Rick Phillips President & Chief Investment Officer 702-932-5330 [email protected]...

Rick PhillipsPresident & Chief Investment Officer702-932-5330 [email protected]

Portfolio Benchmarking

Government Investment Officers Association March 17, 2011

Municipal Investment Managerswww.MainStreetCap.com

Municipal Investment Managerswww.MainStreetCap.com2

Disclosure

The views expressed herein are those of the speaker and do not necessarily represent the views of Main Street Capital Advisors. Views are based on data available at the time of this presentation and are subject to change based on market and other conditions. Main Street cannot guarantee the accuracy or completeness of any statements or data. The information provided does not constitute investment advice and it should not be relied upon as such. It is not a solicitation to buy and/or an offer to sell securities. It does not take into account any investor’s particular investment objectives, strategies, tax status, or investment horizons. All material has been obtained from sources believed to be reliable, but we make no representation or warranty as to its accuracy and you should not place any reliance on this information. Past performance is no guarantee of future results.

© Copyright 2011 Main Street Capital Advisors, LLC. All Main Street logos, trademarks and service marks appearing herein are property of Main Street Capital Advisors, LLC. This document may not be copied or distributed by the recipient. This document is provided for informational purposes only.


GFOA Model Investment Policy

Safety: Safety of principal is the foremost objective of the investment program. Investments shall be undertaken in a manner that seeks to ensure the preservation of capital in the overall portfolio. The objective will be to mitigate credit risk and interest rate risk.

Liquidity: The investment portfolio shall remain sufficiently liquid to meet all operating requirements that may be reasonably anticipated. This is accomplished by structuring the portfolio so that securities mature concurrent with cash needs to meet anticipated demands (static liquidity). Furthermore, since all possible cash demands cannot be anticipated, the portfolio should consist largely of securities with active secondary or resale markets (dynamic liquidity). A portion of the portfolio may be placed in money market mutual funds or local government investment pools, which offer sameday liquidity for short-term funds.

Yield: 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 on investment is of secondary importance compared to the safety and liquidity objectives described above. The core of investments are limited to relatively low risk securities in

anticipation of earning a fair return, relative to the risk being assumed. Securities shall generally be held until maturity, with the following exceptions:

• A security with declining credit may be sold early to minimize loss of principal. • A security swap would improve the quality, yield, or target duration in the portfolio. • Liquidity needs of the portfolio require that the security be sold.


Presentation SummaryDiscuss Pros and Cons and the Mechanics of each method of benchmarking:

So you can determine which type of benchmarking is appropriate and suitable for your entity.

Main Takeaways You Should Benchmark the Portfolio The Benchmark Needs to be Relevant


Primary Factors to Consider

To Be Relevant, Benchmarks Should Reflect the General Characteristics of a Portfolio’s:

Sector Allocations

Duration/Maturity

Turnover


Investment Portfolio

Liquidity Portfolio

(Target: 20%-30%)

Primary Liquidity

(1-90 Days)

Secondary Liquidity

(91-365 Days)

Core Portfolio(Target 70%-80%)

Municipal Portfolio Structure: Typical Allocation

Sector

Target Allocation

%

Money Markets 20%

Treasuries 10%

Agencies

Bullets (non-call) 40%

Callables 30%

Total 100%

More than One Benchmark Component is Usually Needed--Customize


Keeping Score of Your Portfolio

Yield Return Book Return Total Return


Yield ReturnPortfolio’s Month End Average Weighted Book/Purchase Yield

Security Maturity Duration Wgt Dur Par Value % of Portfolio Book Yld Wgt YldLGIP 3/1/2011 0.00 0.00 5,000,000 4.00% 0.15% 0.01%

Agency 3/31/2011 0.08 0.01 10,000,000 8.00% 0.20% 0.02%Treasury 4/30/2011 0.17 0.01 10,000,000 8.00% 0.25% 0.02%Agency 5/31/2011 0.25 0.02 10,000,000 8.00% 0.20% 0.02%

Treasury 6/30/2011 0.33 0.03 10,000,000 8.00% 0.30% 0.02%Agency 7/31/2011 0.42 0.03 10,000,000 8.00% 0.25% 0.02%

Treasury 8/31/2011 0.50 0.04 10,000,000 8.00% 0.35% 0.03%Agency 9/30/2011 0.59 0.05 10,000,000 8.00% 0.30% 0.02%

Treasury 10/31/2011 0.67 0.05 10,000,000 8.00% 0.35% 0.03%Agency 11/30/2011 0.75 0.06 10,000,000 8.00% 0.30% 0.02%

Treasury 12/31/2011 0.84 0.07 10,000,000 8.00% 0.40% 0.03%Agency 1/31/2012 0.92 0.07 10,000,000 8.00% 0.35% 0.03%

Treasury 2/29/2012 1.00 0.08 10,000,000 8.00% 0.40% 0.03%Total 0.52 125,000,000 100.00% 0.30%


Yield Return - Custom BenchmarkSector WeightLGIP 4%Treasury* 48%Agency# 48%Total 100%

