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Oregon Short-Term Fund Overview and Update 2009 OMFOA/OACTFO Annual Spring Conference Salishan Spa & Golf Resort Spring Conference – Gleneden Beach, Oregon.

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Presentation on theme: "Oregon Short-Term Fund Overview and Update 2009 OMFOA/OACTFO Annual Spring Conference Salishan Spa & Golf Resort Spring Conference – Gleneden Beach, Oregon."— Presentation transcript:

1 Oregon Short-Term Fund Overview and Update 2009 OMFOA/OACTFO Annual Spring Conference Salishan Spa & Golf Resort Spring Conference – Gleneden Beach, Oregon March 10, 2009 Perrin Lim - Sr. Fixed Income Investment Officer Tom Lofton – Investment Officer & Sr. Credit Analyst

2 2 Part 1: Oregon Short-term Fund (OSTF) Oversight, Management, and Investment Guidelines. Part 2: Changes in the OSTF Portfolio and Performance. Part 3: Recent market events Part 4: Thoughts on Credit Risk Evaluation. Todays Presentation

3 Oversight and Management Structure Oregon Investment Council Oversight responsibility for all state funds. Meets Monthly Five Voting Members Oregon Public Employees Retirement Fund Oregon Short-term Fund Board Six voting members Meets quarterly OSTF Portfolio Management Team Portfolio Manager – Perrin Lim Investment Officer - Ellen Hanby Credit Analyst - Tom Lofton Investment Analyst - Norma Harvey State Accident Insurance Fund Common School Fund State Agency Accounts 3

4 Portfolio Construction The OSTF is actively managed – does not passively follow an index. Management team seeks to add value while adhering to a disciplined risk control process. Utilizes team approach – investment decisions are openly debated. Investment Objectives: (in order of importance) 1.Principal preservation 2.Liquidity 3.Outperform 91-DayTreasury Bill. Portfolio adheres to comprehensive set of investment guidelines approved by OIC and OSTF Board. Management Strategy: Incorporates a top-down or macro-economic approach to position portfolio sector and interest rate exposures. Utilizes a fundamental (bottom-up) risk assessment to determine individual investment positions. 4

5 Investment Outlook OSTF Portfolio Rules Sector Allocation OSTF Implementation Monitoring & Controls Interest Rate Exposure Issue Selection External Manager Resources Internal Research Third Party Research Ratings AgenciesStreet Research Portfolio Construction 5

6 Generic security types – no structured investments or derivatives. Fixed Income Debt Instruments only - U.S. Treasury Securities U.S. Government Agency Securities Corporate Indebtedness Negotiable Certificates of Deposit. All investments denominated in US$ only. Portfolio Construction 6

7 7 Short Term to Maturity Maturity Guidelines: 50% of the portfolio must mature within 93 days. A maximum of 25% of the portfolio may mature over one year. No investment may mature in over 3 years as measured from settlement date. OSTF Maturity Distribution as of March 4, % matures within 6 months

8 Portfolio Construction Diversified with heavy bias towards US government-backed obligations Diversification guidelines - 100% of the portfolio may be in U.S. Treasury securities. 100% of the portfolio may be in U.S. Government Agency securities. 50% maximum of portfolio per FDIC issuer 33% maximum of portfolio per agency issuer. 50% maximum exposure to corporate obligations. 5% maximum to corporate debt of any single issuer. OSTF diversification as of March 4, 2009 Largest exposure to any corporate issuer = 3.92% Government-backed 51% Banking/Financial 30% Industrial/Manufacturing/Chemical 6% Utility 4% Consumer 3% Energy 1% Aerospace/Defense 1% Import/Export 1% TCD 1% Medical/Pharmaceutical 1% 8

9 Composed of high quality securities Total weighted average credit quality of the portfolio shall be a minimum of Aa2 by Moodys and AA by S&P. Minimum corporate indebtedness credit ratings at time of purchase must be Aa2 by Moodys and AA by S&P. If investment is downgraded below Aa2/AA after purchase, it can remain in the portfolio to protect against forced selling into a potentially weakened marketplace. Portfolio Construction Highest Lowest OSTF as of March 4, 2009: Average credit quality of Aa2/AA 91% of portfolio rated at least Aa3 or AA- or higher Investment Grade High Yield 9

10 Portfolio Construction Active management value can be added through three main areas: 1.Sector Allocation: Ongoing research, analysis, and evaluation of market sectors with respect to current market prices, i.e. spread or risk premium 2.Issue Selection: Primarily a bottom-up process to uncover mispriced or undervalued credits and/or securities 3.Term to Maturity: 1.macro-economic factors as well as the general political environment 2.Staff weighs its views vs. market expectations. 3.Goal is to add value based on the longer term trend and positioning the fund accordingly, not timing the market 10

11 Current State of Fixed Income Markets 11

12 The Cost of Credit Risk Has Increased Dramatically TARP I Passes 12

13 Fear Driving Flight To Safety 13

14 Federal Reserve The US Government Is Responding…..Massively 14

15 Difference between Investment grade and high yield spreads seeks capture price of credit risk in corporate term funding markets. 15 Induced Liquidity Showing Tenuous signs of Success The TED spread (originally: Treasury vs. Eurodollar Futures but now is difference between T-bill rate and LIBOR) captures difference in risk premium between unsecured interbank borrowing (LIBOR) and risk-free gov't borrowing (T-bill) rates. Similar to LIBOR - OIS differential, it seeks to capture credit risk and cash hoarding, and can be highly driven by the flight to quality trade where the T-bill rate moving down dominates the change in the TED spread.

