7 Habits of Highly Effective Investment Programs

Rick PhillipsGIOA Founder &

President of FTN Main Street Advisors

GIOA Annual ConferenceMarch 21, 2019

Kevin Webb, CFAPrincipal

Piper Jaffray & Co.

1

Introduction

Rick Phillips▪ GIOA Founder▪ City of Las Vegas Investment Officer 1989-1998▪ Clark County Chief Investment Officer 1998-2005▪ FTN Main Street President & Chief Investment Officer 2005 - Present▪ Manage/Consult on $50+ Billion AUM

Kevin Webb, CFA▪ Piper Jaffray, Principal▪ Have Spreadsheet. Will travel.▪ Have Speech. Will travel.▪ Optimizing Sleep Adjusted Returns.

2

You Have a Repeatable, Structured Process Based Upon:

2 Things We Know Well and 1 We Don’t:

✓Longer Duration Provides Higher Returns Over the Long Run

✓Your Cash Flows Don’t Always Repeat, But They Usually Really Rhyme

✓Your Can’t Time the Market

3

7 Habits of Highly Effective Investment Programs

1. You Have a Detailed Asset/Liability Matching Model (aka: Cash Flow Model)2. You Have a Responsible Amount of Interest Rate Risk and Credit Risk3. You Don’t Try to Time the Market4. You Love Losses and Hate Gains5. You Follow GAAP6. You Benchmark Your Investment Program and Portfolio in Multiple Ways7. You Provide Quality, Timely, Transparent Reporting

4

You Have a Detailed Asset/Liability Matching Model (aka: Cash Flow Model)

Habit #1

5

A. Safety of Principal: Safety of principal is the foremost objective of the investment program. Investments by the Treasurer shall be undertaken in a manner that seeks to ensure the preservation of capital in the overall portfolio. To attain this objective, diversification is required in order that potential losses on individual securities do not exceed the income generated from the remainder of the portfolio.

B. Liquidity: The investment portfolio shall be structured to timely meet expected cash flow needs and associated obligations which may be reasonably anticipated. This objective shall be achieved by matching investment maturities with forecasted cash outflows and maintaining an additional liquidity buffer for unexpected liabilities.

C. Investment Income: The investment portfolio shall be designed to earn a market rate of investment income in relation to prevailing budgetary and economic cycles, while taking into account investment risk constraints and liquidity needs of the portfolio.

GIOA Model Investment Policy Primary Objectives

6

Detailed Asset/Liability Matching Model

➢ If You Don’t Know Where You’ve Been, You Won’t Know Where You’re Going➢ Many Municipalities Have Too Much Liquidity (But Your Risk is Asymmetrical)

Cash Flow Model:▪ Daily for 12 Months▪ Monthly for 5 Years▪ Worry About the Big Rocks (80/20 Rule)▪ Excel is Awesome!

7

$-1.3B -28%

$-.7B-16%

$-1.4B -28%

$-1.3B-24%

$-1.5B-27%

$-1.3B-20%

$-1.8B-26%

$-2.1B-28%

Apr

Sep/Oct

Cash Flows May Not Repeat Exactly…But Usually Rhyme

Month End Portfolio Balance

$-2.4B-28%

8

Knowing the Rhyme Helps Match Assets with Liabilities

Month End Portfolio Balance by Fiscal Year

9

Material Asset/Liability Changes

Month End Portfolio Balance

Pension Prepayment

10

Material Asset/Liability Changes…Restructuring Maturities

Month End Portfolio Balance by Fiscal Year

11

Portfolio Structure: Buckets of Monies

Segregate Portfolios by Asset/Liability Matching (if you can)▪ Operating Portfolio (Short-Term and Long-Term…Pros/Cons)▪ Property Tax Portfolio▪ Bond Proceeds (Project Funds)▪ Bond Reserve Funds▪ Endowment Funds▪ OPEB Funds

12

Segregate Property Tax Collections Into a Separate Portfolio?

Month End Portfolio Balance by Fiscal Year

13

Different Operating Portfolio Strategies/Structures

14

You Have a Responsible Amount of Interest Rate Risk and Credit Risk

Habit #2

15

Interest Rate Risk Credit Risk

Which Risk Has the Largest Long-Term

Impact on My Investment Income?

