionsOverview of yieldsOverview of yieldsOverview of yieldsOverview of yieldsOverview of yields & Average lifeBloomberg Screenshots: 15 year MBSRJ eFolio Screenshots: 15 year MBSComparative analysis: risk vs rewardsecurity optionsOptions for increases yield/incomeOptions for increases yield/income: Break-even analysisOptions for increases yield/income: Break-Even AnalysisOptions for increases yield/income: Step Up Callable agy Bloomberg screenshots: Step Up Callable agy RJ eFolio screenshots: Step Up Callable agy Options for increases yield/income: AgenCY CMBS Bloomberg screenshots: AgenCY CMBS What’s important: income / yieldWhat’s important: cash flowWhat’s important: RISKWhat’s important: It is all importantDisclaimers & disclosures