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Presented by:
Barbara BoswellFinance DirectorCity of Lancaster
David Witthohn, CFA, CIPMDirectorCutwater Asset Management
Drivers of Portfolio Performance
California Society of Municipal Finance Officers (CSMFO)
February 21, 2013
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Cash Flow Forecasting
Do you really need most of your funds within the next 24 hours?
71.0%
10.0% 8.0% 8.0%3.0%
0.0% 0.0%0%
10%
20%
30%
40%
50%
60%
70%
80%
0 - 3 months 3 - 6 months 6 - 12 months 1 - 2 years 2 - 3 years 3 - 4 years 4 - 5 years
Maturity Distribution – to final
3
Target Duration: Risk/Return Tradeoff
Normally, the yield curve provides higher returns for longer maturities, but these incremental increases are much smaller for securities that are more than 10 years to maturity.
Source: Bloomberg4
What is a Cash Flow Forecast?
• Projection of anticipated receipts
• Projection of anticipated disbursements
• Estimate of investable cash balances•Liquid funds
•Core funds
5
Why Prepare a Cash Flow Forecast?
• Improves investment earnings
• Ensures liquidity for disbursements
• Identifies short-term cash deficits
• Warns of impending budget problems
6
Major Impediments to Forecasting
• Tendency to think in budget years
• Difficulty distinguishing between fund balance and cash balance
• Inadequate time and/or staff
• Unpredictability of revenues and expenditures
• Lack of information and communication
• Lack of adequate technology
7
Types of Cash Forecasts
Annual Forecasts• Estimates monthly cash position
• Determines cash available for investments
• Provides a useful monthly overview for investment decision-making
• Prepared for this fiscal year and next one- to two-fiscal years
8
Types of Cash Forecasts
Project-based Forecasts• Provides monthly data on status of capital projects
• Helps fine tune monthly and weekly forecasts
• May require input from contractors or in-house project managers
9
Tools for Cash Flow Forecasting
• Historical data from general ledger
• Historical data from bank statements
• Current year budget
• Capital project spending projections
• Other major departments’ budgets
• Schedule of investment maturities and coupon payments
10
Identify Revenues and Expenditures
Major revenue types• Property tax
• Sales and use tax
• User fees
• Federal and state assistance
• Grants
• Bond proceeds
• Other
Major expenditure types• Payroll (net)
• Withholding and benefits
• Debt service
• Capital expenditures
• Materials and supplies
• Overhead (e.g., utilities)
• Other
11
Forecasting Receipts
• Identify 4-5 categories for major sources of revenue• Compile historical data of actual monthly receipts• Identify significant changes• Identify non-recurring items from prior years and for
coming year• Develop analysis of monthly receipts as a percent of
annual• Adjust historical distribution for known differences
12
Projected Monthly Receipts
Jan Feb Mar Apr May Jun Total
Property Tax $2,775 $975 $0 $895 $2,855 $0 $15,000
Sales Tax $718 $293 $319 $212 $771 $351 $2,661
Water $209 $209 $209 $209 $209 $209 $2,508
State $2,017 $0 $0 $2,017 $0 $0 $8,068
Other $45 $45 $45 $45 $45 $45 $540
Total $5,764 $1,522 $573 $3,378 $3,880 $605 $28,777
Receipts Forecast
13
Forecasting Disbursements
• Establish reasonable number of categories
• Compile historical data of actual monthly disbursements
• Identify significant changes
• Identify non-recurring items from prior years and for coming year
• Develop analysis of recurring monthly disbursements as a percent of annual
• Include debt service payments
14
Projected Monthly Disbursements
Jan Feb Mar Apr May Jun Total
Payroll $1,130 $1,103 $1,103 $1,103 $1,144 $1,144 $13,614
Payables $65 $65 $65 $65 $65 $65 $780
Capital Projects $32 $33 $50 $23 $44 $47 $456
Debt Service $23 $0 $0 $46 $0 $0 $86
Other $25 $25 $25 $25 $25 $25 $540
Total $1,275 $1,226 $1,243 $1,262 $1,278 $1,281 $15,476
Disbursement Forecast
15
Creating a Cash Flow Forecast
• Beginning balance of cash and investments
• Monthly revenue projections
• Monthly expenditure projections
• Projected net change
• Projected cumulative balance of cash and investments
16
Jan Feb Mar Apr May JunBeginningBalance $3,200
Projected Receipts $5,764 $1,522 $573 $3,378 $3,880 $605 Projected Disbursements $1,275 $1,226 $1,243 $1,262 $1,278 $1,281
Net Receipts(Disbursements) $4,489 $296 ($670) $2,116 $2,602 ($676)
CumulativeBalance $7,689 $7,985 $7,315 $9,431 $12,033 $11,357
17
Cash Flow Forecast
Estimate Timing of Investments
• Schedule of current investments
• List of maturity dates
• Schedule of income payments
18
Required Liquidity
• Look at the projected net cash flows and hold the amount required to meet the largest negative month and add a margin of safety
• Establish a required minimum cash balance that you would prefer to have available.
