Chandler Asset Management | info@chandlerasset.com | chandlerasset.com | 800.317.4747

CGFOA Western Slope Coalition

Investing Public Funds

April 29, 2016

Ned Connolly, CCM SVP, Relationship Manager

Key Components of Investment Program

•  Fiduciary Duty

•  Decision-Making Process

•  Investment Policy and Procedures

•  Cash Flows

•  Documentation and Reporting

2

Fiduciary Duty

3

Fiduciary

•  An individual or institution that has a special relationship of trust with another person or group legally responsible for their assets. Examples include: v  Treasurers v  Finance Directors, v  Investment Personnel, v  Oversight Boards, v  Investment Advisers. v  Brokers are NOT fiduciaries at this time.

•  By law a fiduciary must: 1.  Make decisions in the best interest of the beneficiary; 2.  Always put the beneficiaries’ interests before their own; and, 3.  Act prudently.

4

Prudence Standard

1.  Prudent Person

2.  Prudent Investor

3.  Prudent Expert

Prudence language typically includes statement similar to:

“…shall act with care, skill, prudence, and diligence under the circumstances then prevailing…that a prudent person acting in a like capacity and familiarity with those matters would use…”

5

Compliance with Fiduciary Duty

•  Test of fiduciary duty compliance is one of conduct, not performance

•  Measures for evaluating compliance v  Establishment of formalized investment policy v  Compliance with policy v  Prudent investment decisions v  Best price trade executions v  Diversification of risk v  Strict avoidance of conflicts of interest

6

Developing a Decision-Making Process

Importance of an Investment Plan

8

•  Provides discipline in managing risk

•  Helps manage return expectations

•  Establishes accountability

•  Promotes communication

Portfolio Management Considerations

9

•  What are the objectives of the investment program

•  What are the investment constraints v  Government Code v  Investment Policy v  Agency risk tolerances v  Investment staff experience

•  What strategies can be implemented that achieve stated objectives and are compliant with constraints

Determining Portfolio Structure

1.  Cash flow analysis a.  Identifies near-term (6-12 months) funding needs, trends for high

and low balances and seasonal patterns

2.  Liquidity portfolio a.  Often expressed as percentage (e.g.10-20%) of total portfolio b.  Typically invested in:

I.  Liquidity accounts: LGIPs, MMMFs, Bank Accounts II.  Money market instruments: T-Bills, Discount Notes,

Commercial Paper

3.  Core/Reserve portfolio(s) a.  Invested longer-term and more diversified for potential for higher

earnings and principal growth

10

Determining Appropriate Strategies

1.  Passive or Active 2.  Interest rate exposure

a.  Maximum maturity b.  Weighted average maturity c.  Weighted average duration

3.  Credit exposure (asset classes) a.  Treasuries, agencies, corporate securities, municipal

securities, etc.

4.  Benchmark selection a.  Total return market benchmarks b.  Similar risk profile to investment style selected

11

Managing Risk

1.  Interest rate/market risk a.  Portfolio duration

i.  Equal to; longer than; shorter than benchmark duration b.  Maturity structure

i.  Ladder; Barbell; Bullet

2.  Credit risk a.  Allocation limits to asset classes and issuers b.  Minimum credit ratings c.  Ongoing credit analysis and monitoring

3.  Prepayment risk a.  Callable securities b.  Amortizing securities

4.  Liquidity risk 12

External Factors

1.  Economic environment

a.  Expanding/contracting b.  Employment c.  Inflation d.  Monetary Policy e.  Fiscal Policy

13

2.  Market environment a.  Shape of yield curve b.  Interest rate expectations c.  Spread analysis

3.  Global environment a.  Economic b.  Markets c.  Geo-political

Oversight, Evaluation, Rebalancing

1.  Ongoing compliance monitoring

2.  Reporting a.  Monthly accounting for investments b.  Performance

i.  Weighted average yield ii.  Total return iii.  Comparison to benchmark total return

3.  Rebalancing a.  Bring back in line with duration target b.  Reallocate sector percentages

14

Comprehensive Investment Program

Statutes &

Investment Policy

Disciplined Management

Process

Optimal Investment

Program

Cash Flow

Modeling

Reporting &

Review

Compliance Monitoring

Investment Style

& Benchmark

15

Investment Policy &

Investment Procedures

16

Governance of Public Funds

•  State Statutes specify: v  Investment types v  Maximum maturity v  Potential partners v  Credit criteria v  Reporting v  Safekeeping

•  Entity’s Investment Policy

•  Bond Indentures

17

Why an Investment Policy?