16

Optimal Operating Fund Duration: Risk Adjusted Yield

Maturity Avg Yield

Avg

Duration

Modified

Sharp Ratio

3 Mon T-Bill 4.92 0.25 73% / 3%

1 Yr T-Bill 5.33 1.00 0.409 79% / 13%

Sweet Spot 2 Yr T-Note 5.73 1.90 0.427 85% / 24%

3 Yr T-Note 5.95 2.76 0.373 89% / 35%

5 Yr T-Note 6.30 4.50 0.306 94% / 57%

10 Yr T-Note 6.72 7.94 0.227 100% / 100%

Benchmark Treasury Modified Sharp Ratio Analysis

1/31/1982 to 12/31/2018% Return of 10Yr

/ % 10Yr Risk

(Avg Yield – Risk Free Yield) / Avg Duration = MSR

(5.73% 2y – 4.92% 3m) / 1.90 2y = .427

5.73% 2yr / 6.72% 10yr = .85% 1.90 2Yr / 7.94 10Yr = 24% Yield Comparison Duration Comparison

Source: Bloomberg

17

1 Year Weighted Avg Maturity vs. 2 Year Weighted Avg Maturity

18

1 Year WAM vs. 2 Year WAM: A Long View of Returns

Source: Bloomberg

19

The Worry of Skyrocketing Interest Rates??P

erc

en

t

20

Duration vs. Credit: Study 1

Longer Duration Avg Yield: 1.82%Shorter Duration Avg Yield: 1.16%

Avg Annual Variance .66%

21

Duration vs. Credit: Study 2

Longer Duration Avg Yield: 1.82%Shorter Duration Avg Yield: 1.14%

Avg Annual Variance .68%

22

Before/After: Implementing a Asset/Liability Matching Strategy

MATURITY DISTRIBUTION78.4%

8.7% 7.4%4.0%

1.5%

0%

10%

20%

30%

40%

50%

60%

70%

80%

0-1Y 1-2Y 2-3Y 3-4Y 4-5Y

NR: Not

Before: .9 DurationMATURITY DISTRIBUTION

32.1%

17.7% 16.8% 17.5% 15.9%

0%

10%

20%

30%

40%

50%

60%

70%

80%

0-1Y 1-2Y 2-3Y 3-4Y 4-5Y

NR: Not

After: 2.1 Duration

23

You Have a Responsible Amount of Interest Rate Risk

Before: .9 Duration After: 2.1 Duration

24

Credit Risk

25

Credit Risk – Mitigate not Eliminate

Prudence Investor Standard“The standard of prudence to be used by investment officials shall be the "uniform prudent investor act" standard and shall be applied in the context of managing an overall portfolio. Investment officers acting in accordance with written procedures and this investment policy and exercising due diligence shall be relieved of personal responsibility…”

GFOA Sample Investment Policy, accessed 1/21/19, page 3. Emphasis added.

GFOA Sample IPS

General Objectives“The primary objectives of investment activities shall be...1. SafetyInvestments 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. …2. LiquidityThe investment portfolio shall remain sufficiently liquid to meet all operating requirements that may be reasonably anticipated.3. ReturnThe investment portfolio shall be designed with the objective of attaining a market rate of return throughout budgetary and economic cycles…”GFOA Sample Investment Policy, accessed 1/21/19, pages 1-2. Emphasis added.

26

Ratings: The Letters

Bond credit rating. (2016, January 15). In Wikipedia, The Free Encyclopedia. Retrieved 07:22, January 21, 2016, from

https://en.wikipedia.org/w/index.php?title=Bond_credit_rating&oldid=691840556

Also see, Frank J. Fabozzi;Harry M. Markowitz. The Theory and Practice of Investment Management (p. 451). Kindle Edition.

27

Default Rates

Standard & Poor’s “Default, Transition, and Recovery: 2017 Annual Global Corporate Default Study And Rating Transitions”, Table 25 on Page 59.

28

Transition Matrix

“A popular tool used by managers to gauge the prospects of an issue being downgraded or upgraded is a rating transition matrix. This is simply a table constructed by the rating agencies that shows the percentage of issues that were downgraded or upgraded in a given time period. So, the table can be used to approximate downgrade risk and default risk.”