Month-End Yields:*GB1=1 Yr T-Bill#AGDN360Y= 1Yr Agency

Yld Mar-10 Apr-10 May-10 Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11LGIP Yld 0.19 0.18 0.20 0.22 0.23 0.23 0.21 0.21 0.22 0.20 0.19 0.19Tsy Yld 0.38 0.38 0.32 0.31 0.28 0.23 0.25 0.21 0.26 0.27 0.24 0.24Agy Yld 0.48 0.50 0.49 0.44 0.34 0.30 0.26 0.24 0.29 0.24 0.21 0.22 Wgt 4% 4% 4% 4% 4% 4% 4% 4% 4% 4% 4% 4%Tsy 48% 48% 48% 48% 48% 48% 48% 48% 48% 48% 48% 48%Agy 48% 48% 48% 48% 48% 48% 48% 48% 48% 48% 48% 48% Wgt Yld 0.42 0.43 0.40 0.37 0.31 0.27 0.25 0.22 0.27 0.25 0.22 0.23

0.0

0.5

1.0

1.5

2.0

2.5 T-Bill12 MMA

Perc

ent .45% May 09

1.14% 12 Month Moving Avg

Jun 08 to May 09


Yield Return: Pros and Cons

Pros: • Ease of Calculation• Ease of Understanding (presenting to governing boards)• Helpful for Budgeting Interest Income

Cons:• Does Not Account for Realized Capital Gains or Losses• Subject to Yield To Maturity Assumptions


Yield to Maturity Assumption

Step-Up Example: 5 Year Maturity, Annual 1% Steps, Purchased at Par

Coupons: Yr 1 -- 1%Yr 2 -- 2%Yr 3 -- 3%Yr 4 -- 4%Yr 5 -- 5%Avg -- 3%

What is the YTM?1% or 3% or %?

Future Coupon Payments Are Reinvested at the Purchase Yield


Book Return

+ Accrued/Received Interest +/- Amortization or Premiums/Discounts +/- Realized Gains/Losses

Average Daily Book Balance for the Period = Book Return


Total Return

+ Accrued/Received Interest +/- Amortization or Premiums/Discounts +/- Realized Gains/Losses+/- Unrealized Gains/Losses

Time Weighted Invested Value for the Period (Market Value Based)

= Total Return

Public Fund Investment Managerswww.MainStreetCap.us14

Interest Rates Decline 50 Basis Points for the MonthCalculation of Return

Book Return vs Total ReturnInterest Collected 300,000

Plus Accrued Interest at End of Period 150,000

Less Accrued Interest at Beginning of Period (100,000)

Less Accrued Interest at Purchase During Period (50,000)

Interest Earned During Period 300,000

Adjusted by Premiums and Discounts 50,000

Adjusted by Realized Capital Gains or Losses 100,000

Adjusted by Mark-to-Market N/A

Earnings During Period 450,000

Daily Weighted Balance for Period100,000,00

0

Book Rate of Return - Period 0.45%

Book Rate of Return - Annualized 5.40%

Interest Collected 300,000

Plus Accrued Interest at End of Period 150,000

Less Accrued Interest at Beginning of Period (100,000)

Less Accrued Interest at Purchase During Period (50,000)

Interest Earned During Period 300,000

Adjusted by Premiums and Discounts N/A

Adjusted by Realized Capital Gains or Losses 100,000

Adjusted by Mark-to-Market 750,000

Earnings During Period 1,050,000

Daily Weighted Balance for Period100,000,00

0

Total Rate of Return - Period 1.05%

Total Rate of Return - Annualized 12.60%

Mark-to-Market: $100,000,000 x 1.5 duration x .50%= $750,000


Book Return – Under the HoodSample Benchmark Composition:(Combined Liquidity and Core Portfolio)

Sector Maturity Index Bberg Ticker Moving Average LGIP 1 Day LGIP N/A Monthly Distb. Rate

Agy Discount Notes 0-6 Months 3 Mon Discount Notes AGDN090Y 6 Month

Commercial Paper 0-3 Months A1/P1 45 Day Dealer CP DCPB045Y 3 Month

CDs 0-3 Months A1/P1 45 Day CDs DCDB45D 3 Month

Agy Bullets 1-3 Years 1-3 Yr Agency Bullets G1PB 12 Month

Agy Callables 1-3 Years 1-3 Yr Agency Callables G1PC 12 Month

T-Notes 1-3 Years 1-3 Yr Treasuries G102 12 Month

Corporate Notes 1-3 Years 1-3 Yr Corp Notes A-AAA C1A1 12 Month


Yield & Book Return Benchmark

The views

Jan-07

Mar-0

7

May-07

Jul-07

Sep-07

Nov-07

Jan-08

Mar-0

8

May-08

Jul-08

Sep-08

Nov-08

Jan-09

Mar-0

9

May-09

Jul-09

Sep-09

Nov-09

Jan-10

Mar-1

0

May-10

Jul-10

Sep-10

Nov-100.00.51.01.52.02.53.03.54.04.55.0

2Yr T-Note: Daily Average Yield vs Month-End Yield1/1/07 to 12/31/10

Daily AvgMon. End

Perc

ent

Daily Avg = 1.99%Month End = 1.95%


Moving Average Benchmarks

Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-100

1

2

3

4

5

62Yr T-Note Month-End Yld : 12 Mon. vs 24 Mon.

