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Presenter:

Steven Alexander, CTP, CGFO, CPPTManaging Directoralexanders@pfm.com(407) 406-5750

June 19 2019 | 3:40 p.m. – 4:30 p.m.Tools for Developing a Successful Investment Program Learning Objective: When you complete this session, you should be able to: Recognize and discuss components that are essential in constructing and managing investment programs, including: month end statements, asset allocation reports, third-party custody statements, investment transaction reports, cash flow modeling, and investment policies

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Tools for Developing a Successful Investment ProgramJune 19, 2019

PFM Asset Management LLC

407.648.2208pfm.com

300 South Orange Ave,Suite 1170Orlando, FL 32801

Steven Alexander, CTP, CGFO, CPPTManaging Director

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Properly identifying assets for long-term

investment

• Maintaining purchasing power of assets

Properly diversifying assets

Manageable oversight of investment program

Challenges Public Entities Face

3

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• Does investing outside of a money market or pool make sense for me?• If yes, what components do I need to have a successful investment program?

• Do I have an investment policy in place?

• What securities should be used in these portfolios? • How much risk am I comfortable taking to achieve my goals?

• How much is available for investment? • Am I investing appropriately for my cash flow needs/maximizing investment

income?

• I have an investment portfolio, what do I do now?

Questions to Ask Yourself

3

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Policy should be structured to place the highest

priority on the:

• Safety of principal

• Liquidity of funds

The optimization of Returns shall be secondary

(yet important - maximize earnings through

diversification)

Compliance with legal restrictions/regulations

Flexibility/Simplicity

Provides a road map during periods of volatility

Developing an Investment Policy

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An Investment Policy Allows for Greater Diversification

Investment Options Without an Investment Policy

Investment Options With a written Investment Policy

• Local Government Investment Pools • Local Government Investment Pools

• SEC registered Money Market Funds • SEC registered Money Market Funds

• Interest-bearing time deposits or savings accounts • Interest-bearing time deposits or savings accounts

• U.S. Treasury Securities • U.S. Treasury Securities

• Federal Agency/GSE

• Supranationals

• Corporate Bonds

• Municipal Obligations

• Government Agency Mortgage-Backed Securities

• Asset-Backed Securities

• Certificates of Deposit

• Commercial Paper

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Sector Allocation Changes

State Pool

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Investment Policy Review Framework

S t a t e S t a t u t e s

A s s o c i a t i o n o f P u b l i c Tr e a s u r e r s o f

U S a n d C a n a d a G F O A

B e s t P r a c t i c e s

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APT US & C* Investment Policy Requirements

• Policy/Purpose• Scope• Prudence• Objective (Safety, Liquidity, Yield)• Delegation of Authority• Ethics and Conflict of Interest• Authorized Financial Dealers and Institutions• Authorized & Suitable Investments• Investment Pools/Mutual Fund Questionnaire • Collateralization• Safekeeping and Custody • Diversification• Maximum Maturities• Internal Control• Performance Standards• Reporting• Investment Policy Adoption• Glossary

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GFOA Investment Policy Best Practices

• Scope and investment objectives

• Roles, responsibilities, and standards of care

• Suitable and authorized investments

• Investment diversification

• Safekeeping, custody, and internal controls

• Authorized financial institutions, depositories, and broker/dealers

• Risk and performance standards

• Reporting and disclosure standards

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Cash Flow AnalysisCash Flow Analysis

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Cash Flow Analysis

• Determines your liquidity needs

• Identify short term vs. long term

• Short-term assets should be the primary source for near term disbursements

• Long-term/core assets are designed as a last resort for liquidity needs

• Enhances cash management - better understanding of timing of revenues and expenditures

• Results in more effective cash flow management, e.g. stretching out accounts payables and speeding up collection of receivable to finance part of the operations internally

• Identifies an optimal allocation of funds to maximize investment income

• Investment selection

• Purchasing power

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0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

7/15 9/15 11/15 1/16 3/16 5/16 7/16 9/16 11/16 1/17 3/17 5/17 7/17 9/17 11/17 1/18 3/18 5/18 7/18 9/18

Erosion of Purchasing Power - $100 Million Portfolio

Inflation Rate(Core PCE)

3 Month T-Bill Index

$2.9 millionlost purchasing

power

Bloomberg is the source of Inflation data. Loss is based on a starting portfolio size of $100,000,000. The 3 Month Treasury Bill Index is sourced from Bloomberg utilizing monthly data from 7/31/2015 –9/30/2018.

