1 sofia anastopoulos, cfa senior manager gfoa research & consulting 312-578-2292,...

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Sofia Anastopoulos, CFASenior ManagerGFOA Research & Consulting 312-578-2292, [email protected]

INVESTING BASICS

SC GFOA Conference

Sheraton Convention Center, Myrtle Beach,South Carolina

October 13, 2008

mailto:[email protected]

2©2008. Government Finance Officers

Association

Investment Framework & Policy

Internal ControlSafekeeping

CDs and collateralization


Association

TREASURY & INVESTMENT MANAGEMENT

All activities undertaken to insure liquidity and maximum investment return on government’s idle cash

Balancing act – risk and return liquidity while maximizing return


Association

TREASURY MANAGEMENT

Cash mobilizationGet cash in as fast as you can

Cash concentration Investing – Do something worthwhile with cash

DisbursementRelease cash efficiently

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INVESTMENT FRAMEWORK & POLICY


Association

FIDUCIARY

Individual or institution

Special relationship of trust with another person or group

Legally responsible for assets


Association

FIDUCIARY

EXAMPLES

TreasurersFinance directors Investment personnel Oversight boards Investment advisersBrokers are NOT


Association

FIDUCIARY

Legally bound to:

Make decisions in the best interest of the beneficiary

Act prudently

Always put the beneficiaries’ interests before their own


Association

PRUDENCE

Original standard of investment care – Prudent Person

Consider safety and yield of an investment

“ to exercise the judgment and care, under the circumstances then prevailing, which persons of prudence, character and intelligence in the management of their own affairs, not in regard to speculation but in regard to the permanent disposition of their funds, considering the probable income as well as the probable safety of their capital.”


Association

PRUDENCE

Limitations - did not address how investment fits into overall portfolio

Evolving standards of fiduciary duty Prudent InvestorPrudent Expert


Association

INVESTMENT POLICY

WHY?

Defines investment program Legal & permitted activities Who’s in charge Measurement of results Relationship to counterparties

Protection

Dynamic process


Association

COMPONENTS

Scope Funds covered by policy

Different funds have different objectives

INVESTMENT POLICY


Association

COMPONENTS

Objectives

Safety Liquidity Yield/return (SLY) Other

Conform to laws

INVESTMENT POLICY


Association

COMPONENTS

Standards of Care Prudence

Ethics & conflict of interest• Existing guidelines for the entity• Expectations of investment personnel• Guidelines for handling deviations

Delegation of authorityCite statutesIdentify personnel by titleDiscuss personal liability

INVESTMENT POLICY


Association

COMPONENTS

Investment Instruments State statutes - legality Risk tolerance Selection & purchase of investments Collateralization

Authorized institutions

INVESTMENT POLICY


Association

INVESTMENT POLICY

Investing is fundamentally a balancing act

risk and return

So investment policy should address risk & establish a risk tolerance

Diversification


Association

INVESTMENT POLICY

Risks

Credit (default) risk Risk that all / some of principal and interest will be

lost

To mitigate credit risk:know your banks and/or broker-dealersRequire delivery-versus-paymentLimit investments to those of highest credit quality


Association

INVESTMENT POLICY

Liquidity Risk

Ability to sell investment (prior to maturity) Some short-term investments are relatively illiquid

Marketability – ability to sell security on short notice without incurring meaningful loss in price


Association

INVESTMENT POLICY

Market Risk

Risk value decreases due to changes in market Interest rate risk

Reinvestment RiskRisk that cash flows from securities reinvested at a lower rate than original investment callable


Association

INVESTMENT POLICY

Reputational Risk

Risk that mistakes negatively harm reputation of government and official

Loss of stature


Association

GFOA RP-DIVERSIFICATION

Fiduciary responsibility to reach objectives: safety, liquidity, return

Greater risk typically increases returns

Effective management of risk critical to achievement of objectives


Association


Diversification-useful strategy for managing risk

Establish risk profile Use profile to determine levels of diversification

Can be achieved by investing in variety of securities with dissimilar risk characteristics

Areas where diversification can be achieved include:

Maturity distributionSector allocationIssuer allocationStructures


Association


Recommendations

Government investors should:

Define objectives

Prepare cash flow – determine liquidity

Consider political climate

Use LGIPs, repos, MMMF to ensure liquidity day-to-day

Establish limits on specific securities specific business sectors


Association


Recommendations

Government investors should:

Develop guidelines for investing in single classes

Limit investments in securities with high credit and/or market risk

Limit particular structures

Define maturity/duration ranges

Establish risk profile for portfolio


Association

COMPONENTS

Safekeeping

• Third-party• Delivery versus payment (DVP) settlement

Internal Control

INVESTMENT POLICY


Association

COMPONENTS

Accounting GAAP

Reporting specify types and frequency of reports

provide information for wide audiences both technical and easy-to-read

Monitoring and adjusting the portfolio marking-to-market

INVESTMENT POLICY


Association

COMPONENTS

Performance evaluation Benchmarks

Criteria for selecting benchmarks Minimum yield standards Methods of calculation

INVESTMENT POLICY


Association

COMPONENTS

Appendices Authorized personnel - title Statutes, ordinances, etc. Authorized broker-dealers Authorized depositories B-D questionnaire and certification

INVESTMENT POLICY


Association

COMPONENTS

Appendices (cont’d)

Master repurchase agreementSafekeeping agreementWire transfer agreementCollateralization agreementSample investment reportsFormulas for returnsInternal control checklistGFOA recommended practices

INVESTMENT POLICY


Association

ADDITIONAL POLICY THOUGHTS

Internal document Involve staff responsible for investments

External document Distribute to outside parties

Board approval As resolution, ordinance, etc.