19
Comprehensive Cash Flow Forecast
Beg. Balance Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Total
Beg. Balance 19,534,000
Property Tax Revenues 519,000 2,766,000 442,000 498,000 496,000 181,000 8,702,000Other Revenues 1,134,000 1,134,000 1,168,000 1,202,000 1,134,000 1,285,000 11,648,000Payroll and Payables (1,386,000) (1,395,000) (1,427,000) (1,354,000) (1,455,000) (1,550,000) (11,829,000)Capital Projects (95,000) (105,000) (65,000) (150,000) (180,000) (45,000) (4,235,000)Debt Service 0 0 0 0 0 (1,430,000) (3,245,000)
Projected Net Change 172,000 2,400,000 118,000 196,000 (5,000) (1,559,000)
Portfolio Income & Maturity 0 0 0 250,000 1,525,000 1,023,000
Projected Cash Balance 19,534,000 19,706,000 22,106,000 22,224,000 22,420,000 22,415,000 20,856,000
Required Liquidity 10,000,000 10,000,000 10,000,000 10,000,000 10,000,000 10,000,000 10,000,000
Core Portfolio 9,534,000 9,706,000 12,106,000 12,224,000 12,420,000 12,415,000 10,856,000
20
Review Cash Forecast
• Compare actual versus forecast
• Identify reasons for variances
• Adjust assumptions if warranted
• Follow up with department heads on capital project slippage
• Update database for accurate future projection
• Retain documentation for future reference
21
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Portfolio Management
How Did We Get Here?
23
Active Management Strategies
There are three primary drivers of performance for high quality short-term fixed income portfolios:
Duration management
Sector allocation
Security selection
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Duration Management
Cash Flow Analysis
To determine how much money you have to invest in your core portfolio and for how long, you need to analyze some basic cash flow projections. Here is an illustration of what that could look like.
