1. Cash Flow Analysis in Portfolio Management January 13, 2011 Presented by: Carlos Oblites, Senior Managing Consultant PFM Asset Management LLC

2. PFM Investment Advisors to the Public Sector $0 $5 million $10 million $15 million $20 million $25 million Liquid0-1 Years1-2 Years2-5 Years $20 $10 $0 $5 Current Investments $15 $9 $6 $5 Cash Flow Needs Do Current Investments Meet Cash Flow Needs? 2

3. PFM Investment Advisors to the Public Sector $0 $5 million $10 million $15 million $20 million $25 million Liquid0-1 Years1-2 Years2-5 Years $20 $10 $0 $5 Current Investments $15 $9 $6 $5 Cash Flow Needs Do Current Investments Optimize Earnings? 3

4. PFM Investment Advisors to the Public Sector4 How Much Liquidity is Enough? Cost of insufficient liquidity –Delayed payments –Additional interest costs –Transaction costs –Bad press Cost of excess liquidity –Lost investment income –Bad press Understanding cash flow is critical! 4

5. PFM Investment Advisors to the Public Sector Cash Flows Most Crucial Questions –How much to keep liquid? = “Will I have it available when I need it?” –How much to lock up in longer maturity securities? = “Will I earn a good return it?” 5

6. PFM Investment Advisors to the Public Sector6 What to Do? “I think we’re all in agreement that it’s time to abandon the “waiting for a miracle strategy.” Earnings 6 Returns

7. PFM Investment Advisors to the Public Sector Approach Determine Cash Flow Needs –Consider all funds –Determine amount of cash needed for expenditures –Consider the timing of receipts and expenses Categorize your funds –Funds that needs to be kept liquid –Funds available to invest longer = “core balance” 7

8. PFM Investment Advisors to the Public Sector Cash Flow Information Sources Bank statements General ledger balances Budgets Capital project spending Investments 8 All Accounts--Historical Cash Balance JanuaryFebruaryMarchAprilMayJune 2006 146,653 62,132 128,696 271,752 253,689 91,298 2007 159,316 231,776 233,711 256,840 354,342 172,293 2008 143,452 312,719 398,301 334,999 335,778 206,748 2009 311,183 322,314 411,459 372,365 479,918 279,289 2010 302,354 382,075 627,762 352,203 523,190 378,193 JulyAugustSeptemberOctoberNovemberDecember 2006 142,743 238,846 155,024 157,220 41,327 131,154 2007 270,991 155,720 259,047 301,516 97,385 171,371 2008 269,545 254,939 252,113 262,490 150,764 187,172 2009 234,185 384,253 333,707 357,302 243,477 233,042 2010 270,991 155,720 259,747 301,516 97,385 171,371

9. PFM Investment Advisors to the Public Sector Sample Cash Flow Report (in $1,000’s) JulyAugustSeptemberOctober Revenues Tax receipts10,0004,0003000 Investment income35050100150 Other income1,0004001015 Total Revenues11,3504,450410165 Expenses Accounts Payable500003,000 Insurance Premiums01,0004003,000 General Admin.7565 75 Total Expenses5751,0654656,075 Monthly Net Cash10,7753,385(55)(5,910) Beg Balance2,00012,77516,16016,105 End Bal12,77516,16016,10510,195 9

10. PFM Investment Advisors to the Public Sector10 Macro Forecasting Process Analysis of Historical Monthly Cash Flows 5,000,000 10,000,000 15,000,000 20,000,000 25,000,000 30,000,000 35,000,000 40,000,000 Jan-99 Apr-99 Jul-99 Oct-99 Jan-00 Apr-00 Jul-00 Oct-00 Jan-01 Apr-01 Jul-01 Oct-01 Jan-02 Apr-02 Jul-02 Oct-02Jan-03 10

