1 Davidson Fixed Income Management Davidson Fixed Income Management Deanne Woodring, CFA Deanne Woodring, CFA Managing Director Managing Director (866) 999-2374 (866) 999-2374 www.DavidsonFIM.com [email protected]Benchmarking for Public Fund Benchmarking for Public Fund Investment Guidance and Performance Investment Guidance and Performance BEST PRACTICES BEST PRACTICES “ “ Safety, Liquidity and Return” Safety, Liquidity and Return” OMFOA - 2008 OMFOA - 2008
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1 Davidson Fixed Income Management Deanne Woodring, CFA Managing Director (866) 999-2374 [email protected] Benchmarking for Public.
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Davidson Fixed Income ManagementDavidson Fixed Income ManagementDeanne Woodring, CFADeanne Woodring, CFA
Process:Process:* Control Risk* Control Risk* Manage Return* Manage Return* Accountability* Accountability* Strategy* Strategy
Encompassing Portfolio Management Tools
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Prudent Portfolio Management
“The measure of success in managing public fund dollars lies most appropriately in safety and liquidity, with yield there after.”
Dan Dowell Chief Investment Officer State of California
However, there is a responsibility as public fund steward to manage safety, liquidity and returns through process, discipline and planning.
44Davidson Fixed Income Management
Reality 2008 – Public Fund Cash Management Process
Investment Policy
Political and Internal
Environment
Risk Return
Safety
Liquidity
Market Rate of Return
Board
Investment Committee
Staff Turnover
Resources (Experience,
time, software, etc.)
Safety
Liquidity Cash-Flow
Mark to Market
Political
Book Yield & Accrual
Performance (Mark to Market)
Optimizing the Growth of
Funds
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Principles Of Investing
Considerations when:
1. Buying a house
2. Buying a car
3. Investing in retirement
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Principles Of Investing = Growth
Considerations when:1. Buying a house: Timing (Market Conditions)
Location (Where to buy)Objectives (What fits your profile)Time Horizon
2. Buying a car: Type of car Resell Value Objectives
Time Horizon
3. Investing in retirement: Objectives
Best ReturnsGrowth ValueTime Horizon
Each consideration will generate a different outcome or dollar value at the end of period of time.
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Yield versus Return
Yield to maturity: Is an assumption of return based on interest rates at the time the bond is purchased and assumes that all cash flow generated from the bond will be reinvested at YTM rate.
Return: Incorporates what really happens to the investment over a period of time.
Changing Interest rates Impact:1. Value of the bonds2. Reinvestment Rates3. New purchase rates
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Does it matter how you invest?
LETS LOOK AT THIS YEAR 2007:$10,000,000.00 or $100,000,000.00
12 Months Earnings Due to Given Change in RatesCore SplitCore Split
(Interest Only) (with Price Change)
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Facts of public fund investing
• Interest rates change.
• Your entity’s cash flow requirements change.
• Your investments and earnings are impacted by changing rates.
• Forethought into the investment strategy is important. It can have a substantial impact in your earnings outcome.
• Strategy is important and can be applied to any size portfolio.