Frank J. Fabozzi. Fixed Income Analysis (Kindle Locations 828-830). Kindle Edition.

Standard & Poor’s “Default, Transition, and Recovery: 2017 Annual Global Corporate Default Study And Rating Transitions”, Table 36 on Page 79.

29

Composite Credit Rating

Numeric

Rating

Composite

Rating

Moody

RatingS&P Rating Fitch Rating

21 AAA Aaa AAA AAA

20 AA1 Aa1 AA+ AA+

19 AA2 Aa2 AA AA

18 AA3 Aa3 AA- AA-

17 A1 A1 A+ A+

16 A2 A2 A A

15 A3 A3 A- A-

14 BBB1 Baa1 BBB+ BBB+

13 BBB2 Baa2 BBB BBB

12 BBB3 Baa3 BBB- BBB-

AMZN AMAZON.COM INC

NRSRO Rating Number

Moody Baa1 14.00

S&P AA- 18.00

Fitch

Average 16.00

Rounded 16.00

Composite A2

Ratings information from Bloomberg as of 8/11/16

30

Credit Ratings – A Digression

Lehman Brothers Credit Rating History

Credit Rating History Source: BloombergFor a timeline and other data on the financial crisis visit the Federal Reserve Bank of St. Louis Financial Crisis webpage.

Source: Bloomberg

31

“The Worst Prediction of a Sorry Lot”

“The ratings agencies had given their AAA rating, normally reserved for a handful of the world’s most solvent governments and best-run businesses, to thousands of

mortgage-backed securities, financial instruments that allowed investors to bet on the likelihood of someone else defaulting on their home. The ratings issued by these

companies are quite explicitly meant to be predictions: estimates of the likelihood that a piece of debt will go into default. Standard & Poor’s told investors, for

instance, that when it rated a particularly complex type of security known as a collateralized debt obligation (CDO) at AAA, there was only a 0.12 percent

probability— about 1 chance in 850— that it would fail to pay out over the next five years. …

In fact, around 28 percent of the AAA-rated CDOs defaulted, according to S&P’s internal figures. … This is just about as complete a failure as it is possible to make in

a prediction: trillions of dollars in investments that were rated as being almost completely safe instead turned out to be almost completely unsafe. It was as if the

weather forecast had been 86 degrees and sunny, and instead there was a blizzard.”

Silver, Nate (2012-09-27). The Signal and the Noise: Why So Many Predictions Fail-

but Some Don't (pp. 20-21). Penguin Group US. Kindle Edition.

An article published by Nate Silver for his FiveThirtyEight blog at the New York Times titled “Why S&P’s Ratings are Substandard and Porous” is an interesting read and can be found here.

32

Supplement credit ratings: Merton model, Equity Analysts Buy/Hold

Source: Bloomberg

DRisk Analyst Recommendations

33

You Don’t Try to Time the Market

Habit #3

34

You Don’t Time the Market

"The only function of economic forecasting is to make astrology look respectable." - John Kenneth Galbraith

“He who lives by the crystal ball soon learns to eat ground

glass.”

C.C. Gaither;Alma E Cavazos-Gaither. Statistically Speaking: A Dictionary of Quotations (Kindle Locations 960-961). Kindle Edition.

35

Experts kNOw better, right?

http://www.buzzfeed.com/lukelewis/26-shockingly-bad-predictions#.fanwK6eXE

Variety magazine, 1955.

36

Experts kNOw better, right?

http://www.buzzfeed.com/lukelewis/26-shockingly-bad-predictions#.fanwK6eXE

Microsoft CEO Steve Ballmer, 2007.

37

Financial Experts kNOw better, right?

http://www.zerohedge.com/news/2013-12-09/10-worst-economic-predictions-ever

Joseph Cassano (Head of Financial Products at AIG),

2007: "It is hard for us, without being flippant, to even see a scenario within any kind of realm of reason

that would see us losing one dollar in any of these

Credit Default Swap transactions."

38

Financial Experts kNOw better, right?

http://www.zerohedge.com/news/2013-12-09/10-worst-economic-predictions-ever

Ben Bernanke, 10th January 2008

- "The Federal Reserve is

currently not forecasting a recession."