12 MMA

24 MMA

Perc

ent

Date 12 MMA 24 MMA VarDec-01 3.70 4.95 -1.25Dec-02 2.55 3.12 -0.58Dec-03 1.64 2.09 -0.45Dec-04 2.41 2.02 0.38Dec-05 3.89 3.15 0.74Dec-06 4.80 4.35 0.45Dec-07 4.26 4.53 -0.27Dec-08 1.91 3.09 -1.17Dec-09 0.95 1.43 -0.48Dec-10 0.65 0.80 -0.15

Avg 2.68 2.95 -0.28


Book Return: Pros and Cons

Pros: • Matches Budgeting Process• Closely Matches Actual Cash Flows

Cons:• Subject to Manipulation of Realized Gains/Losses• May Not Reflect Portfolio’s Market Volatility Changes (The Primary Reason for GASB 31)


Total Return Parameters/RulesBank of America/Merrill Lynch 1-3 Year Treasury and Agency Index

(Ticker: G1A0)

• Issue Size: $250 Million and Up (Agy*), $1 Billion and Up (Tsy*)

• Monthly Rebalanced

• Index “Buys” all Tsy and Agy Fixed Rate Securities Between 1-3 Yrs

• Index “Sells” all Tsy and Agy Fixed Rate Securities Less Than 1 Yr

• “Buys” Newly Added Securities at the Bid Side – Worth about 12’ish Basis Points Annually

*Non-Subordinated # Non-TIPS


1-3 Yr Govt Index Sector Allocation

Tsy 76.2%

Agy 19.6%

Corp FDIC 4.1%Sector Percent

Tsy 76.2%FNMA 7.4%FHLMC 6.6%FHLB 4.7%FFCB 0.8%TVA 0.2%Corp FDIC 4.1%Total 100%


0.0-1.0 1.0-1.5 1.5-2.0 2.0-2.5 2.5+0%

5%

10%

15%

20%

25%

30%

35%

9.2%

29.6%27.7%

21.0%

12.5%

1-3 Yr Govt Index Duration Allocation

Effective Duration


% of Mkt ValBullets 95.2%Calls 4.8%

# of IssuesBullets 260Calls 231Total 491

% of IssuesBullets 53%Calls 47%


1-3 YR Govt Index Duration

Oct 2010 Jan 2011 Mar 2010

1.82

1.74Month-End

Month-Start

Dur

atio

n


1-3 YR Govt Callable Index Duration

Oct 2010 Jan 2011 Mar 2010

Dur

atio

n


*Book Return= 12 Mon Moving Avg of Index Month-End Yield

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 20100

2

4

6

8

10

12

141-3 Yr Govt Index: Total Return vs Book Return*

12MMA

Annual TRR

Pe

rce

nt


1-3 Yr Govt Index Components of Return

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010-6

-4

-2

0

2

4

6

8

10

12

14

Coupon Return

Price Return

Total Return


1-3 Govt Index: Price* vs Coupon Return

1991 to 2010

Price Return*: .4% = .02%Coupon Return: 99.6% = 5.25%Total Return: 100.0% = 5.27%

Price Return=Mark-to-Market Change

Year 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 Avg

Price 3.2 -0.9 -0.9 -5.4 4.1 -1.2 0.2 0.6 -2.8 1.7 2.6 1.2 -1.7 -2.2 -1.8 0.0 2.5 2.6 -1.6 0.2 0.02

Coupon 8.5 7.2 6.4 6.0 6.9 6.2 6.4 6.4 5.9 6.4 5.8 4.7 3.7 3.2 3.5 4.2 4.6 4.1 2.8 2.2 5.25

Total 11.7 6.3 5.4 0.6 11.0 5.0 6.7 7.0 3.1 8.1 8.4 5.9 2.0 1.0 1.7 4.1 7.1 6.7 1.2 2.3 5.27

Book Return (Coupon) and Total Return are

basically the same over the long run


Total Return Implications

“The total rate of return implies that a dollar of wealth is equally meaningful to the investor, whether that wealth is generated by the secure income from a 90-day Treasury bill or by the unrealized appreciation in the price of a share of common stock (or bond).” (CFA Institute curriculum)


Conclusions

• To Adhere To the 3rd Object of Your Investment Policy-You Need to Benchmark Your Portfolio to See if it’s Earning a “Market Rate of Return”

• It’s Okay to Use All Three Measures

• Book Return and Total Return Are More Sophisticated Measures and Capture More Information

• Book Return Is Generally More Congruent With Most Municipalities’ Budgeting Programs

• Total Return Captures the Mark-to-Market Volatility of a Portfolio

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