Investing The Main Street Way

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Investing The Main Street Way

• California Municipal Treasures Association
• 2007 Annual Conference
• Long Beach, California
• May 2, 2007

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THE PERFECT HUSBAND
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Key Learning Outcomes

• Illustrate a performance measure for Investing
  The Main Street Way
• Understanding budgeting
• The Main Street Way
• Politics - GASB 31
• Wall Street - Total Return
• Main Street Market Rate of Return

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• Main Street Money Manager
• Ladies and gentlemen of the council, I have
  great news! Our unit of local government is in
  the top 1 quartile of all professional money
  managers using the Merrill Lynch 1-3 year
  Government Index.
• We lost only 2.00 of the publics money while
  our Merrill Lynch benchmark lost 2.50.

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After more then a decade of asking the
question- Do you believe a public fund should
manage their money like Wall Street? I
realized that while important difference clearly
exist there was no comprehensive study that
educated stakeholders/public to what these
differences were.
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• A key conclusion from research on my book -
• Communities are losing millions of dollars
  each year not through poor investment management
  or market volatility but through performance
  measurement practices that are simply irrelevant
  and which often time confuse the public about the
  skill and expertise of main street money managers.

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Public Funds Are Not Pension Funds

• I. Scope
• This policy applies to the investment of
  short-term operating funds. Longer-term funds,
  including investments of employees' investment
  retirement funds and proceeds from certain bond
  issues, are covered by a separate policy.
• GFOA Sample Investment Policy

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If public funds are not pension funds then why
use pension fund objectives, strategies, and
performance measureswhen main street investing?
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• What performance measure is most suited to
  measure the performance of a public fund?

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• Main Street Investing should be measuring
  stewardship

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Stewardship Over What?

• Stewardship over how well the public fund has
  balanced or is balancing the need to preserve
  principal with the want to earn a market rate of
  return.

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• Is the current Wall Street model of performance
  reporting consistent with Investing The Main
  Street Way

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The Policy - Rank The Risk

• SAFETY
• LIQUIDITY
  
• INCOME
• Total 100

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The Policy - Rank The Risk

• SAFETY 40
• LIQUIDITY 40
  
• INCOME 20
• Total 100

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Yet what is the most frequent question asked
about the portfolio?
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Is Performance Reporting Practice Consistent With
Investment Policy?

• Return on investment is of secondary importance
  compared to the safety and liquidity objectives
  described above
• GFOA Sample Investment Policy

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Why Is Performance Reporting Not Consistent With
Main Street Practice

• Using A Market Benchmark
• Peer Group Comparison

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Characteristics Of A Benchmark

• Unambiguous
• Investable
• Measurable
• Appropriate
• Specified in advance

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Market BenchmarksRelevant and Appropriate?

• Current performance reporting as a Wall Street
  model places to much importance on one policy
  objective return.
• Total return performance reporting increases
  political pressure on Main Street to defend
  portfolio returns in the context of beating some
  market index

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Peer Groups

• Peer group comparisons provide little relevant
  insight into the performance between public funds
  
• Peer group comparisons increase political
  pressure to compete for highest returns a
  practice counter to the spirit of most investment
  policies

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Relevance No Risk Adjustment

• CITY OF ME
• 100mm Portfolio
• Policy Priorities
• Safety
• Liquidity
• Income
• Portfolio Holdings
• 80 MMF
• 20 Disc Notes
• Return 3.00

• CITY OF ME TOO
• 100mm Portfolio
• Policy Priorities (same)
• Safety
• Liquidity
• Income
• Portfolio Holdings
• 20 MMF
• 80 1-5 yr Agencys
• Return 4.00

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Relevance Community Priorities

• CITY OF ME
• 100mm Portfolio
• Policy Priorities
• Safety
• Liquidity
• Income
• Portfolio Holdings
• 20 MMF
• 80 1-5 yr Agencys
• Return 3.75