39

FOMC kNOw better?

Source: Bloomberg

Effective Fed Funds Rate @ 1.33

on 12/29/172014 2015 2016 2017 Long Term

%

3.5%

1.33%

2017

40

Coin Flipping Framework

Taleb, Nassim Nicholas (2008-10-06). Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets (Incerto) (Kindle Locations 2813-2815). Random House Publishing Group. Kindle Edition.

“Generate a long series of coin flips producing heads and tails with 50% odds each and fill up sheets of paper. If the series is long enough you may get eight heads or eight tails in a row, perhaps even ten of each. Yet you know that in spite of these wins the conditional odds of getting a head or a tail is still 50%.”

41

Coin Flipping Framework

Browne, Malcom W. “Following Benford's Law, or Looking Out for No. 1.” New York Times, August 4, 1998. http://www.nytimes.com/1998/08/04/science/following-benford-s-law-or-looking-out-for-no-1.html

“DR. THEODORE P. HILL asks his mathematics students at the Georgia Institute of Technology to go home and either flip a coin 200 times and record the results, or merely pretend to flip a coin and fake 200

results. The following day he runs his eye over the homework data, and to the students' amazement, he easily found nearly all those who faked their tosses.”

42

Odds of 6 Heads in a Row on 200 Flips?

http://www.wolframalpha.com/input/?i=probability+of+6+heads+in+a+row+200+coin+flips

43

Coin Flipping Simulator

Simulation #1 Simulation #237 14 9 5

Forecaster Flip #1 Flip #2 Flip #3 Flip #41 H H T

2 T

3 H T

4 H T

5 T

6 H H H T

7 H H H H

8 T

9 T

10 H T

11 T

12 T

13 T

14 T

15 H T

16 T

17 H T

18 T

19 T

20 T

21 T

22 H H H T

23 H T

* Out of 100 Simulations - where each simulation consisted of 75 forecasters - an average of 5.0 forecasters flipped heads four times in a row.

* The total number of Simulations with 3 or more forecasters flipping heads four times in a row is 87.

* The total number of Simulations with 4 or more forecasters flipping heads four times in a row is 71.

44

First question asked but last in priority…

General Objectives“The primary objectives, in priority order...1. SafetySafety of principal is the foremost objective… The goal will be to mitigate credit risk and interest rate risk.2. LiquidityThe investment portfolio shall remain sufficiently liquid to meet all operating requirements that may be reasonably anticipated.3. ReturnThe 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 of safety and liquidity needs.”

GFOA Sample Investment Policy, accessed 12/31/16, pages 1-2. Emphasis added.

"...the basic assumption that most institutional investors can outperform the market is false. The institutions are the market. They cannot, as a group, outperform themselves. In fact, given the cost of active management—fees, commissions, and so forth—most investment managers will, over the long term, underperform the overall market. ...

For any one manager to outperform the other professionals, he must be so skillful and so quick that he can regularly catch other professionals making errors—and can systematically exploit those errors faster than other professionals can. ...

The beginning of wisdom for you is to understand that few—if any—major investment organizations will outperform the market averages over long periods of time and that it is very difficult to estimate which managers will outperform. ...

Ellis, Charles D.. Winning the Loser's Game: Timeless Strategies for Successful Investing (Winning the Loser's Game, 3rd ed) (Kindle Locations 243-540). McGraw-Hill Education. Kindle Edition.

45

Success Rate of the Professional Managers to Beat the Market?

46

The Original “Bond King”

Bill Gross

47

The New “Bond King”

Went Bond Bearish in Sep 2018

48

Security Type Selection for Different Strategies

Securities to Match Cash Outflows:▪ Bullets▪ ABS Credit Card (soft bullets)▪ Floating Rate Notes

Securities to Market Time:▪ Bullets▪ Paydowns (ABS/MBS/SBA) ▪ Floating Rate Notes▪ Callables▪ Step-Ups/Step-Downs▪ Bond Mutual Funds▪ Floating NAV Funds