February 2017 Difference of 1.34%

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100,000,000

200,000,000

300,000,000

400,000,000

500,000,000

600,000,000

Jan-

13

May

-13

Sep-

13

Jan-

14

May

-14

Sep-

14

Jan-

15

May

-15

Sep-

15

Jan-

16

May

-16

Sep-

16

Jan-

17

May

-17

Sep-

17

Jan-

18

May

-18

Sep-

18

Jan-

19

Total - All FundsAnalysis of Core Portfolio

Cash Flow Analysis

Liquid Funds

Core Portfolio $146 million

Projected

Immediate Liquidity

Liquidity Reserve

Short-Term Liquidity

Core Portfolio

For illustrative purposes only

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Portfolio Segmentation and Strategy Considerations

Portfolio Segment Strategy Consideration Potential Characteristics

Immediate Liquidity Daily Liquidity• Bank operating cash• Money Market Funds • Local Government Investment Pools (LGIPs)

Short-Term LiquidityMaturity matched to

expenditures (3-6 Months)

• Maturities matched to know cash flow needs (i.e. debt service, construction, etc.)

• Commercial paper

Liquidity Reserve Short Duration Target(6 Months-2 Year Duration)

• Highly liquid securities- Securities/sectors with active secondary markets- Limited structure/optionality risk

• Allocation to high-quality, diversified credit securities to maximize the income potential of short duration needs

• Commercial paper, ABS, corporate notes

Core Portfolio Longer Duration Target(1-3, 1-5 years)

• Diversified across high-quality asset classes• Realize the benefits of a positively sloped yield curve• Greater focus on income generation (lower liquidity

profile)- Corporate notes, MBS, federal agencies

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Improving Diversification to Maximize IncomeCurrent Allocation Sample Allocation

Balance Yield Liquidity Tier Balance YieldBank

Account $6,000,000 0.07%

ImmediateLiquidity

Bank Account $6,000,000 0.07%

State LGIP 15,000,000 2.04% State LGIP 25,000,000 2.04%

Money Market Fund 5,000,000 0.47% Money Market

Account/LGIP 50,000,000 1.99%

Short Term Liquidity

Enhanced Cash Portfolio 147,000,000 2.27%

Liquidity Cushion Long Term Pool 40,000,000 1.64%

Long Term Pool 388,000,000 1.64% Core

Reserves Core Portfolio 146,000,000 2.46%

Total $414,000,000 1.62% Total $414,000,000 2.20%

Estimated Annual Earnings $6,696,900 Estimated Annual Earnings $9,093,700

For illustrative purposes only

Difference $2,396,800

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50

100

150

200

250

300

Jan-

15

May

-15

Sep-

15

Jan-

16

May

-16

Sep-

16

Jan-

17

May

-17

Sep-

17

Jan-

18

May

-18

Sep-

18

Milli

ons

Total - All FundsAnalysis of Core Portfolio

Historical Short-term Portfolio Historical Core Projected Short-term PortfolioSeries2 Projected Core

Total Core $222.8 Million

Projected

Immediate Liquidity

Liquidity Reserve

Core Portfolio

Liquidity Reserve

Cash Flow Analysis

For illustrative purposes only

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Improving Diversification to Maximize Income

