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1 Davidson Fixed Income Management Deanne Woodring, CFA Managing Director (866) 999-2374 Benchmarking for Public.

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Presentation on theme: "1 Davidson Fixed Income Management Deanne Woodring, CFA Managing Director (866) 999-2374 Benchmarking for Public."— Presentation transcript:

1 1 Davidson Fixed Income Management Deanne Woodring, CFA Managing Director (866) 999-2374 www.DavidsonFIM.com Dwoodring@dadco.com Benchmarking for Public Fund Investment Guidance and Performance Benchmarking for Public Fund Investment Guidance and Performance BEST PRACTICES Safety, Liquidity and Return OMFOA - 2008

2 2 Yield Investment Policy Benchmark Benchmark Process Process Effect: * Purchase date * Maturity of Portfolio Framework: * Maturity * Asset Allocation * Broker Relationships * Define Goals Process: * Control Risk * Manage Return * Accountability * Strategy Encompassing Portfolio Management Tools

3 3 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.

4 4 4 Davidson Fixed Income Management Reality 2008 – Public Fund Cash Management Process Investment PolicyPolitical and Internal Environment RiskReturn 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

5 5 Principles Of Investing Considerations when: 1. Buying a house 2. Buying a car 3. Investing in retirement

6 6 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 Returns Growth Value Time Horizon Each consideration will generate a different outcome or dollar value at the end of period of time.

7 7 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 bonds 2. Reinvestment Rates 3. New purchase rates

8 8 Does it matter how you invest? LETS LOOK AT THIS YEAR 2007: $10,000,000.00 or $100,000,000.00 Pool Funds Average Return for 2007 = 5.10% $10,000,000.00 = $10,510,000 $100,000,000.00 = $105,150,000 0-3 Year Treasury Portfolio - 1.2 year Maturity = 6.635% Book Yield 5% $10,000,000.00 = $10,663,500 $100,000,000.00 = $106,635,000.00

9 9 US Treasury 2 Year Note 12/31/97 – 12/31/07

10 10 US Treasury 2 Year Note 12/31/07 – 03/04/08

11 11 SAFETY Smoothing Out Interest Earnings Assumptions – Current Portfolio Size: $ 50,000,000 Liquid Portion (50%)$ 25,000,000 Core Portion (50%) $ 25,000,000 – Historical Average Rates for last 10 years (12/31/97 – 12/31/07) Liquid: 4.0% (Average Pool Funds) Core: 4.43% (US Treasury 0-3 year) – Benchmark US Treasury 0-3 yearDuration: 1.2 yrs

12 12 Facts of public fund investing Interest rates change. Your entitys 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.

13 13 Best Practice Benchmark Considerations Incorporate Objectives LIQUIDTY = Cash Flow – Liquidity vs. Core SAFETY = Asset Allocation - Diversification RETURN = Market Risk Exposure Duration

14 14 A Market Benchmark in Review Basket of fixed income securities that reflect your entitys 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

15 15 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

16 16 1. Evaluate Return Expectations Based on Duration Ending Value and Return - Manage Duration $10,000,000.00 Invested Over the Last 10 Years ValueRaw Return/ Annualized ML 0-1 Year Treasury Index 0.5 duration $14,748,08047.58% / 3.97% ML 0-3 Year Treasury Index 1.2 duration $15,434,00054.34% / 4.43% ML 0-5 Year Treasury Index 1.85 duration $15,880,00058.80% / 4.73% Source: Merrill Lynch indices

17 17 Evaluate Return Based on Duration Ending Value and Return- Manage Duration $10,000,000.00 Invested Over the Last 5 Years ValueRaw Return/ Annualized ML 0-1 Year Treasury Index 0.5 duration $11,631,00016.31% / 3.07% ML 0-3 Year Treasury Index 1.2 duration $11,651,00016.51% / 3.10% ML 0-5 Year Treasury Index 1.85 duration $11,730,00017.30% / 3.24% Source: Merrill Lynch indices

18 18 Evaluate Return Based on Asset Allocation Ending Value and Return- $10,000,000.00 Invested Over the Last 5 Years ValueRaw Return/ Annualized ML 1-3 Year Treasury Index$11,738,00017.38% / 3.26% ML 1-3 Year Bullet Agency Index$11,786,00017.86% / 3.34% ML 1-3 Year Callable Agency Index$11,618,00016.18% / 3.04% ML 1-3 Year AA or Better Corporate$11,826,30018.263% / 3.41% Source: Merrill Lynch indices

19 19 Outperforming Asset Classes do not repeat year to year Year What Happened 2 Year Yield Change (y/y) – 2007Spreads 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 high3.08% to 4.40% – 2004Rate rose a little, curve flattened1.83% to 3.08% – 2003 Yields low, unchanged1.59% to 1.83% INDEX 20072006200520042003 US Treasury 1-3 Year7.3173.961.670.911.90 US Agency 1-3 Year Bullet7.1244.461.721.152.37 US Agency 1-3 Year Callable5.7684.631.871.261.78 TIPS 1-3 Year8.733.082.25 1-3 Year Corp A-AAA6.0414.621.961.453.82 0-3 Yrs WAL Mortgages6.9484.642.152.801.83