Dec-1
0
Mar
-11
Jun-
11
Sep-1
1
Dec-1
1
Mar
-12
Jun-
12
Sep-1
2
Dec-1
2
Mar
-13
Jun-
13
Sep-1
3
Dec-1
3
Mar
-14
Jun-
14
Sep-1
4
Dec-1
4
Mar
-15
Jun-
15
Sep-1
5 $-
$20
$40
$60
$80
$100
$120
$140
Cash Flow Illustration
Liquid Funds Core Funds
Mill
ion
s $
Historical Cash Flows Projected Cash Flows
26
Traditional Portfolio Structure
Utilizes traditional money market sectors
Manages liquidity and credit risks
Enables timely reinvestment of cash flows
Captures best duration risk-adjusted returns with the “reserve” portion of the portfolio
Allocates to government and high quality sectors, ensuring liquidity if needed
Insulates portfolio return from interest rate volatility, enhancing portfolio performance
Liquidity Portion of Portfolio
1 to 3 Year Portion of Portfolio
30%
70%
27
3-month Treasury Bill 6-month Treasury Bill 1-Year Treasury 1-3 Year Treasury Index
1-5 Year Treasury Index
3-5 Year Treasury Index
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
3.00%
3.50%
4.00%
4.50%
5.00%
0
2
4
6
8
10
12
14
16
18
20
1.81%
2.11%2.24%
2.75%
3.36%
4.38%
0 0
4
6
11
14
Return Number of Negative Quarters
Analyzing the Risk/Return Tradeoff
Source: Bloomberg
Return vs. Number of Negative QuartersJanuary 1, 2003 to December 31, 2012
28
Reduces Volatility of Returns
Source: Bloomberg29
30303030
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Duration Management - Looking Forward
Dec-05
Jan-06
Feb-06
Mar-06
Apr-06
May-06
Jun-06
Jul-06
Aug-06
Sep-06
Oct-06
Nov-06
Dec-06
Jan-07
Feb-07
Mar-07
Apr-07
May-07
Jun-07
Jul-07
Aug-07
Sep-07
Oct-07
Nov-07
Dec-07
Jan-08
Feb-08
Mar-08
Apr-08
May-08
Jun-08
Jul-08
Aug-08
Sep-08
Oct-08
Nov-08
Dec-08
Jan-09
Feb-09
Mar-09
Apr-09
May-09
Jun-09
Jul-09
Aug-09
Sep-09
Oct-09
Nov-09
Dec-09
Jan-10
Feb-10
Mar-10
Apr-10
May-10
Jun-10
Jul-10
Aug-10
Sep-10
Oct-10
Nov-10
Dec-10
Jan-11
Feb-11
Mar-11
Apr-11
May-11
Jun-11
Jul-11
Aug-11
Sep-11
Oct-11
Nov-11
Dec-11
Jan-12
Feb-12
Mar-12
Apr-12
May-12
Jun-12
Jul-12
Aug-12
Sep-12
Oct-12
Nov-12
Dec-12
0.00%
1.00%
2.00%
3.00%
4.00%
5.00%
6.00%
7-Year Average 2.17
Lengthen Duration
Shorten Duration
Duration Management
Source: Bloomberg31
Yield Curve - top of the interest rate cycle
The curve is inverted, enticing investors to stay short.
Source: Bloomberg
Lengthen Maturity
-40 Basis Points
32
Yield Curve - bottom of the interest rate cycle
The curve is steeply sloped, enticing investors to extend maturities, lower quality or take on extension risk.
Source: Bloomberg
71 basis points
33
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Sector Allocation
Sector Allocation - Treasury, Agency & Corporate
Source: Bloomberg 35
Sector Allocation – Treasury, Agency & Corporate
Source: Bloomberg 36
Sector Allocation - Treasury to Agency Spreads
Source: Bloomberg 37
Sector Allocation – Corporate MTN
Source: Bloomberg 38
Disclaimer: All securities shown in this presentation are shown for the purpose of instruction only and are not recommendations to buy or sell a specific security. Cutwater Asset Management acts solely as an investment advisor and not as a broker dealer.
Sector Allocation – Corporate MTN
Source: Bloomberg 39
Commercial Paper – “the other corporate”
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Security Selection – Security Structure
Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-120.00%
1.00%
2.00%
3.00%
4.00%
5.00%
6.00%
7-Year Average 2.17%
Buy Callables
Buy Non-callables
Security Selection - Structure
Source: Bloomberg 42
Security Selection - Structure
The structure of a callable security greatly affects both the bond’s duration and performance. Extension risk is a big issue with callable securities.
Source: Bloomberg
235 days
1,695 days
43
How Many Callables is Too Many?