Existing Allocation Sample AllocationBalance Yield Liquidity Tier Balance Yield

Bank Account $214,046,099 0.57%Immediate Liquidity

Bank Account $25,462,290 0.57%

Enhanced Cash Investments 41,995,405 1.56% Local LGIP 49,943,673 1.30%

Liquidity Reserves

Enhanced Cash Portfolio 155,448,439 1.79%

Core Portfolio 22,892,870 1.65% CoreReserves Core Portfolio 48,079,972 1.93%

Total $278,934,374 0.80% Total $278,934,374 1.62%

For illustrative purposes only

Estimated Annual Earnings $2,221,157 Estimated Annual Earnings $4,504,873 Difference $2,283,716

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In Summary

Short-term Portfolio

• Highly liquid funds to meet daily disbursements needs and unforeseen expenditures

• Funds to cover specific, predictable cash flows (i.e. payrolls, debt service)

• Can be lower during periods of net cash inflow

Core Portfolio

• Funds not expected to be spent, but may be disbursed in extraordinary circumstances

• Can be invested in longer-term securities to generate a higher expected return

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Investment Program Building Blocks

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Building Blocks of Portfolio Construction Process

Issuer & Industry Selection

Yield Curve

Sector Allocation• Focused sector allocation

• Identify attractive portions of the curve

• Manage interest rate risk

Duration

• “Roll down the curve” for enhanced earnings

• Increased income potential

• Thorough review of issuer-specific trends and credit profile

• Macroeconomic factors unique to the industry

• Disciplined approach to maintaining target duration

Interest rates are the headline, but they are not the foundation

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100%

70%

40%

30%

20%

20%

30%

30%

30%

30%

20%

30%

30%

30%

30%

10%

10%

10%

10%

10% 10%

Example 1-5 Year Portfolio Sector Allocation

Treasury Agency Corp A-AAA Mortgage-BackedSecurities

Asset-BackedSecurities

Corp BBB

Benefits of Diversification

Sample portfolio returns are based on the ICE BofAML 1-5 Year indices for all the sectors shown. Source: ICE BofAML Indices

0.0% 0.5% 1.0% 1.5% 2.0%

2017 Portfolio Returns

+0.50%

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Long-Term Performance Correlations

Correlations of sector indices from Sep, 1997 – Sep, 2017.

Correlation Matrix

Column1 Treasury Agency CorpAAA-A MBS Municipal ABS Corp

BBB

Treasury 1.00 0.94 0.59 0.79 0.62 0.56 0.32

Agency 1.00 0.70 0.87 0.68 0.68 0.44

Corporate AAA-A 1.00 0.66 0.62 0.76 0.84

MBS 1.00 0.68 0.63 0.48

Municipal 1.00 0.59 0.48

ABS 1.00 0.75

Corporate BBB 1.00

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$95

$100

$105

$110

$115

$120

Sep 08 Sep 09 Sep 10 Sep 11 Sep 12 Sep 13 Sep 14 Sep 15 Sep 16 Sep 17 Sep 18

Mill

ions

Risk/Return of Various Treasury Investment Strategies

Source: Bloomberg, Bank of America Merrill Lynch Indices, based on quarterly returns.

Risk/Return of Various Investment Strategies10 Years Ended September 30, 2018

Bank of America Merrill Lynch Index

Duration(years) Yield Annualized

Total ReturnCumulative Value of

$100 Million

1-Year Treasury 0.98 2.67% 0.71% $107,309,524

1-3 Year Treasury 1.87 2.81% 1.09% $111,432,388

1-5 Year Treasury 2.64 2.86% 1.63% $117,555,071

1-Year Treasury

1-3 Year Treasury

1-5 Year Treasury

Growth of $100 Million PortfolioSeptember 30, 2008-September 30, 2018

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Cash/Securities Information

Investment strategyTrade execution

Competitive biddingTrade coordination

Approved Broker-Dealers

The Entity’s Custodian

Bank

Trad

e Ex

ecut

ion

Investment Advice

Cash TransactionsCash only moves between the

Entity and custodian bank

Trade SettlementVia Federal Reserve “Delivery

versus Payment” system

Best Practice Discretionary Trade Process

City, Town, County,

Authority, School District

Investment Manager

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Monitoring Your Investment Program

