fundamentals of treasury investingnyce.tmany.org/2014/wp-content/uploads/2014/02/nyce-2014.pdf ·...

Information Security Identification: Confidential

FUNDAMENTALS OF TREASURY INVESTING

PRESENTED BY: KIRK BLACK


AGENDA

I. Introduction

II. Active investing

III. How fixed income markets function

IV. Passive and hybrid investment strategies

V. Taxable equivalent yield

VI. Things to watch

VII. Questions ?

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Treasury Investing—An Exercise in Safety

3

Treasury investing not predominately return driven like other types of

investing

Objectives

• Safety – The entire principal amount invested needs to return

• Liquidity – Treasury must have access to the funds immediately

when they are needed

• Yield – Only an objective once the first two are clearly met

To ensure objectives are met, organizations establish and maintain

investment policies

• Board review and approval initially and with any changes

• Controls in place and tested to insure adherence

• Parameters include investment types, duration, minimum ratings

requirement, country exposure, maximum amounts


Investment Strategies

4

Active Strategy-- in house trading desks buying and selling individual

securities. Not as common in practice

Passive Strategy– a more hands off approach with monies deposited in a

bank or investing outsourced to an asset manger

Money market funds

Separately managed accounts

Earnings credits

Hybrid– in between pure passive and active

Portfolio of money funds

Buy and hold

Tax Based– company with high tax rate seeks tax advantaged returns

In practice– most are passive or hybrid


Investment Strategies

5

Active strategy—client uses a broker dealer or an online system to actively

and frequently trade in short-term, fixed income securities

Commercial paper Bank obligations

US Treasuries Repurchase agreements

Agencies Floating rate notes

Municipal securities

Typically larger more sophisticated investors who have a good handle on

their cash flow forecasts

The upside with an active strategy over a passive strategy is enhanced

yield

Typically the longer the maturity and or lower the credit quality, the higher

the yield


Normal Yield Curve

6


Yield Curve – Flat vs Steep

7


Inverted Yield Curve

8


Types of Active Investing

9

Bullet

• Investor has 100MM and invests the entire 100MM to mature on

one specific date in the future

• Ideal if know need the money on a specific date in the future

Barbell

• Investor has 100MM and invests 50MM in an overnight liquid

investment and 50MM to mature at some point in the future

• Ideal when have short-term liquidity needs combined with long-term

component

Ladder

• Investor has 100MM and invests in instruments that mature 25MM

every three months

• Cash flow matching. Typically used for project funds


Risks of Active Investing

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Credit Risk

• The risk of an issuer defaulting on a security

• Mitigate with ratings and other independent research

Liquidity Risk

• The risk a security cant be sold quickly without incurring loss

• Mitigate by market monitoring and accurate cash forecasting

Price/Interest Rate Risk

• Interest rates and security prices have inverse relationship

• When rates rise, security prices fall

• Mitigate by market awareness in a rising rate environment


Key Yield Calculations

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Holding Period Yield = (cash received at maturity – amount invested)/ amount

invested

Annual Yield = Holding Period Yield x (days in a year/ days to maturity)

Money market quotes and pricing always based on 360 day year

Treasury bills, commercial paper, and certain other instruments sold at a discount to

stated par value. Difference is the income

Example: Par value $1000, purchase price $950, matures in 9 months

Holding Period Yield = (1000 – 950)/950 = .0526

360 day basis yield = .0526 x (360/270) = .0701

365 day basis = .0701 x (365/360) = .0711 = 7.11%


Money Market Funds

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Passive strategy--money market fund a portfolio of high quality securities

regulated by rule 2a-7 of SEC with primary goals of safety and liquidity

Ratings agencies apply even more stringent standards for AAA rating

Fixed $1 net asset value (NAV)