20 20 Evaluate Return Based on Yield Curve Ending Value and Return- $10,000,000.00 Invested Over the Last 5 Years ValueRaw Return/ Annualized 1 Year Sector – Treasury$11,569,00015.69%/2.96% 2 Year Sector – Treasury$11,660,90016.60%/312% 3 Year Sector _ Treasury$11,816,90018.17%/3.39% 5 Year Sector - Treasury$11,917,20019.17%/3.58% Source: Merrill Lynch indices

21 21 2. Determine Acceptable Risk Tolerance Mark to Market 100bp+/-200bp+/- IndexDuration% PValue% PValue Merrill 0-1 Year.58.58%$58,0001%$116,000 Merrill 0-3 Year1.22%$120,0002.4%$240,000 Merrill 0-5 Year1.851.85%$185,0003.7%$370,000 $10,000,000 Portfolio Value Change Calculation: $100,000,000 (portfolio size) * 1.2 (duration) *.01 (rate move) = $1,200,000 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

22 22 2. Determine Acceptable Risk Credit Diversification ASSET ALLOCATION TARGETS State Code & PolicyPractice Treasury100%5% Agency Securities100%80% Corporate35%15%

23 23 3. Establish Appropriate Benchmark TWO CHOICES: 1. Customize a benchmark that reflects your practices: 5% Treasury 1-3 Year Duration 1.65 60% Agency 1-3 Year Duration 1.65 15% Corporate 1-3 YearDuration 1.76 Average Maturity 1.66 years 2. Pick Standard Market Index: 1-3 Agency IndexDuration 1.65 0-3 Treasury IndexDuration 1.2

24 24 Standard Index Comparison to Practice COMPARISON OF INDEX TO CUSTOM INDEX20072006200520042003 US Treasury 1-3 Year7.313.961.66.9071.89 US Agency 1-3Year7.2684.541.581.732.30 1-3 Year Corp AA-AAA6.0414.621.961.453.82 CUSTOM PRACTICE 5% Treasury 1-3 /80% Agency 1-3 / 15% Corporate Duration 1.556.694.491.771.182.31

25 25 Standard Index versus Custom Index based on Legal Parameters COMPARISON OF INDEX TO CUSTOM LEGAL 12/31/07 INDEX2007200620052004200310 Year US Treasury 0-3 Year6.6354.242.10.981.664.43 US Agency 1-3 Year – Duration 1.656.734.521.771.182.184.97 1-3 Year Corp AA-AAA6.244.561.861.293.18 5.37 Legal Maximum Custom 25% 0-1 / 40% 1-3 Agency /35% 1-3 Corp Duration 1.296.244.572.061.212.304.85

26 26 Standard Index versus Custom Index based on Legal Parameters COMPARISON OF INDEX TO CUSTOM LEGAL 12/31/07 INDEX2007200620052004200310 Year DFIM 0-3 Year Index – 1.29 Duration - OREGON6.474.581.981.182.00 4.76 Legal Maximum Custom 25% 0-1 / 40% 1-3 Agency /35% 1-3 Corp Duration 1.296.244.572.061.212.304.85

27 27 Davidson Fixed Income Management Establish Benchmark Establish Benchmark Select the Agency/Treasury 0-3 year Index 1.Duration is appropriate 2.Agency exposure appropriate 3.Add value when spreads are wide on corporate and agency issues

28 28 4. Establish Duration Targets US TreasuryHistorical Average RatesCurrent Rates 5 Year (12/31/02 - 12/31/07) 10 Year (12/31/97 - 12/31/07) As of: 3/7/08 3 Month2.903.511.42 6 Month3.093.651.51 2 Year3.313.951.48 5 Year3.824.382.40 Historical Yield Levels

29 29 Establish Duration Targets Duration Neutral Yields Rise Duration (Risk/Reward) Increases Neutral point – duration is at neutral point when yield is at average Duration/Yield Relationship Yields Decline Duration (Risk/Reward Declines 2.0% 6.0% 4.20% 1.51..901.41.20 Benchmark: DFIM 0-3 Treasury/ Agency 0-3 Year Benchmark duration: 1.2 years (this is your neutral position) 10 year Average rate on 2 year note is 3.9% Strategy: Based on current rates relative to historical rates portfolios should be approaching their neutral positions.

30 30 5. Determine Guidelines Target size of core balance Benchmark to control risk and measure return $75MM- $100MM DFIM 0-3 year T/Agency Duration: Approximately 1.2 years Asset allocation: Within policy Maturity structure: Within policy

31 31 Guidelines Duration rage of portfolio relative to +/- 25% or duration benchmark Minimum.90years Maximum 1.5years Asset Allocation Targets Neutral5% Treasury 70% Agency 20% Callable 15% Corporate Securities Strategy and timelineThe portfolio will be adjusted periodically to reflect the above guidelines.

