Member NYSE|FINRA|SIPC
Creating a Foundation for Investing
North Carolina Local Government Investment Association
2016 Winter Conference
February 8, 2016
Discussion Summary
Setting Goals and Objectives

–
Identify funds to manage
–
Timing of cash needs
–
Determine investment approach
Investment Policy Considerations

–
Authorized Investments
–
Asset Allocation
–
Duration
Purchasing Investments

–
Broker-Dealers
–
Setting up a Process
–
Evaluation of Offers
1
Setting Goals and Objectives
 Key Questions
– What cash are you currently managing?
– What is the timing of using those funds?
 Funds typically fall into different categories
– Day to day operating funds (General/Utility)
– Capital Funds/Bond Proceeds
– Other reserves
 This categorization will help determine timing of cash
flow needs
Types of Cash Deposits
Purpose
Operating
Funds
Payroll

Debt Service

Other
Operating
Expenditures

Capital
Projects
No Specific
Expense
Capital/Bond
Proceeds
Reserves


2
Key Investment Concept – Yield Curve
Normal Yield Curve
– A curve on a graph in which the yield of fixed-interest
securities is plotted against the length of time they
have to run to maturity
Y ield
 Yield Curve
 Basic types of yield curves:
– Normal
M aturity
Inverted Yield Curve
– Inverted
Y ield
• A yield curve in which short-term debt instruments
have a lower yield than long-term debt instruments
of the same credit quality
• A yield curve in which long-term debt instruments
have a lower yield than short-term debt instruments
of the same credit quality
M aturity
– Flat
Y ield
• A yield curve in which there is little difference
between short-term and long-term rates for bonds
of the same credit quality
Flat Yield Curve
M aturity
3
Investment Objectives
 Safety – Avoiding the loss of your principal investment
Impact of Rising Interest Rates on Market Value
– Credit Quality
– Avoiding unexpected sale of investments
 Liquidity – Timely access to your funds
– Short-term deposits
– Matching assets and liabilities
– Secondary market for investments – ability to sell
securities if needed
Market Value of Investment
Maturity
Current
Market
+0.50%
+1.00%
1-Year
$1,000,000
$995,036
$990,109
3-Years
$1,000,000
$985,378
$971,008
5-Years
$1,000,000
$976,213
$953,060
Change in Market Value
 Yield
– Credit Quality
– Diversification of Investments
– Positive slope to yield curve
– Taxable vs. Tax-Exempt
– Cost considerations
Maturity
Current
Market
+0.50%
+1.00%
1-Year
$0
($4,964)
($9,891)
3-Years
$0
($14,622)
($28,992)
5-Years
$0
($23,787)
($46,940)
4
Determine an Investment Approach
 Four main investment approaches:
1. Maintain a Short-term portfolio
– Keep all available cash in readily accessible shortterm investments (i.e. NCCMT, Bank Deposits)
2. Build a Simple Investment Ladder
– Investment purchases are made in equal amounts
spread evenly across a time horizon
3. Build a Targeted Investment Ladder
– Utilize a cash flow forecast to match investment
purchases against future unfunded expenses
4. Hire an Outside Manager
– Hire a third party manager with full discretion to
manage your investment portfolio
 Maintaining a short-term liquidity balance is key under any of these approaches
5
Investment Approach – Short-Term
 Basic Approach: Keep all cash in short-term
investments such as bank deposits or the NCCMT
Effective Federal Funds Rate since 2000
8.0%
7.0%
 Pros:
– Liquidity
6.0%
5.0%
4.0%
– Limited time commitment
3.0%
– Low cost
2.0%
1.0%
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
– Invested on short-end of the yield curve
2000
 Cons:
0.0%
– Budgetary uncertainty of investment income
6
Investment Approach – Simple Investment Ladder
Simple Investment Ladder
Thousands
 Basic Approach: A strategy where investment maturities
are spread out in equal amounts over equal increments
of time. New investments are made as funds become
available or as existing investments mature
$200
$180
$160
$140
$120
 Pros:
– Additional yield under normal yield curve
– Predictable investment income
$100
$80
$60
$40
$20
 Cons:
$0
0 Months 3 Months 6 Months 9 Months
– Liquidity
– Costs
– Limited additional time commitment
12
Months
15
Months
18
Months
Yield Curve – Agency Yields
0.70%
0.60%
0.50%
0.40%
0.30%
0.20%
0.10%
0.00%
0 Months 3 Months 6 Months 9 Months
12
Months
15
Months
18
Months
7
Investment Approach – Targeted Investment Ladder
$400.0
Revenues
$350.0
Expenses
$300.0
$250.0
$200.0
– New/revised operating budgets
$150.0
– Change in timing of projects
$100.0
$50.0
– New/revised debt service payments
– Additional yield under a normal yield curve
Week 26
Week 24
Week 22
Week 20
Week 18
Week 16
Week 14
Week 12
Week 10
Investment Cash Flow
Revenues
Liquidity Position
Expenses
$350.0
$300.0
$250.0
$200.0
– Additional time commitment
$150.0
– Costs
$100.0
$50.0
Week 26
Week 24
Week 22
Week 20
Week 18
Week 16
Week 14
Week 12
Week 10
Week 8
Week 6
Week 4
$0.0
Week 2
Thousands
$400.0
Week 0
 Cons:
Week 8
Optimized Cash Flow
– Predictable investment income
– Liquidity by matching assets and liabilities
Week 6
 Pros:
Week 4
Week 0
$0.0
Week 2
 It is important to regularly update your forecast
Cash Flow Forecast