•  GFOA’s Best Practice on “Creating an Investment Policy” starts with: “A written investment policy is the single most important element in a public funds investment program.”

•  Why? v  It improves the quality of decisions v  It demonstrates a commitment to the fiduciary care of

public funds, with emphasis on balancing safety of principal and liquidity with yield.

v  It signals to rating agencies, the capital markets, and the public that a government entity is well managed and is earning interest income suitable to its situation and economic environment. 18

What Does an Investment Policy Do?

•  Defines the investment program v  Legal and permitted activities and investments v  Who’s in charge v  Measurement of results v  Relationship to counterparties

•  Provides protection for the agency

•  Addresses the dynamic nature of the investment process

19

Policy Components - 1

1.  Introduction and Statement of Intent v  Overview of entity v  Sound fiscal management v  Adoption of policy v  Approval by governing board

2.  Scope v  Funds covered by policy

3.  Objectives v  Safety, liquidity, yield/return (SLY) & others

4.  Delegation of Authority

5.  Statement of Prudence, Indemnification & Ethics 20

Policy Components - 2

5.  Authorized Investments & Transactions v  Research state statutes v  Risk tolerance v  Types of securities & transactions v  Maximum maturities & weighted average maturities v  Credit criteria v  Repurchase agreement criteria

6.  Collateralization v  Repurchase Agreements v  Bank deposits

21

Policy Components - 3

7.  Local Government Investment Pools/Mutual Funds v  Criteria for evaluating pools and mutual funds

8.  Authorized Financial Institutions, Depositories & Broker/Dealers v  Criteria for selection v  Competitive trade executions

9.  Delivery, Safekeeping and Custody v  Criteria for selecting custodian v  Delivery versus payment (DVP) settlement

§  Fed wire §  Depository Trust Company (DTC)

22

Policy Components - 4

10.  Risk Management and Diversification v  Addresses how market and credit risk will be managed v  Maximum maturities, weighted average maturities, weighted

average duration v  Diversification among asset classes and issuers v  Liquidity targets v  Prohibited investments and practices

11.  Reporting v  Disclosure of activities & holdings v  Methods for calculations v  Frequency of reports & who receives them

23

Policy Components - 5

12.  Performance Benchmarks v  Criteria for selecting benchmarks v  Minimum yield standards v  Methods of calculation

•  Policies will often have a “Glossary of Terms” that follow the body of the Policy

24

Additional Policy Thoughts

•  Start by v  Examining State Statutes v  Review sample investment policies, but don’t just copy

•  The Policy is an internal document v  Involve staff responsible for investments v  Prepare draft of new policy and anytime making revisions v  Have the right parties review the drafts

•  The Policy is an external document v  Distribute to outside parties

•  Get governing body approval v  As resolution, ordinance, etc.

•  Perform annual reviews & updates 25

Investment Policy Resources

•  Government Finance Officers Association v  “Sample Investment Policy” v  (312) 977-9700 www.gfoa.org

•  Association of Public Treasurers v  “Model Investment Policy” v  (202) 737-0660 www.aptusc.org v  Policy certification program

26

Investment Procedures

•  An Investment Procedures Manual assists the staff in day-to-day operations of the investment program

•  It should include explicit delegation of authority for executing transactions and investment decisions and include reference to procedures like: v  Review of daily cash balances v  Process for selecting investments v  Steps for purchasing an investment v  Settlement and safekeeping process v  Wire transfer agreements v  Banking service contracts v  Collateral/depository agreements

27

Internal Controls

•  Internal controls are designed to ensure assets are protected from loss, theft or misuse and should address the following areas:

v  Control of collusion v  Separation of investment transaction authority from

accounting and recordkeeping v  Third-party safekeeping of assets v  Clear delegation of authority to subordinate staff members v  Staff training v  Dual authorization of wire transfers v  Written confirmation of telephone transactions for investments

and wire transfers

28

Cash Flow Forecasting

What is a Cash Flow Forecast

•  Projection of anticipated cash receipts

•  Projection of anticipated cash disbursements

•  To create an estimate of investable cash balances v  Liquid funds v  Reserve funds

•  “Cash” is the operative word in “cash flow forecasting”. v  It is not accruals or budgeted funds v  Only cash is spendable or investable!