11. PFM Investment Advisors to the Public Sector11 Computation of Growth Fund balances sometimes show growth trends Historic Monthly BalanceAverage Portfolio Growth Analysis of Historical Monthly Cash Flows 5,000,000 10,000,000 15,000,000 20,000,000 25,000,000 30,000,000 35,000,000 40,000,000 Jan-99 Apr-99 Jul-99 Oct-99 Jan-00 Apr-00 Jul-00 Oct-00 Jan-01 Apr-01 Jul-01 Oct-01 Jan-02 Apr-02 Jul-02 Oct-02 Jan-03 Average Monthly Increase: $205,118 Historic Annual Growth Rate: 9.9% 11

12. PFM Investment Advisors to the Public Sector12 Balance Projections Historic data can be used to predict future investable balances Actual Monthly Balances Projected Monthly Balances Projected Portfolio Growth 5,000,000 10,000,000 15,000,000 20,000,000 25,000,000 30,000,000 35,000,000 40,000,000 45,000,000 Jan-99 May-99 Sep-99 Jan-00 May-00 Sep-00 Jan-01 May-01 Sep-01 Jan-02 May-02 Sep-02 Jan-03 May-03 Sep-03 Jan-04 May-04 Sep-04 Jan-05 12

13. PFM Investment Advisors to the Public Sector13 Core Portfolio Most governments have a “core” or stable portion of the portfolio Analysis of Portfolio 5,000,000 10,000,000 15,000,000 20,000,000 25,000,000 30,000,000 35,000,000 40,000,000 45,000,000 Jan-99 May-99 Sep-99 Jan-00 May-00 Sep-00 Jan-01 May-01 Sep-01 Jan-02 May-02 Sep-02 Jan-03 May-03 Sep-03 Jan-04 May-04 Sep-04 Jan-05 Historical Liquid Funds Historical Core Funds Projected Liquid Funds Projected Core Funds 13

14. PFM Investment Advisors to the Public Sector How to Invest it? Determined by: 1.Cash flow needs 2.California Government Code 3.Investment policy 4.Investment objectives 5.Current market conditions 14

15. PFM Investment Advisors to the Public Sector15 Key Investment Objectives Protect principal Provide necessary liquidity to cover both ongoing and unexpected cash needs Maximize earnings recognizing need for safety and liquidity, and subject to restrictions specified by Government Code and the local governing body 15

16. PFM Investment Advisors to the Public Sector16 And If These Are Bond Proceeds? 1. Determine if issue will meet spend-down exceptions per arbitrage rebate regulations 2. Identify investment options (legal, bond covenants, policy) 3. Formulate investment strategy based on rebate status 16

17. PFM Investment Advisors to the Public Sector Selecting Maturities for Project Funds Things to consider: –What is the project schedule? –What are future rate expectations? Does it make sense to buy longer investments if interest rates are rising? 17

18. PFM Investment Advisors to the Public Sector Selecting Maturities for General Funds Things to consider –Are there any investment restrictions? –What is your target average maturity? –What is your benchmark to measure performance? 18

19. PFM Investment Advisors to the Public Sector Before you buy, you must make sure that the investments comply with your public agency’s preferences. –Social issues –Prior history with particular investment Additional Considerations 19

20. PFM Investment Advisors to the Public Sector Specific Goals Assure steady income stream = Enhance portfolio yield Grow the portfolio value = Enhance portfolio total return 20

21. PFM Investment Advisors to the Public Sector Risk and Return of Different Duration Targets © 2011 PFM Asset Management LLC 21 Risk/Return of Various Benchmarks 10 Years Ended 12/31/2010 Merrill Lynch IndexDuration Overall Return Cumulative Value of $50,000,000 Quarters With Negative Returns LAIF0.50 Years2.85%$66,225,4620 out of 40 1 Year Treasury Index0.99 Years3.16%$68,230,6323 out of 40 1-3 Year Treasury Index1.85 Years3.92%$73,448,5125 out of 40 1-5 Year Treasury Index2.57 Years4.46%$77,394,91111 out of 40 3-5 Year Treasury Index5.51 Years5.50%$85,399,05815 out of 40