32 32 6. Report on Portfolio Core Component Of Portfolio - 12/31/07 Liquidity Component of Portfolio IssueAcq DateAcq Yield % HoldingDuration (Years) Effective Duration (Years) 2,000M FFCB 4 1/18/085/5/053.85820%.01 1,000M FHLB 5.125 6/13/085/31/065.2510%.5 1,000M FFCB 4.125 9/26/089/13/054.57110%.75 2,000M FNMA 5.05 1/12/09-1/081/27/065.0920%.9.1 2,000M FHLB 5 5/15/096/15/065.2520%1.2 1, 000M FHLMC 4.875 2/9/102/10/075.00010%2.4 1,000M FHLB 5.375 9/8/10-9/08 Callable6/30/075.37510%2.81.0 10,000,0004.85100% 1.08.74 15MM State Pool or Short Term Money Market Issues – Rate 4.80%

33 33 Monitor Portfolio Compared to Benchmark Returns Risk Portfolio Benchmark Portfolio Benchmark 1/31/07.307%.215% 1.351.64 2/28/07.791%.797% 1.44 1.62 3/31/07.356%.384% 1.53 1.68 4/30/07.416%.356% 1.43 1.65 5/31/07.001% -.074% 1.461.72 6/30/07.423%.419% 1.511.67 7/31/07.729%.911% 1.401.64 8/31/07.637% 1.028% 1.241.61 9/30/07.848%.708 1.361.64 10/31/07.435%.37% 1.26 1.61 11/30/07 1.073%1.718% 1.32 1.60 12/31/07.414%.262% 1.39 1.61

34 34 Monitor Portfolio Compared to Benchmark ($100,000,000 Portfolio) Returns YTD - 12/07Since Inception - 12/97 PortfolioBenchmarkPortfolioBenchmark Raw Return6.618%7.317%67.30959.079% Annualized 6.618%7.317%5.28%4.75% VALUE ADDED SINCE 12/31/97 Portfolio$67,309,000 Benchmark$58,079,000 Pools (0-1)$47,580,000 DIFFERENCE Portfolio vs. Benchmark $9,230,000 DIFFERENCE Portfolio vs. CASH $19,729,000 Benchmark: US Treasury 1-3 Duration: 1.65

35 35 7. Rebalance the Portfolio Conditions to Rebalance: Large change in interest rates Large change in asset class valuations Time has shorten duration below guideline The yield curve has made a large shift OBJECTIVE OF REBALANCING To rebalance duration and asset weighting back to guideline levels.

36 36 Rebalance Portfolio – Decision Process Scenario: Yields have dropped to 2.5% on the two year note Want to move portfolio out, but remain short to the benchmark $50,000,000 portfolio with $10,000,000 (20%) in maturing bond Neutral Duration 1.2 years Current duration.75 years Target duration 1.0 years Question #1: What maturity do you buy?

37 37 Answer – What If Scenario duration Duration% of PortfolioWeighted Portfolio Existing.7580%.60 Target Buy Issue2.020%0.40 New Duration 1.0

38 38 Other Scenarios Want to stay shorter the benchmark Duration % of PortfolioWeighted Portfolio Existing.7580%.6 Target Buy Issue1.020%.2 New Duration.80 If want to stay shorter but cant resist the yield on the 3year 3mth callable Duration % of PortfolioWeighted Portfolio Existing.7580%.6 Target Buy Issue3/3 mth call20%0.5 New Duration 1.1

39 39 What do you buy? GuidelinesActualSpreadsValue Treasury5%0%0 Agency Bullet50% WideADD Agency Callable20%30%Wide Corporate15% Wide Recommendation: Buy 2 year bullet agency

40 40 BEST PRACTICE BENCHMARK 2008 and Beyond Compl y BEST PRACTICE BENCHMARK SAFETYLIQUIDTYMARKET RETURN DiversificationRequirementsBook Yield QualityMaintenanceBenchmark Return

41 41 How to implement? Evaluate Internal System and Expertise Cost/Benefit Analysis of Outsourcing - Advisors Evaluate Value of Improved Process

42 42 Benefits of a Benchmark Strategy Clear Sense of Direction Focus in Overall Portfolio vs. Yield Accountability to Decision Making Process Balances Risk and Return Communication, Communication, Communication Confidence and Peace of Mind

43 43 BENCHMARK RESOURCE www.DavidsonFim.com

44 44 TOP TEN ISSUES 1.CASH FLOW 2.DIVERSIFICATION OF LIQUIDITY AND INVESTMENTS 3.DIVERSIFICATION OF MATURITY AND DURATION 4.DIVERSIFICATION OF ASSET CLASS 5.KNOW THE RISKS IN YOUR PORTFOLIO 6.KNOW THE CURRENT MARKET ENVIRONMENT 7.HAVE A STRATEGY 8.ESTABLISH GUIDELINES 9.COMMUNICATE 10.MONITOR THE PORTFOLIO

45 45 MARKET OBSERVATIONS

46 46 THE LAST EASE

47 47 Today- Treasuries have lead ease

48 48 Where are Fed Funds Rates and Short Rates Headed?

49 49 YIELD CURVE

50 50 HAVE A PLAN

51 51 THANK YOU


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