Thousands
 Basic Approach: By using a cash flow forecast,
investment purchases are made to match future
unfunded expenses
8
Importance of Maintaining a Short-Term Liquidity Position
Actual Revenues vs. Forecast
– Cash flow forecast accuracy
– Uncertain timing of some expenditures (e.g. capital
projects)
– Unexpected/unbudgeted expenses
Thousands
 Even under a targeted ladder approach, maintaining a
short-term position necessary
250.0
Actual
200.0
Forecast
150.0
100.0
50.0
 It is important to set an internal liquidity target that
everyone is comfortable with
 The liquidity target can be refined over time based on
cash flow analysis (i.e. forecast vs. actual performance)
9/25/15
9/11/15
8/28/15
8/14/15
7/31/15
7/17/15
7/3/15
6/19/15
6/5/15
5/22/15
5/8/15
4/24/15
4/10/15
3/27/15
0.0
250.0
Actual
200.0
Forecast
150.0
100.0
50.0
9/25/15
9/11/15
8/28/15
8/14/15
7/31/15
7/17/15
7/3/15
6/19/15
6/5/15
5/22/15
5/8/15
4/24/15
4/10/15
0.0
3/27/15
Thousands
Actual Expenses vs. Forecast
9
Developing an Investment Policy
 Start with a framework
– LGC sample policy
– GFOA sample policy
LGC Sample Policy
GFOA Sample Policy
– Similar North Carolina peers
 Policy Contents
– Goals and Objectives
– Authorized Investments
– Asset Allocation
– Duration
– Delegation of Responsibility
– Investment Procedures
– Safe Keeping and Custody
– Reporting
10
Basic Types of Investments
Types of Investments
Types of Investments
 Collateralized Bank Deposits and CDs
 NCCMT (Cash and Term Portfolios)
 Treasuries
– Bills (discount security with up to 1 year
maturity)
 Agencies
– Federal National Mortgage Association (Fannie
Mae/FNMA)
– Federal Home Loan Mortgage Corporation
(Freddie Mac/FHLMC)
– Federal Home Loan Bank (FHLB)
– Federal Farm Credit Bank (FFCB)
– Notes (up to 10 year maturity)
– Bonds (up to 30 year maturity)
– STRIPS (discount security)
 North Carolina Municipal Bonds/Notes
– State of North Carolina
– Local government or public authority bond
 'Prime Quality' Commercial Paper
– Foreign vs. Domestic
– Non-financial vs. Financial
– Asset Backed
11
Select Investment Risks
Company Risk
Sovereign Risk
Industry Risk
Market Risk
12
Investment Policy Considerations
Consider Types of Permitted Investments
 Permitted Investments
– NC Investment of Public Funds (159-30)
– Additional Considerations
Asset Allocation and Maturity Limitations
 Potential Asset Allocation Considerations
– Maximum allowable investment by investment
type
– Minimum credit ratings
– Maximum limit by issuer
– Industry Risk
– Maximum limit by credit rating
– Sovereign Risk
– Callable securities
– Asset Backed Investments
 Investment Maturity Considerations
– Maximum maturity
– Targeted percentage ranges by maturity
13
Purchasing Investments
 Identify funds that are available to invest
Sample Request for Offers
 Approve a group of Broker-Dealers
Investment Bid Request
February 07, 2016
Request 1 of 2
 Provide Broker-Dealers with Investment Policy and NC
G.S. 159-30
 If regularly purchasing securities, create a manageable
investment process:
Additional Specifications
Request Details
Agencies:
FFCB, FHLB, FNMA, FHLMC
Security Type Requested
All offers must conform with N.C. General Statute 159-30
Non-callable Agencies Requested
Bids Due By
2/8/2016
@ 11:00 AM
Par Amount Requested
$1,000,000
6/1/2017
Latest Maturity
No
Callable
– Request for offers
Please fill out Bid Information below and return in Excel format:
– Identify amount, maturity and asset class
Bidder Name
Example Bidder
Wire/delivery instructions will be provided to the
successful offeror.
Par Amount
$
1,000,000
Security Type
FFCB Discount
Note
Maturity Date
6/1/2017
Price
(%)
99.500%
Yield to Call
YTM % / Call Date
% (if
Coupon Bond Equiv. (if
applicable) applicable)
Yield
(%)
0.000%
0.500%
N/A
N/A
– Receive bid(s) at certain date/time
– Create template for evaluating bids
– Document winning bidder and reason
Other Bid Information
 Clearly communicate with Broker-Dealers about other
harder to find asset classes that meet your needs (e.g.
municipal bonds, CP)
14
Investment Purchasing Process
Roles of Various Parties
1. Requests investment
Municipality
Broker-Dealers
2. Finds requested security
3. Provides trade confirmation
4. Provides
confirmation
and makes
money available
for purchase
Third-Party
Custodian
15
Summary
 Identify the various cash balances to invest and match those funds against anticipated cash flow expenses
 Set your Investment Objectives and determine an Investment Approach
 Create/Modify your Investment Policy based on your objectives/approach and consider additional restrictions
beyond state statute
 Set up a manageable process for purchasing investments
16
Richmond Office
One James Center
901 East Cary Street
11th Floor
Richmond, VA 23219
Charlotte Office
Ty Wellford
First Vice President
(804) 697-2915
[email protected]
Independence Center
101 N. Tryon Street
Suite 1220
Charlotte, NC 28246
Raleigh Office
Glenwood Plaza
3605 Glenwood Ave.
Suite 390
Raleigh, NC 27612
17
Disclaimer
The U.S. Securities and Exchange Commission (the “SEC”) has clarified that a broker, dealer or municipal securities dealer engaging in municipal advisory activities outside the scope of underwriting