Annual reviews & updates

INVESTMENT POLICY


Association

HELP

Government Finance Officers Association “Sample Investment Policy”www.gfoa.org

INVESTMENT POLICY

http://www.gfoa.org/

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INTERNAL CONTROL


Association

INTERNAL CONTROL

There are two ways to steal funds from governments…

On the way in and on the way out!


Association

INTERNAL CONTROL

Citizens/tax payers have 2 expectations for their money

Safeguarded

Spent wisely for authorized purposes


Association

INTERNAL CONTROL

Process

determined by an organization's people and information technology (IT) systems

designed to help the organization accomplish specific goals

helps direct, monitor, measure entity’s resources

protects from fraud, misuse, poor decisions, errors, loss


Association

INTERNAL CONTROL

ORGANIZATIONAL STRUCTURE

Management’s attitude

Familiarize staff with formal procedures and internal control

Train managers to detect erratic employee behavior

Mandate reporting of perceived impropriety or errors

Implement and communicate consequences

Provide professional development


Association

INTERNAL CONTROL

ORGANIZATIONAL STRUCTURE OR DESIGN

Segregate duties

1. Authorization of transactionsClear lines of authority and authorizationsLevel of authorizations spelled out in proceduresOne “go-to” person for questions

2. Execution of transactions3. Recording of transactions4. Reconciling of transactions5. Maintaining custody / control of assets

Custody separate from accounting collusion


Association

INTERNAL CONTROL

ORGANIZATIONAL STRUCTURE OR DESIGN

Segregate duties

Harder for small entities but “do-able”Management’s awareness of issue helps

Perhaps other controls implementedMandatory vacationsRotating tasks


Association

INTERNAL CONTROL


HR – PERSONNEL

Pre-employment screeningCheck references and credentialsStrict screening for financial positions with bona fide security requirements

Check background and creditTest skills, knowledge and accuracyRequire drug tests


Association

INTERNAL CONTROL


HR – Human Resources

Mandatory VacationsHard to cover up when someone else takes over the position

Document policies

Train, train, train


Association

INTERNAL CONTROL

PRE-EMPLOYMENT SCREENING

Check references and credentials

Strict screening for financial positions with bona fide security requirements

Check background for criminal activity

Test skills, knowledge and accuracy

Require drug tests


Association

INTERNAL CONTROL

TRAININING

Minimize loss from judgment errors and technical mistakes

Familiarize staff with formal procedures and internal control

Train managers to detect erratic employee behavior

Mandate reporting of perceived impropriety or errors

Provide professional development


Association

INTERNAL CONTROL

RISK ASSESSMENT

Asses risks, determine risk tolerance and develop response

Identify - What loss could occur?

Evaluate - What is probability it might occur? frequency ? magnitude of loss or negative effect?

Risk appetite

What is our response? avoid?

Do the costs of establishing IC outweigh benefits ?


Association

INTERNAL CONTROL

IMPLEMENTATION

Employees must buy into and understand the need for controls

Procedures should be understandable and make sense

Consequences for noncompliance or willful neglect of procedures should be established and enforced


Association

INTERNAL CONTROL

MONITORING

Internal audits

• Authorization and execution• Recording and accountability• Exception monitoring• Safeguards

External audits• Routinely change external audit firms


Association

INTERNAL CONTROL

RED FLAGS OF FRAUD

Ineffective IC Limited or NO segregation of dutiesNo reconciliation Lifestyle changes

New cars, jewelry, houses, tripsSignificant personal problems

Debt or credit problemsHigh turnoverRefusal to take vacationReluctance to provide info to auditorsFrequent disputes with auditorsFrequent changes in external auditors


Association

INTERNAL CONTROL

RED FLAGS OF FRAUD

Excessive number of checking accountsFrequent changes in banking accountsExcessive year end transactionsPhotocopied or missing documents

Stuff that just doesn’t seem right


Association

SECURITY DELIVERY

Strongly recommend delivery vs. payment (DVP) ONLY

Settlement procedure where payment for securities is simultaneous to transfer of purchased securities.

Ensures funds are released only upon receipt of securities, thus protecting government

Delivered to your custodian who is your agent

Perfected ownership

In your control through your custodian


Association

CONCLUSION

Plan

Policies and procedures

Internal Control

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LEARN MORE


GFOACash Committee Resources

Reference Library samples, agreements


1 sofia anastopoulos, cfa senior manager gfoa research & consulting 312-578-2292,...

Documents

investment fits

maximum investment return

returnso investment

probable safety

cashdisbursementrelease

policydifferent funds

risk establis

beneficiary act