Offered by major players in financial industry – Dreyfus, Federated, Fidelity,

JP Morgan, Morgan Stanley, BlackRock, etc

Significant growth over the past decade to a nearly $4 trillion industry

Traditionally investors conducted minimal due diligence and wanted AAA

fund with highest yield

The 2008 market collapse changed everything


Money Market Funds

13

One large fund ‘broke the buck’ with the collapse of Lehman and a couple

others stopped redemptions. Mass redemptions from funds

The US treasury stepped in with the money fund guaranty program and

Fed with commercial paper conduit

The SEC imposed tougher regulations 2010

• 10% and 30% liquidity

• More stringent credit requirements

Funds rebound and reach their all time high of nearly 4 trillion around the

end of 2009

Procedures changed around due diligence with a sharp focus on the

underlying holdings and liquidity of funds


Methods of Money Fund Investing

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Call the fund or use the fund web-site

Transact through a broker-dealer

Automated investment sweep

• Client sets up a sweep with their bank to automatically invest and

redeem fund shares from DDA

• Typically used by clients with smaller balances or personnel

constraints

Investment Portal

• Like an Etrade for treasury investors

• Clients use single online site to purchase and redeem dozens of

fund providers

In practice sweeps and portals are heavily used tools


Investment Portal

15

Hybrid strategy

Dozens of money funds on single platform and sometimes securities

like commercial paper, treasuries, and agencies

Facilitates heightened due diligence with fund holdings, prospectus,

fact sheet, performance reports, etc

Consolidated reporting one of most powerful features Compliance features help investors comply with policies and control risk

• Pre-trade compliance, segregation of duties, custom inventory

• Exposure aggregation reporting


Separate Accounts

16

Passive strategy--asset managers create portfolios based on the clients parameters The ‘heavy lifting’ transferred from the client to asset manger Like a money fund but tailored to clients specs The ‘heavy lifting’ transferred from the client to asset manger Attractive relative returns given flexibility in duration and underlying instruments Potential drawbacks

• Moderate liquidity • Not addressed in most investment policies • Hot heavily used in practice


Earnings Credit Rate (ECR)

17

Passive strategy--Treasury clients leave their balances uninvested in DDA and bank pays them a credit towards their fees Companies like for budgeting purposes and to take advantage of attractive ECR rates at times Dodd Frank mandated unlimited FDIC on uninvested DDA balances for 2011 and 2012 creating large inflows into DDA Program expired but much of the cash stayed 40% of the nearly 2 trillion in corporate cash sitting in DDA – more that twice the historical average Potential drawbacks

• Many banks have too much cash and are limiting ECR • Investors lose the benefit of diversification


Taxable Equivalent Yield

18

Municipal bonds and municipal mutual funds are tax free

If an investor has a high marginal tax rate, it makes sense to calculate the

taxable equivalent yield of these muni instruments to compare to taxable

instruments

TEY= tax free rate / (1 – tax rate)

Example: An investor has a 40% tax rate and is evaluating investments

Taxable return = 4%

Tax free return = 3%

TEY= .03 / (1-.40)

TEY= .05 or 5%


Taxable Equivalent Yield

19

TEY= tax free rate / (1 – tax rate)

Example: Another investor has a 20% tax rate and is evaluating

investments

Taxable return = 4%

Tax free return = 3%

TEY= .03 / (1-.20)

TEY= .0375 or 3.75%

This investor would select the taxable investment

In practice, there are sometimes supply/ demand abnormalities in the

market that change the relative benefit of taxable vs tax free


Things to Watch

20

The Economy and Inflation

• Modest economic growth expected

• Inflation remains low

• Unemployment improving

The Federal Reserve (Fed)

• The Fed sets short-term rates in the US

• Accommodative policy for last 6 years with rates set at 0-.25

• Signs of changing course recently – tapering asset purchases

• Rate hike probable in 2015

The SEC

• Regulate securities industry including money funds

• New money fund regulations have been proposed

• Comment period over

• Awaiting final decision on proposed regulations

Questions ?


Contact Information

Kirk Black, CTP, CPA, FINRA Licensed Representative

Senior Relationship Manager, Treasury Investments

(412) 234-3976

[email protected]

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fundamentals of treasury investingnyce.tmany.org/2014/wp-content/uploads/2014/02/nyce-2014.pdf ·...

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