49

Effective Duration: Agency 1-5Yr Bullets vs. 1-5Yr Callables

Effe

ctiv

e D

ura

tio

n

1-5 Yr Agency Bullet Index

1-5 Yr Agency Callable Index

Brexit

Source: Bloomberg

50

Average Prices: 1-5Yr Callables vs. 1-5Yr Bullets

Avg

Pri

ce

100

1-5 Yr Bullets

1-5 Yr Callables

Source: Bloomberg

51

Total Return: 2000-2019 1-5Yr Callables vs. 1-5Yr Bullets

1-5 Yr Bullets

1-5 Yr Callables

Avg Effective Duration: Bullets 2.33 Callables 1.48

194.55% – 164.78% = 29.77%Or 1.65% Per Year from 2000-2019

Pe

rce

nt

Tota

l Re

turn

Source: Bloomberg

52

Total Return: 2000-2019 1-5Yr Callables vs. 1-3Yr Bullets

1-3 Yr Bullets

1-5 Yr Callables

Avg Effective Duration: Bullets 1.78 Callables 1.48

179.08% – 164.78% = 14.3%Or .79% Per Year from 2000-2019

Pe

rce

nt

Tota

l Re

turn

Source: Bloomberg

53

What If Your Timing Was Awesome!

Brexit Low .89%

Powell Hawkish High 3.10%

5Yr

Yie

ld

Source: Bloomberg

54

Awesome Timing: 1-3Yr Bullets vs. 1-5Yr Callables Total Return

Pe

rce

nt

Tota

l Ret

urn

101.108% – 100.833% = .275%Or Only .12% Per Year from 2016-2018

1-5 Yr Callables

1-3 Yr Bullets

Source: Bloomberg

55

The Yield Curve Trap: Why Buy a 5Yr at the Same Yield as a 3 Month?

Source: Bloomberg

56

You Love Losses and Hate Gains

Habit #4

57

#4: You Love Losses and Hate Gains!

58

Preference for Income Growth or Price Increase?

Price

Income

Total rate of return measures the increase in the investor’s wealth due to both investment income (for example, dividends and interest) and capital gains (both realized and unrealized). 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.

Managing Investment Portfolios: A Dynamic Process (CFA Institute Investment Series) (p. 723). Wiley. Kindle Edition. Emphasis added.

59

Time Heals All Wounds…

94

96

98

100

102

104

106

0 10 20 30 40 50 60

Pri

ce

Months Since Purchase

Price Rates Rise

Price Rates Fall

Time Heals All WoundsMonth Price Rates Rise Price Rates Fall

0.00 95.45 104.80

6.00 95.87 104.33

12.00 96.30 103.87

18.00 96.73 103.40

24.00 97.18 102.92

30.00 97.63 102.44

36.00 98.08 101.96

42.00 98.55 101.48

48.00 99.03 100.99

54.00 99.51 100.50

59.00 99.91 100.08

Settlement: 2/28/2019

Maturity: 2/28/2024

Par Amount: 1,000,000.00

Price: 100.000

Coupon: 2.52%

Payment Frequency: 2

Yield: 2.52%

Modified Duration: 4.670

Yield Move (+/-): 1.00%

Assume rates rise or fall by the amount of the Yield Move (+/-) and see how time heals all wounds.

60

Losses Through Time: Rates Rise 200bp over 5 Years

($30,000)

($25,000)

($20,000)

($15,000)

($10,000)

($5,000)

$0

$5,000

$10,000

0 10 20 30 40 50 60

Gai

n/L

oss

$

Months Since Purchase

Book Value ChangeBook(t) - Book(t-1)

Gain/LossMkt(t) - Book(t)

Gain/LossMkt(t) - Mkt(t-1)

Month Book Value Market Value

Book Value

Change Book(t) -

Book(t-1)

Gain/Loss Mkt(t) -

Book(t)

Gain/Loss Mkt(t) -

Mkt(t-1)

0.00 1,000,000.00 1,000,000.00 0.00

6.00 1,000,000.00 991,582.68 0.00 (8,417.32) (8,417.32)

12.00 1,000,000.00 985,002.03 0.00 (14,997.97) (6,580.66)

18.00 1,000,000.00 980,251.39 0.00 (19,748.61) (4,750.64)

24.00 1,000,000.00 977,334.91 0.00 (22,665.09) (2,916.48)

30.00 1,000,000.00 976,267.64 0.00 (23,732.36) (1,067.26)