Report Date: 12/31/07Wtd. Avg. Wtd. Avg. Weighted
Issuer / Maturity Call Acquisition % ofDays to Days to YTM Maturity Maturity Average Security Coupon Date Date Cost PortfolioFinal Call (Purchase Y) to Final Call Yield
FHLB 3.100% 01/08/08 1,000,000.00 8 3.100% 0.86 0.86 0.334%FHLMC 4.890% 02/01/08 429,959.00 32 5.000% 1.48 1.48 0.232%FHLB-Called 4.570% 04/29/08 01/29/08 359,507.00 120 29 5.000% 4.65 1.12 0.194%FHLB 5.000% 06/27/08 125,000.00 179 5.000% 2.41 2.41 0.067%FNMA 3.250% 08/15/08 371,528.00 228 3.000% 9.13 9.13 0.120%FHLB-Called 4.600% 08/22/08 02/05/08 374,415.00 235 4.850% 9.49 9.49 0.196%FHLB 4.010% 09/17/08 03/17/08 347,995.00 261 4.860% 9.79 9.79 0.182%FHLB 4.570% 10/17/08 349,839.00 291 4.630% 10.98 10.98 0.175%FHLB 4.100% 11/26/08 02/26/08 348,218.00 331 4.700% 12.43 12.43 0.176%FNMA 4.550% 12/01/08 06/01/08 431,669.00 336 153 4.900% 15.64 7.12 0.228%FHLB-Called 5.000% 01/02/09 01/02/08 430,461.00 368 2 4.880% 17.08 0.09 0.227%FNMA-Called 4.100% 02/13/09 02/04/08 399,827.00 410 35 4.850% 17.68 1.51 0.209%FHLB 4.000% 02/23/09 02/04/08 357,265.00 420 35 4.700% 16.18 1.35 0.181%FHLB-Called 4.660% 04/13/09 01/16/08 369,290.00 469 16 4.810% 18.68 0.64 0.192%FFCB-Called 4.300% 06/09/09 01/25/08 303,205.00 526 25 4.730% 17.20 0.82 0.155%FHLB-Called 4.550% 07/14/09 01/28/08 209,365.00 561 28 4.760% 12.67 0.63 0.107%FHLB-Called 4.520% 08/26/09 01/28/08 119,538.00 604 28 4.770% 7.79 0.36 0.061%FHLMC-Called 4.500% 08/10/09 01/10/08 349,962.00 588 10 5.150% 22.19 0.38 0.194%FHLMC-Called 4.500% 08/10/09 01/10/08 159,982.00 588 10 5.150% 10.14 0.17 0.089%FHLB 4.280% 09/08/09 03/08/08 198,486.00 617 68 4.760% 13.21 1.46 0.102%FNMA-Called 4.500% 09/30/09 01/22/08 443,103.00 639 22 4.760% 30.53 1.05 0.227%FHLMC-Called 4.130% 10/09/09 01/30/08 291,661.00 648 30 4.800% 20.38 0.94 0.151%FFCB-Called 4.500% 11/13/09 02/01/08 1,404,513.00 683 32 4.320% 103.44 4.85 0.654%FFCB-Called 4.300% 11/18/09 02/01/08 98,985.00 688 32 4.880% 7.34 0.34 0.052%
Totals 9,273,773.00$ 391.37 79.41 4.507%
44
06/30/10 Final Effective Weighted
Issuer / Maturity Call Date Acquisition % of Days to Days to YTM Wtd. Avg. Wtd. Avg. Average
Security Coupon Date (if any) Cost Portfolio Final Call (Purchase Y) Maturity Maturity Yield
FNMA POOL 5.000% 11/01/10 $ 1,438,167.80 2.68% 124 0.308% 3.33 3.33 0.008%FNMA POOL 4.000% 12/01/10 $ 1,326,607.49 2.48% 154 0.164% 3.81 3.81 0.004%
FNMA POOL 4.500% 01/01/11 $ 1,630,747.40 2.30% 185 0.412% 4.25 4.25 0.009%
FNMA POOL 4.000% 06/01/11 $ 2,077,436.49 3.88% 336 0.667% 13.02 13.02 0.026%
FNMA 2.000% 08/12/13 08/12/10 $ 997,500.00 1.86% 1139 43 2.074% 21.20 0.80 0.039%
FHLB 1.000% 05/26/15 11/26/10 $ 1,000,000.00 1.87% 1791 149 1.000% 33.42 2.78 0.019%