22. PFM Investment Advisors to the Public Sector Target: Average Maturity or Duration 0.75 1.25 1.50 1.75 2.00 Time years High Average Maturity Band Low Average Maturity Band Target 22

23. PFM Investment Advisors to the Public Sector Implementation Based upon expected cash flows and investment policy, four decisions must be made: –Sector selection –Credit quality –Average maturity or duration –Maturity position (yield curve strategy) 23

24. PFM Investment Advisors to the Public Sector Once you know your target duration, choose a portfolio structure that will capitalize on market conditions. –Match cash flows exactly—great for most liquid portions of portfolio –Laddered –Bullet –Barbell Maturity Positioning 24

25. PFM Investment Advisors to the Public Sector $0 $5 million $10 million $15 million $20 million Liquid0-1 Years1-2 Years2-5 Years $15 $9 $6 Current Investments Cash Flow Needs $6 $15 $9 Portfolio Structure: “Match Cash Flows Exactly” 25

26. PFM Investment Advisors to the Public Sector Portfolio Structure: “Laddered” $0 $5 million $10 million $15 million $20 million 0-1 Yr1-2 Yrs2-3 Yrs3-4 Yrs4-5 Yrs $12 mm $0 Laddered 26

27. PFM Investment Advisors to the Public Sector Portfolio Structure: “Bullet” $0 $5 million $10 million $15 million $20 million $25 million $30 million $35 million $40 million 0-1 Yr1-2 Yrs2-3 Yrs3-4 Yrs4-5 Yrs Bullet $36 mm $0 27

28. PFM Investment Advisors to the Public Sector Portfolio Structure: “Barbell” $0 $5 million $10 million $15 million $20 million $25 million $30 million $35 million $40 million 0-1 Yr1-2 Years2-3 Years3-4 Years 4-5 Years $18 mm $0 $18 mm $0 Barbell 28

29. PFM Investment Advisors to the Public Sector U.S. Treasury Yield Curve 3m 2y 5y 10y 30y Time to Maturity Yield Yield Curves: “Positively Sloped” 29

30. PFM Investment Advisors to the Public Sector Time to Maturity Yield U.S. Treasury Yield Curve 3m 2y 5y 10y 30y Yield Curves: “Inverted” 30

31. PFM Investment Advisors to the Public Sector U.S. Treasury Yield Curve 3m 2y 5y 10y 30y Time to Maturity Yield Yield Curves: “Flat” 31

32. PFM Investment Advisors to the Public Sector Actual U.S. Treasury Yield Curves 32 11/3/20101/4/2011Change 3 month0.12%0.13%+ 0.01% 6 month0.15%0.18%+ 0.03% 1 year0.20%0.26%+ 0.06% 2 year0.33%0.62%+ 0.29% 3 year0.47%1.02%+ 0.55% 5 year1.11%2.01%+ 0.90% 10 year2.57%3.33%+ 0.76% 30 year4.04%4.41%+ 0.37% U.S. Treasury Yield Curve November 3, 2010 vs. January 4, 2011 Source: Bloomberg Fed holding short rates near zero What structure does this environment call for?

33. PFM Investment Advisors to the Public Sector Yield Curve Getting Steep Once More 291 bps 271 bps Source: Bloomberg 33

34. PFM Investment Advisors to the Public Sector Source: Bloomberg Treasury Yields Rebound From Record Lows 1.17% 0.33% 0.62% 34

35. PFM Investment Advisors to the Public Sector Determine how much is liquid, how much is core Reduce unnecessary liquidity—but mind the current environment Keep communication lines open with all parties involved: –Project Manager –Investment Manager –Budget Manager After ensuring safety and correct liquidity level, invest it! Optimize! Key Concepts 35

36. PFM Investment Advisors to the Public Sector Questions? Cash Flow and Investing 36 Insufficient Liquidity Risky Investments Volatile Markets Bad Returns