36.00 1,000,000.00 977,075.80 0.00 (22,924.20) 808.16

42.00 1,000,000.00 979,797.08 0.00 (20,202.92) 2,721.28

48.00 1,000,000.00 984,481.16 0.00 (15,518.84) 4,684.08

54.00 1,000,000.00 991,190.29 0.00 (8,809.71) 6,709.13

59.00 999,978.00 998,300.19 (22.00) (1,677.81) 7,109.90

Settlement: 2/28/2019

Maturity: 2/28/2024

Par Amount: 1,000,000.00

Price: 100.000

Coupon: 2.52%

Payment Frequency: 2

Yield: 2.52%

Modified Duration: 4.670

Convexity: 0.249

61

Losses Through Time: Random Rate Changes over 5 Years

($150,000)

($100,000)

($50,000)

$0

$50,000

$100,000

$150,000

0 10 20 30 40 50 60

Gai

n/L

oss

$

Months Since Purchase

Book Value ChangeBook(t) - Book(t-1)

Gain/LossMkt(t) - Book(t)

Gain/LossMkt(t) - Mkt(t-1)

Month Book Value Market Value

Book Value

Change Book(t) -

Book(t-1)

Gain/Loss Mkt(t) -

Book(t)

Gain/Loss Mkt(t) -

Mkt(t-1)Yield Chane (bp) New Discount Rate

0.00 1,000,000.00 1,000,000.00 0.00 0.00 2.52%

6.00 1,000,000.00 1,113,400.00 0.00 113,400.00 113,400.00 (385.00) 0.00%

12.00 1,000,000.00 1,009,507.99 0.00 9,507.99 (103,892.01) 227.00 2.27%

18.00 1,000,000.00 1,088,200.00 0.00 88,200.00 78,692.01 (423.00) 0.00%

24.00 1,000,000.00 1,074,660.80 0.00 74,660.80 (13,539.20) 3.00 0.03%

30.00 1,000,000.00 1,063,000.00 0.00 63,000.00 (11,660.80) (179.00) 0.00%

36.00 1,000,000.00 1,050,400.00 0.00 50,400.00 (12,600.00) (224.00) 0.00%

42.00 1,000,000.00 1,021,519.33 0.00 21,519.33 (28,880.67) 107.00 1.07%

48.00 1,000,000.00 969,322.26 0.00 (30,677.74) (52,197.07) 465.00 5.72%

54.00 1,000,000.00 1,004,214.81 0.00 4,214.81 34,892.55 (405.00) 1.67%

59.00 999,978.00 1,002,100.00 (22.00) 2,122.00 (2,114.81) (386.00) 0.00%

Settlement: 2/28/2019

Maturity: 2/28/2024

Par Amount: 1,000,000.00

Price: 100.000

Coupon: 2.52%

Payment Frequency: 2

Yield: 2.52%

Modified Duration: 4.670

Convexity: 0.249

62

The Yield Curve Trap: Why Buy a 5Yr at the Same Yield as a 3 Month?

Source: Bloomberg

63

Losses are good if you love increasing income…

General Objectives“The primary objectives, in priority order...1. SafetySafety of principal is the foremost objective… The goal will be to mitigate credit risk and interest rate risk.2. LiquidityThe investment portfolio shall remain sufficiently liquid to meet all operating requirements that may be reasonably anticipated.3. ReturnThe 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 of safety and liquidity needs.”

GFOA Sample Investment Policy, accessed 12/31/16, pages 1-2. Emphasis added.

"...the basic assumption that most institutional investors can outperform the market is false. The institutions are the market. They cannot, as a group, outperform themselves. In fact, given the cost of active management—fees, commissions, and so forth—most investment managers will, over the long term, underperform the overall market. ...

For any one manager to outperform the other professionals, he must be so skillful and so quick that he can regularly catch other professionals making errors—and can systematically exploit those errors faster than other professionals can. ...

The beginning of wisdom for you is to understand that few—if any—major investment organizations will outperform the market averages over long periods of time and that it is very difficult to estimate which managers will outperform. ...

Ellis, Charles D.. Winning the Loser's Game: Timeless Strategies for Successful Investing (Winning the Loser's Game, 3rd ed) (Kindle Locations 243-540). McGraw-Hill Education. Kindle Edition.