FNMA 2.000% 12/30/15 12/30/10 $ 1,000,000.00 1.87% 2009 183 2.000% 37.48 3.41 0.037%
FNMA 4.100% 07/01/16 07/01/10 $ 1,012,434.23 1.89% 2193 1 3.889% 41.43 0.02 0.073%
FNMA 2.530% 05/04/17 08/04/10 $ 1,000,000.00 1.87% 2500 35 2.530% 46.65 0.65 0.047%
FHLMC 3.100% 05/19/17 $ 1,000,000.00 1.87% 2515 3.100% 46.93 46.93 0.058%
FNMA 2.000% 11/27/17 $ 1,000,000.00 1.87% 2707 2.000% 50.51 50.51 0.037%
FNMA 2.000% 12/18/17 09/18/10 $ 747,000.00 1.39% 2728 80 2.000% 38.02 1.12 0.028%
FNMA 3.000% 01/29/18 07/29/10 $ 1,000,000.00 1.87% 2770 29 3.000% 51.68 0.54 0.056%
FNMA 3.000% 02/12/18 08/12/10 $ 1,000,000.00 1.87% 2784 43 3.000% 51.95 0.80 0.056%
FHLB 2.500% 12/23/19 09/23/10 $ 1,000,000.00 1.87% 3463 85 2.500% 64.61 1.59 0.047%
FNMA 2.000% 02/24/20 02/24/11 $ 1,000,000.00 1.87% 3526 239 2.000% 65.79 4.46 0.037%
FNMA 3.000% 05/19/20 11/19/10 $ 1,000,000.00 1.87% 3611 142 3.000% 67.38 2.65 0.056%
FNMA 2.000% 06/16/20 06/16/11 $ 1,000,000.00 1.87% 3639 351 2.000% 67.90 6.55 0.037%
FHLMC POOL 6.000% 09/01/21 $ 1,313,080.36 2.45% 4081 4.945% 99.98 99.98 0.121%
FHLMC 4.000% 02/25/22 08/25/10 $ 1,000,000.00 1.87% 4258 56 4.000% 79.45 1.04 0.075%
FNMA 4.000% 05/28/24 08/28/10 $ 965,000.00 1.80% 5081 59 4.320% 91.49 1.06 0.078%
FNMA 5.125% 08/19/24 $ 478,514.06 0.89% 5164 4.848% 46.11 46.11 0.043%
FNMA 3.000% 09/30/24 09/30/10 $ 1,000,000.00 1.87% 5206 92 3.000% 97.14 1.72 0.056%
FHLMC 3.000% 02/02/25 08/12/10 $ 1,000,000.00 1.87% 5331 43 3.000% 99.47 0.80 0.056%
CD 12/28/10 $ 14,000,000.00 26.12% 181 2.650% 47.28 47.28 0.692%
Money Market 07/01/10 $ 13,594,074.82 25.36% 1 0.210% 0.25 0.25 0.053%
Totals $ 53,594,961.99 100.00% 1271.94 346.90 1.850%
How Many Callables is Too Many?
45
Security Selection - Structure
Mortgage backed securities may provide a performance opportunity for a small portion of the portfolio.
Source: Bloomberg 46
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Security Selection – Credit Analysis
Credit Exposure – Are you a sitting duck?
48
Practical Example – credit analysis
Lehman Brothers MTN 7 7/8% of August 2010
9/12/08 A rated
9/15/08 CCC- rated
9/16/08 D rated
3/1/08 A+ rated 6/2/08
A rated
March 17th 2008“JPMorgan scoops up troubled Bear”
CNN
“Many will say that standalone investment banks’ days are numbered”
49
Lehman Brothers Stock
Practical Example – credit analysis
50
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Risk Return Tradeoff
Drivers of Portfolio Performance
1. This is not your father’s yield curve
2. Three main drivers of performance
3. Duration is key
4. Look to new asset classes
5. Credit analysis is mandatory
6. Risk is just as important as return
7. The next major move is up
52