16 16 Significant OSTF Developments. New class of investments : Government-backed corporate obligation. Added dedicated credit analyst position. Allows for better monitoring of credit risk. Increases capacity to improve diversification within the portfolio. Building Reserve Fund Offsets short-term effects of potential future credit events. Targeting about 1% of OSTF as a reserve fund balance. Providing an excess of approximately 58 basis points versus historical default rates for the current credits in the OSTF.

17 17 FDICs Temporary Liquidity Guarantee Program (TLGP) Creates a new class of government-backed senior corporate debt Explicit full faith and credit guarantee by FDIC regarding timely payment of principal and interest. In the event of a default, each of the FDIC members would be charged a special assessment to cure the default. Triple-A or (P1/A+/F1+: Money Market) rated by all three rating agencies (Moody's, S&P; Fitch). TLGP issuance is over $200 billion and continues to grow. TLGP securities improve diversification versus other federal agency exposures. TLGP Debt has outperformed agency debt. FDIC-backed TGLP Securities

18 18 Lehman Brothers Bankruptcy Update On September 15, 2008, Lehman Brothers, Inc. filed for bankruptcy. The OSTF held 2 positions in Lehmans senior unsecured debt (rated A2/ A) with a combined cost of $187.5 million or 1.98% of total fund. Lehman Brothers was one of the largest bankruptcies in history with significant complexity given geographic dispersion of assets and liabilities. Significant events since bankruptcy: Eight operating divisions (mostly trading, sales, money management) sold for approximately $2.7B in cash and securities. Resolved most of derivative counterparty contracts. Operated by Alvarez & Marsal, a turnaround law firm, to manage restructuring. Alvarez & Marsals objective is to position LBHI to exit from bankruptcy in 18 to 24 months or late Current OPERF mangers average recovery estimate is 35% with 3 to 4 year time horizon.

19 19 OSTF Portfolio Changes

20 20

21 OSTF Portfolio Performance 21

22 OSTF Portfolio Performance 22

23 23 OSTF Investment Environment The number of corporate credits with long-term ratings of at least Aa2/AA has shrunk significantly. Investments beyond 270 days will likely be heavily weighted towards government-backed investments – (a good thing in the current economic environment?). Corporate debt that was non-financial and not commercial paper (i.e. original issue > 270 days) comprises less than 1% of OSTF. Regardless of your economic outlook, interest rates have little room to decline further. However, significantly higher levels of government debt create uncertainty regarding market expectations for inflation. Given the renewed interest in risk control (regulation, leverage, underwriting) it is difficult to envision robust economic growth in the near future. In the shorter-term maturity part of the yield curve, where the OSTF invests, debt issued by financials comprises that vast majority of available non-government related investments.

24 24 Credit Risk Assessment Relative Value in Credit Why not buy all issues that fit portfolio guidelines? »Cash Generation – Stability? Sources? Uses? »Income stability and diversification »Leverage trends »Liquidity »Refinancing risk »S.W.A.T. – Position of Core businesses. »Filings; Management Presentations; Earnings Calls »Event Risk: LBOs, Share Repurchases, Break-up value. »Covenants. »Market value of related public credit and equity instruments are an important indicator. »Investment alternatives: »Fixed vs. float »2 yr vs. 5yr

25 25 Credit Risk Assessment We try to avoid the rush of looking at investments when-offered by the street, instead, we have built a pre-approved/pre-sorted set of issuers that we monitor continuously. Despite a strong focus on fundamentals for security selection, subjective considerations are a significant part of the credit evaluation process. In the prior cycle, debt investors needed to be aware of a business breakup value for potential LBO risk, now we need to be cognizant of recovery value of the parts. Free cash flow : positive? stable? Are the assets fungible? There are few well-funded buyers in this market; do I really want an exotic or niche business exposure? Maintain a healthy degree of cynicism and suspicion of management. Do they really have a clue about what is going to happen six months ahead? Managements job is to improve the perceived value of the company. How easy is it to cook the books? Examples: Frequency of non-recurring charges. What about add-backs? Revenue & expense recognition characteristics in growth vs. decline phase.

26 Credit Risk Assessment Placed MetLife on hold on 11/3/08 for commercial paper investments. In context to market and economic developments, what were Mets risks? MET was profitable – double-digit margin before taxes! Seemingly well capitalized with Debt/Capital at < 50%. Worries: Given the convulsions going on in the market, Level II and Level III (hard to value assets) posed significant risk if the auditors decided these assets were permanently impaired. (Compare to BAC at 610% or USB at 208%) Earnings from the investments portfolio drove a significant portion of overall revenues. Debt/EBIT was already 3.1x. In other words I would need to have faith in the next three years profit to repay outstanding debt. Annuity sales, long an earnings driver, had become an albatross. Annuity liabilities were huge overhang given the declining value of the underlying investments. METs short-term and money market ratings were lowered by S&P from A-1 to A-2 on 2/26/09. 26

27 27 Summary: Take Aways Investment Policy dictates investment of assets Mistakes happen…Goal is to learn and minimize in the future Know what one buys…Form own opinion and evaluate relative to all outside resources. Always consider Worst Case Scenario/Reaching for Yield – Sleep Factor If 2-year US Treasuries bought and 2-year Treasuries increase 200 b.p.? If credit bought and issuer experiences negative headlines

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