30

Identify Liquid & Reserve Balances

•  Total balances are trending higher

•  But balances fluctuate throughout the year

•  The “Liquid Balances" are established to meet cash needs

•  The “Reserve Balances" are generally stable and available for longer-term more diversified investing

Reserve Balances

Liquid Balances

Entity’s Balances 5 Year Period

31

Objectives Of Cash Flow Forecasting

•  Ensure sufficient liquidity for 6-12 month disbursements

•  Improve investment earnings by v  Matching sources and uses of funds v  Investing reserve/core funds longer-term and more diversified v  Managing investment risks

§  Liquidity risk §  Market risk

•  Identify Short-term Cash Deficits

•  Warn of Impending Budget Problems 32

Annual Cash Flow Forecasts

•  Estimates monthly cash position

•  Determines cash available for investments of more than 30 days

•  Provides a useful monthly overview for investment decision-making

•  Prepared for this fiscal year and next one to three fiscal years

33

Creating Annual 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

•  Schedule of current investments and coupon payments

34

Identify Revenues and Expenditures

Major revenues

v  Property tax

v  Sales and use tax

v  User fees

v  Shared revenues

v  Non-recurring §  Bond proceeds

v  Other

Major expenditures

v  Payroll and benefits

v  Operating expenses

v  Debt service

v  Capital projects §  Draw-down schedule

v  Non-recurring

v  Other

35

Sources of Information

•  Historical Data from General Ledger

•  Historical Data from Bank and Pool Statements

•  Current Year Budget

•  Capital Project Spending Projections

•  Schedule of Investment Maturities and Coupon Payments

36

Annual Cash Flow - Example

Beg.Balance Jan-15 Feb-15 Mar-15 Apr-15 May-15Liquid Fund Balances 95,542,961 94,422,259 93,301,557 92,180,855 91,060,153 89,939,451

InflowSales Tax Collections 3,516,116 3,516,116 3,516,116 3,516,116 3,516,116Property Tax Collections 10,507,259 10,507,259 10,507,259 10,507,259 10,507,259Intergovernmental 10,264,623 10,264,623 10,264,623 10,264,623 10,264,623Other Revenues 7,919,282 7,919,282 7,919,282 7,919,282 7,919,282

OutflowsPersonnel (12,778,319) (12,778,319) (12,778,319) (12,778,319) (12,778,319)Operating & Maintenance (1,199,030) (1,199,030) (1,199,030) (1,199,030) (1,199,030)Charges for Services (11,597,717) (11,597,717) (11,597,717) (11,597,717) (11,597,717)Debt Service (1,093,706) (1,093,706) (1,093,706) (1,093,706) (1,093,706)Other Expenses (6,659,210) (6,659,210) (6,659,210) (6,659,210) (6,659,210)

Actual/Projected Net Change (1,120,702) (1,120,702) (1,120,702) (1,120,702) (1,120,702)

Projected Liquid Balance 94,422,259 93,301,557 92,180,855 91,060,153 89,939,451Projected Invested Balance 141,565,000 141,565,000 141,565,000 141,565,000 141,565,000Total Projected Balance 285,268,483 285,268,483 285,268,483 285,268,483 285,268,483

Actual Liquid Balance 85,862,465 203,231,573 124,216,038 201,625,430 150,181,434Acutal Invested Balance 141,565,000 146,645,000 146,645,000 146,645,000 149,645,000Total Actual Balance 227,427,465 349,876,573 270,861,038 348,270,430 299,826,434Difference (57,841,018) 64,608,090 (14,407,445) 63,001,947 14,557,951