a particular issuance of municipal securities should be subject to municipal advisor registration. Davenport & Company LLC (“Davenport”) has registered as a municipal advisor with the SEC. As a
registered municipal advisor Davenport may provide advice to a municipal entity or obligated person. An obligated person is an entity other than a municipal entity, such as a not for profit
corporation, that has commenced an application or negotiation with an entity to issue municipal securities on its behalf and for which it will provide support. If and when an issuer engages
Davenport to provide financial advisory or consultant services with respect to the issuance of municipal securities, Davenport is obligated to evidence such a financial advisory relationship with a
written agreement.
When acting as a registered municipal advisor Davenport is a fiduciary required by federal law to act in the best interest of a municipal entity without regard to its own financial or other interests.
Davenport is not a fiduciary when it acts as a registered investment advisor, when advising an obligated person, or when acting as an underwriter, though it is required to deal fairly with such
persons,
This material was prepared by public finance, or other non-research personnel of Davenport. This material was not produced by a research analyst, although it may refer to a Davenport research
analyst or research report. Unless otherwise indicated, these views (if any) are the author’s and may differ from those of the Davenport fixed income or research department or others in the firm.
Davenport may perform or seek to perform financial advisory services for the issuers of the securities and instruments mentioned herein.
This material has been prepared for information purposes only and is not a solicitation of any offer to buy or sell any security/instrument or to participate in any trading strategy. Any such offer
would be made only after a prospective participant had completed its own independent investigation of the securities, instruments or transactions and received all information it required to make its
own investment decision, including, where applicable, a review of any offering circular or memorandum describing such security or instrument. That information would contain material information
not contained herein and to which prospective participants are referred. This material is based on public information as of the specified date, and may be stale thereafter. We have no obligation to
tell you when information herein may change. We make no representation or warranty with respect to the completeness of this material. Davenport has no obligation to continue to publish
information on the securities/instruments mentioned herein. Recipients are required to comply with any legal or contractual restrictions on their purchase, holding, sale, exercise of rights or
performance of obligations under any securities/instruments transaction.
The securities/instruments discussed in this material may not be suitable for all investors or issuers. Recipients should seek independent financial advice prior to making any investment decision
based on this material. This material does not provide individually tailored investment advice or offer tax, regulatory, accounting or legal advice. Prior to entering into any proposed transaction,
recipients should determine, in consultation with their own investment, legal, tax, regulatory and accounting advisors, the economic risks and merits, as well as the legal, tax, regulatory and
accounting characteristics and consequences, of the transaction. You should consider this material as only a single factor in making an investment decision.
The value of and income from investments and the cost of borrowing may vary because of changes in interest rates, foreign exchange rates, default rates, prepayment rates, securities/instruments
prices, market indexes, operational or financial conditions or companies or other factors. There may be time limitations on the exercise of options or other rights in securities/instruments
transactions. Past performance is not necessarily a guide to future performance and estimates of future performance are based on assumptions that may not be realized. Actual events may differ
from those assumed and changes to any assumptions may have a material impact on any projections or estimates. Other events not taken into account may occur and may significantly affect the
projections or estimates. Certain assumptions may have been made for modeling purposes or to simplify the presentation and/or calculation of any projections or estimates, and Davenport does
not represent that any such assumptions will reflect actual future events. Accordingly, there can be no assurance that estimated returns or projections will be realized or that actual returns or
performance results will not materially differ from those estimated herein. This material may not be sold or redistributed without the prior written consent of Davenport.
Version 01/13/2014 LS|TW
18