• CITY OF ME TOO
• 100mm Portfolio
• Policy Priorities (same)
• Safety
• Liquidity
• Income
• Portfolio Holdings
• 20 MMF
• 80 1-5 yr Agencys
• Return 4.00

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Peer Group Comparisons

• Why peer group comparisons are irrelevant
• Same policy objectives does not mean same risk
• Same size portfolio does not mean same risk
• No common standard for reporting returns
• Different budgets (established versus new city)
• No risk adjusted return is practiced

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• Fiduciary Benchmark Investment Policy Peer Group

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How A Fiduciary Benchmark Works

• Differentiates legal vs. suitable portfolio
• Captures all investment policy objective
• Uses five components to define suitability
• Provides compliance a early warning monitor for
  potential problems

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Five Components Of Suitability

• Adequate liquidity to meet obligations without
  needing to sell security
• Appropriate level of interest rate risk
• Diversified portfolio that also avoids
  concentration risk
• Consist of legal holdings
• Earn a market rate of return

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Main Street Performance Model

Static to Dynamic Legal to Suitable
Policy
Plan
Defines Suitability
Links Practice To Policy
Portfolio
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Toward Financial Stewardship
Policy Rulebook
Plan Playbook
Stewardship
Suitable Portfolio
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Budgeting The Main Street Way
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Investing The Main Street Way And Budgeting

• Why have yield included as a investment policy
  objective
• What yield is recommended by GFOA Investment
  Policy Statement
• Market rate of Return
• Total Return
• What is Main Streets investment goal
• Income
• Growth

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Why Have Yield Included As An Investment Policy
Objective

• Increase Public Services
• Mitigate Tax Burden On Citizens
• Help Pay For Government Operations

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What Yield Is Recommended by GFOA Sample
Investment Policy

• The investment portfolio shall be designed
  with the objective of attaining a market rate of
  return throughout budgetary and economic cycles
  taking into account the investment risk
  constraints and liquidity needs. Return is of
  secondary importance compared to the safety and
  liquidity objectives
• GFOA Sample Investment Policy

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What is Main Streets Investment Goal And
Standard of Care

• Investments shall be made with judgment and
  care, under circumstances then prevailing, which
  persons of prudence, discretion and intelligence
  exercise in the management of their own affairs,
  not for speculation, but for investment,
  considering the probable safety of their capital
  as well as the probable income to be derived.
• GFOA Sample Investment Policy

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Budgeting The Main Street Way

• Why is budgeting a market rate of return method
  the most suitable standard for balancing
  preservation of principal with maximizing income.

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Why Market Rate of Return

• Market rate of return more closely approximates
  the real buying and selling practices of public
  funds
• Market rate of return avoids the extreme
  volatility of total return
• Market rate of return is more predictable then
  total return.

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ObservationsTotal Return Market Rate Return

• Neither GASB 31, GASB 40, or GFOA sample
  investment policy uses total return.
• Public funds rarely if ever budget paper gains or
  losses
• Public funds spend coupons making total return
  difficult at best

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Source Stanford Group Company
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Which Portfolio Manager Produces Optimum Budget
With Minimum Principal Risk?

• The GASB 31 Portfolio
• 3mo duration / 3mo TB
• The Total Return Portfolio
• 1.80yr / 2yr USTN
• The Market Rate Of Return Portfolio
• 1.80 / 12 mo moving average 2yr USTN

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Source Stanford Group Company
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Source Stanford Group Company
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ConclusionsInvesting The Main Street Way

• The key performance focus is on stewardship and
  demonstrating the portfolio is suitable
• Main Street has only one peer
• Investment Policy
• Main Street benchmark
• Fiduciary Benchmark consisting of all investment
  policy objectives
• Budget using market rate of return

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STANFORD GROUP COMPANY
Stanford Group Company does not guarantee nor
make any representation as to the accuracy of any
projections, rate of returns or outcome from any
information or scenarios presented.