37

Funds Balance Cash Flow

Month Beg.Balance CashInflows CashOutflows NetChangeJanuary-15 95,542,961 243,572,384 -253,257,765 -9,685,381February-15 85,857,580 143,962,217 -26,607,427 117,354,790March-15 203,212,370 41,584,603 -119,098,784 -77,514,181April-15 125,698,189 94,526,488 -17,116,990 77,409,497May-15 203,107,686 33,277,738 -84,727,349 -51,449,611June-15 151,658,075 102,278,132 -76,404,216 25,873,915July-15 177,531,991 2,747,874 -36,416,262 -33,668,388

August-15 143,863,603 32,888,804 -39,493,932 -6,605,128September-15 137,258,475 251,833,487 -251,697,780 135,707October-15 137,394,182 242,834,825 -242,187,729 647,095

November-15 138,041,277 232,485,117 -239,719,807 -7,234,690

LowBalance $85,857,580HighBalance $259,994,231

Prior12Months $155,641,677Prior36Months $159,324,198

AverageBalance

ForPeriod

ConsolidatedCashFlowFundsBalance

38

Graphing Balances Over Time

0

50,000,000

100,000,000

150,000,000

200,000,000

250,000,000

300,000,000

Liquidity+ReserveFundsBalance

Beg.Balance

39

Challenges to Developing Forecasts

•  Systems v  Limitations of computer systems for historical data or data

management

•  Physical structure v  Locations of people

•  Political v  Elected officials agenda

•  Inter-departmental communications v  Departments not understanding importance of information

40

Review and Maintain Cash Flow 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

41

Documentation and Reporting

Documentation, Disclosure, Evaluation

•  Trade documentation is important for internal accounting and controls against potential errors, loss and theft v  Trade ticket v  Broker confirmation v  Custodian statements

•  Comprehensive monthly reports v  Summary of portfolio characteristics v  Accounting of investments

•  Performance results – GIPS standards v  How is risk being managed versus benchmark

43

Trade Ticket

44

Broker/Dealer Confirmation

45

Custodian Holdings Report

46

Importance of Reporting

•  Investment reports disclose information needed for effective oversight in monitoring compliance with constraints and objectives v  Security description: par amount, issuer, coupon, maturity,

yield, cost, credit rating, market value, v  Risk diversification v  Yield and total return measurements v  Compliance with investment constraints v  Transaction ledger

•  Reports help instill a sense of disclosure and openness and serve to keep stakeholders informed about the entity’s investment program

47

48

Portfolio Summary

48

49

Monthly Compliance Report

49

50

Holdings Report

50

51

Transaction Ledger

51

52

Income Earned

52

53

Cash Flow Report

53

54

Issuer Report

54

Accounting Considerations

•  Book value vs. cost v  Will you amortize premiums and accrete discounts or carry at

original cost?

•  Yield vs. total return v  Yield - measures income v  Total return - measures outcomes of investment strategies

•  Calculating weighted average maturity (WAM), weighted average duration (WAD) and weighted average yield (WAY)

•  Accruing interest v  Purchased interest v  Monthly accrual

55

Evaluating Results

•  Portfolio management is risk management v  Market/interest rate risk v  Credit risk v  Liquidity risk v  Prepayment risk

•  How well is investment risk being managed? v  Is liquidity sufficient to fund disbursements for the next 6-12

months? v  What is the appropriate market (total return) benchmark

based on the entity’s investment objectives and constraints? v  Is there appropriate duration distribution and credit

diversification versus the benchmark given the current market and economic environment?

v  What is the current and historic total return and yield versus the benchmark? 56

Portfolio Characteristics

57

Sector Distribution

58

Duration Distribution

59

Investment Performance

60

Biography

61

Ned Connolly Senior Vice President, Relationship Manager

Ned Connolly is Senior Vice President of client service. He is a member of the firm’s Client Service team which develops client relationships and coordinates the delivery of services related to the review and implementation of recommended practices. Ned works with public agencies in writing and revising investment policies and procedures, developing cash flow projections and providing investment education for finance staff. Ned joined the firm in 2004. He has 33 years of experience in the investment industry in the areas of institutional fixed-income investing and portfolio management. Ned has been a member of the Government Finance Officers Association’s (GFOA) Committee on Treasury and Investment Management. He has spoken on a variety of investment topics before numerous regional and national organizations. Ned received his B.A. from Boston College and holds the designation of permanent Certified Cash Manager (CCM) through the Association for Financial Professionals.