Investment Advisor

Investment Committee

Quarterly Performance Report

Monthly Statement

Custody Statement

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Quarterly Performance Report

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Performance Reporting

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Total Return and Yield

Returns shown could be:

• Total Return

• Yield

Returns are retrospective

Yields are prospective

Total Return takes into account

• Interest earnings

• Realized gains/losses

• Unrealized gains/losses

Total Return =

𝐸𝐸𝐸𝐸 − 𝐵𝐵𝐸𝐸 − 𝑁𝑁𝑁𝑁𝑁𝑁𝐵𝐵𝐸𝐸 + 𝑊𝑊𝑁𝑁𝑁𝑁

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Total Return – Income + Price Return

-10%

-5%

0%

5%

10%

15%

20%Series2 Price ReturnIncome Return

9.95%

6.84%

4.46%

0.75%

Source: Bloomberg, BofA Merrill Lynch 1-5 Year U.S. Treasury Index, as of 12/31/17.

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Using Benchmarks in Portfolio Management

Identification and Explanation• Specifically identified and explained before implementing the

proposed portfolio strategy Comparability

• Be representative of the policy guidelines and investment strategy

Direction• Provide PM with an understanding of investment goals and

objectives Investable & Unambiguous

• Data should be available with the names and weights of the securities comprising the benchmark

• Security type can be purchased in the Market Measurable

• The benchmark return is readily available through 3rd party sources (WSJ, Bloomberg)

• Independent representation of the market

Typical Benchmarks* include:

• Merrill Lynch 1 Year T-Note Index

• Merrill Lynch 1-3 Year Treasury and Agency Index

• Merrill Lynch 1-5 Year Corporate and Government Index

• Barclays Capital 1-3 Year Government Index

*This is a partial listing of available benchmarks

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Duration ComparisonComparing portfolio duration to

prior period and benchmark show investment managers strategy with regard to the direction of

interest rates

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Deconstructing Duration

Duration BehaviorLower Higher

Factor Duration Duration

Term to maturity shorter longerCoupon rate higher lowerMarket yield level higher lowerFrequency of coupon quarterly annual

Simply defined, duration is a measure of a security’s or portfolio’s interest-rate sensitivity.

Duration is similar to, but more precise, than average life or average maturity. The longer the duration of a security or portfolio, the more sensitive it is to changes in interest rates.

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Portfolio Maturity vs. Benchmark

Comparing portfolio maturity distribution to benchmark

confirms managers interest rate strategy as well as value

along the yield curve

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Active Duration ManagementAv

erag

e D

urat

ion

Time

LowerLimit

Target

UpperLimit

Neutral

Expect LowerRates

Expect HigherRates

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Portfolio Characteristics

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Transaction Reports

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Transaction Reports

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Investment Policy Compliance

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Investment Policy Compliance

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Reconcile Month-End Statements

Coupon Rate

Maturity Date

CUSIP Par Value Settlement Date Original Cost Accrued Interest Market Value

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Custody Statement vs. Investment Manager Statement

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Different Financial Companies Use Different Pricing Sources

Pricing sources can vary from third party vendors such as Bloomberg, ICE Data Services and Thomson Reuters to a custodian’s internal pricing group.

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Important Disclosures

This material is based on information obtained from sources generally believed to be reliable and available to the public, however PFM Asset Management LLC cannot guarantee its accuracy, completeness or suitability. This material is for general information purposes only and is not intended to provide specific advice or a specific recommendation. All statements as to what will or may happen under certain circumstances are based on assumptions, some but not all of which are noted in the presentation. Assumptions may or may not be proven correct as actual events occur, and results may depend on events outside of your or our control. Changes in assumptions may have a material effect on results. Past performance does not necessarily reflect and is not a guaranty of future results. The information contained in this presentation is not an offer to purchase or sell any securities.

The views expressed within this material constitute the perspective and judgment of PFMAM 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 if 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.

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