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Best Practice Benchmark Considerations Incorporate Objectives
• LIQUIDTY = Cash Flow – Liquidity vs. Core
• SAFETY = Asset Allocation - Diversification
• RETURN = Market Risk Exposure Duration
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A Market Benchmark in Review
• Basket of fixed income securities that reflect your entity’s risk and return profile
• Standard investment management tool
• Provides guidelines for investment decisions and portfolio positioning
• Typically used for funds in excess of liquidity requirements (core funds)
• Effective in managing expectations within your organization
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Strategy Utilizing Benchmarks
STEPS:
1. Evaluate return expectations
2. Determine acceptable risk tolerance
3. Establish appropriate benchmark
4. Establish duration targets
5. Determine guidelines
6. Monitor and report performance
7. Rebalance the portfolio
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1. Evaluate Return ExpectationsBased on Duration
Ending Value and Return - Manage Duration$10,000,000.00 Invested Over the Last 10 Years
Value Raw Return/ Annualized
ML 0-1 Year Treasury Index0.5 duration
$14,748,080
47.58% / 3.97%
ML 0-3 Year Treasury Index 1.2 duration
$15,434,000
54.34% / 4.43%
ML 0-5 Year Treasury Index1.85 duration
$15,880,000
58.80% / 4.73%Source: Merrill Lynch indices
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Evaluate ReturnBased on Duration
Ending Value and Return- Manage Duration$10,000,000.00 Invested Over the Last 5 Years
Value Raw Return/ Annualized
ML 0-1 Year Treasury Index0.5 duration
$11,631,000
16.31% / 3.07%
ML 0-3 Year Treasury Index 1.2 duration
$11,651,000
16.51% / 3.10%
ML 0-5 Year Treasury Index1.85 duration
$11,730,000
17.30% / 3.24%Source: Merrill Lynch indices
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Evaluate Return Based on Asset Allocation
Ending Value and Return-$10,000,000.00 Invested Over the Last 5 Years
Value Raw Return/ Annualized
ML 1-3 Year Treasury Index $11,738,000
17.38% / 3.26%
ML 1-3 Year Bullet Agency Index
$11,786,000
17.86% / 3.34%
ML 1-3 Year Callable Agency Index
$11,618,000
16.18% / 3.04%
ML 1-3 Year AA or Better Corporate
$11,826,300
18.263% / 3.41%Source: Merrill Lynch indices
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Outperforming Asset Classes do not repeat year to year
Year What Happened 2 Year Yield Change (y/y)
– 2007 Spreads widened, rates fell, inflation picked up 4.80% to 3.04% – 2006 Rates rose – curve inverted 4.40% to 4.80%– 2005 Spreads were flat, rates rose, inflation high 3.08% to 4.40%– 2004 Rate rose a little, curve flattened 1.83% to 3.08%– 2003 Yields low, unchanged 1.59% to 1.83%
INDEX 2007 2006 2005 2004 2003
US Treasury 1-3 Year 7.317 3.96 1.67 0.91 1.90
US Agency 1-3 Year Bullet 7.124 4.46 1.72 1.15 2.37
US Agency 1-3 Year Callable 5.768 4.63 1.87 1.26 1.78
TIPS 1-3 Year 8.73 3.08 2.25
1-3 Year Corp A-AAA 6.041 4.62 1.96 1.45 3.82
0-3 Yrs WAL Mortgages 6.948 4.64 2.15 2.80 1.83
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Evaluate Return Based on Yield Curve
Ending Value and Return-$10,000,000.00 Invested Over the Last 5 Years
Value Raw Return/
Annualized
1 Year Sector – Treasury $11,569,000
15.69%/2.96%
2 Year Sector – Treasury $11,660,900
16.60%/312%
3 Year Sector _ Treasury $11,816,900
18.17%/3.39%
5 Year Sector - Treasury $11,917,200
19.17%/3.58%
Source: Merrill Lynch indices
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2. Determine Acceptable Risk ToleranceMark to Market
•2 YEAR TREASURY NOTE JUNE 1997 – JUNE 2007•Average annual yield change (high to low) was 153 basis points•Standard Deviation is 51 basis points•One Standard Deviation range (68%) is 102 bp to 204 bp•Two Standard Deviation range (95%) is 51 bp to 255 bp
1. CASH FLOW2. DIVERSIFICATION OF LIQUIDITY AND INVESTMENTS3. DIVERSIFICATION OF MATURITY AND DURATION4. DIVERSIFICATION OF ASSET CLASS5. KNOW THE RISKS IN YOUR PORTFOLIO6. KNOW THE CURRENT MARKET ENVIRONMENT7. HAVE A STRATEGY8. ESTABLISH GUIDELINES9. COMMUNICATE10.MONITOR THE PORTFOLIO