Title: Portfolio Management 2 Tools for Analyzing Trades
1 Benchmarking for Public Fund Investment
Guidance and Performance BEST PRACTICES Safety,
Liquidity and Return
OMFOA - 2008
Davidson Fixed Income Management Deanne Woodring,
CFA Managing Director (866) 999-2374 www.DavidsonF
IM.com Dwoodring_at_dadco.com
2Encompassing Portfolio Management Tools
Effect Purchase date Maturity of Portfolio
Yield
Investment Policy
Benchmark Process
Process Control Risk Manage Return
Accountability Strategy
Framework Maturity Asset Allocation Broker
Relationships Define Goals
3Prudent 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.
4Reality 2008 Public Fund Cash Management
Process
4
Davidson Fixed Income Management
5Principles Of Investing
- Considerations when
- 1. Buying a house
- 2. Buying a car
- 3. Investing in retirement
6Principles 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.
7Yield 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
8Does 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
-
-
9US Treasury 2 Year Note12/31/97 12/31/07
10US Treasury 2 Year Note12/31/07 03/04/08
11SAFETYSmoothing 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 year Duration 1.2 yrs
12Facts 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.
13Best Practice Benchmark Considerations
Incorporate Objectives
- LIQUIDTY Cash Flow Liquidity vs. Core
- SAFETY Asset Allocation - Diversification
- RETURN Market Risk Exposure Duration
-
14A 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
15Strategy Utilizing Benchmarks
- STEPS
- Evaluate return expectations
- Determine acceptable risk tolerance
- Establish appropriate benchmark
- Establish duration targets
- Determine guidelines
- Monitor and report performance
- Rebalance the portfolio
161. Evaluate Return ExpectationsBased on Duration
- Ending Value and Return - Manage Duration
- 10,000,000.00 Invested Over the Last 10 Years
-
Source Merrill Lynch indices
17 Evaluate ReturnBased on Duration
- Ending Value and Return- Manage Duration
- 10,000,000.00 Invested Over the Last 5 Years
-
Source Merrill Lynch indices
18Evaluate Return Based on Asset Allocation
- Ending Value and Return-
- 10,000,000.00 Invested Over the Last 5 Years
-
Source Merrill Lynch indices
19Outperforming 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
20Evaluate Return Based on Yield Curve
- Ending Value and Return-
- 10,000,000.00 Invested Over the Last 5 Years
-
Source Merrill Lynch indices
212. Determine Acceptable Risk ToleranceMark to
Market
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
222. Determine Acceptable Risk Credit
Diversification
233. 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 Year Duration 1.76
- Average Maturity 1.66 years
- 2. Pick Standard Market Index
- 1-3 Agency Index Duration 1.65
- 0-3 Treasury Index Duration 1.2
-
24 Standard Index Comparison to Practice
25Standard Index versus Custom Index based on Legal
Parameters
26Standard Index versus Custom Index based on Legal
Parameters
27 Establish Benchmark
- Select the Agency/Treasury 0-3 year Index
- Duration is appropriate
- Agency exposure appropriate
- Add value when spreads are wide on corporate and
agency issues
27
284. Establish Duration Targets
Historical Yield Levels
29Establish Duration Targets
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.
305. Determine Guidelines
31Guidelines
326. Report on Portfolio
Liquidity Component of Portfolio
15MM State Pool or Short Term Money Market Issues
Rate 4.80
Core Component Of Portfolio - 12/31/07
33 Monitor Portfolio Compared to Benchmark
- Returns Risk
- Portfolio Benchmark Portfolio
Benchmark - 1/31/07 .307 .215 1.35 1.64
- 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
1.46 1.72 - 6/30/07 .423 .419 1.51 1.67
- 7/31/07 .729 .911 1.40 1.64
- 8/31/07 .637 1.028 1.24 1.61
- 9/30/07 .848 .708
1.36 1.64 - 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 Monitor Portfolio Compared to Benchmark
(100,000,000 Portfolio)
Benchmark US Treasury 1-3 Duration 1.65
357. 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 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?
-
37Answer What If Scenario duration
38Other Scenarios
39What do you buy?
Recommendation Buy 2 year bullet agency
40BEST PRACTICE BENCHMARK 2008 and Beyond
Comply
Comply
Comply
41How to implement?
- Evaluate Internal System and Expertise
- Cost/Benefit Analysis of Outsourcing - Advisors
- Evaluate Value of Improved Process
42Benefits 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
43BENCHMARK RESOURCE
44TOP TEN ISSUES
- CASH FLOW
- DIVERSIFICATION OF LIQUIDITY AND INVESTMENTS
- DIVERSIFICATION OF MATURITY AND DURATION
- DIVERSIFICATION OF ASSET CLASS
- KNOW THE RISKS IN YOUR PORTFOLIO
- KNOW THE CURRENT MARKET ENVIRONMENT
- HAVE A STRATEGY
- ESTABLISH GUIDELINES
- COMMUNICATE
- MONITOR THE PORTFOLIO
45MARKET OBSERVATIONS
46THE LAST EASE
47Today- Treasuries have lead ease
48Where are Fed Funds Rates and Short Rates Headed?
49YIELD CURVE
50 51