64

You Follow GAAP(Generally Accepted Accounting Principles)

Habit #5

65

#5: You Follow GAAP (Generally Accepted Accounting Principles)

If you are not amortizing, when will you recognize the $100,000 gain (income)?

You Amortize

❑ Involves More Work: Monthly Journal Entries❑ Custodians’ Amortization Methodology May Not Match Your Investment Accounting System

Participant $$$ In

Participant $$$ Out

Bond MaturesPurchase Bond

66

Not Amortizing Premiums: Overstating Income

67

You Distribute Inv Income on an Accrual Basis…Not a Cash Basis

68

You Benchmark Your Investment Program and Portfolio in Multiple Ways

Habit #6

69

A. Safety of Principal: Safety of principal is the foremost objective of the investment program. Investments by the Treasurer shall be undertaken in a manner that seeks to ensure the preservation of capital in the overall portfolio. To attain this objective, diversification is required in order that potential losses on individual securities do not exceed the income generated from the remainder of the portfolio.

B. Liquidity: The investment portfolio shall be structured to timely meet expected cash flow needs and associated obligations which might be reasonably anticipated. This objective shall be achieved by matching investment maturities with forecasted cash outflows and maintaining an additional liquidity buffer for unexpected liabilities.

C. Investment Income: The investment portfolio shall be designed to earn a market rate of investment income in relation to prevailing budgetary and economic cycles, while taking into account investment risk constraints and liquidity needs of the portfolio.

Investment Policy Primary Objectives

Investment Portfolios are the Only Area Which Provide Revenue to Your Entity Without Charging Taxes or Fees to Your Citizens

70

Primary Liquidity 12%

(Versus 0-3M Target 15%)

Secondary Liquidity 18%

(Versus 3-12M Target 15%)

Total Liquidity 30%

(Versus 0-12M Target 30%)

Effective Duration 2.1

(Versus Target 2.00)

Moody's Composite Credit Rating Aa1

(Versus Target Aa2)

Total Credit Exposure 30%

(Versus Target 30%)

FYTD Book Rate Rate of Return 2.1

(Versus Benchmark)

Book Yield 2.3

(Versus Benchmark)

12 Month Total Rate Rate of Return 2.9

(Versus Benchmark)

15%

15%

1.9%

2.5%

30%

30%

2.0

Aa2

1.7%

Benchmarking Your Investment Plan: Suitable vs. Legal

71

CFA Institute: Characteristics of Useful Performance Benchmarks

A benchmark is a collection of securities or risk factors and associated weights that

represents the persistent and prominent investment characteristics of a manager's

investment process. A benchmark should be:

• Unambiguous: The identities and weights of securities constituting the benchmark are clearly defined.

• Investable: It is possible to forgo active management and simply hold the benchmark.

• Measurable: The benchmark's return is readily calculable on a reasonably frequent basis.

• Appropriate: The benchmark is consistent with the manager's investment style and sectors.

• Specified in Advance: The benchmark is specified prior to the start of an evaluation period and known to all interested parties.

“The failure of a benchmark to possess these properties compromises its utility as an effective investment management tool. The properties listed merely

formalize intuitive notions of what constitutes a fair and relevant performance comparison. It is interesting to observe that a number of commonly used

benchmarks fail to satisfy these properties.” CFA Institute

72

Important Benchmark Characteristics

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

▪ Sector Allocations▪ Duration/Maturity▪ Turnover

Three Types of Benchmarking:

▪ Weighted Yield▪ Book Rate of Return▪ Total Rate of Return

73

Performance Benchmarking

74

Book Return vs. Total Return

Source: Bloomberg

75

Book Return vs. Total Return

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

8.0

Pe

rce

nt

Yie

ld

2 Year T-Note Yield

4.23%

5.15%

7.70%

Source: Bloomberg

76

Long Run: Total Return and Book Return…Basically Equal

-0.5%

100.5%

100.0%

% of Total Return

Source: Bloomberg

77

1-5 Year Tsy/Agy Index Yield History

Yie

ld

Start1988

End2019

Source: Bloomberg

78

2016: A Volatile Total Return Year

Source: Bloomberg

79

A Real World Example

80

A Real World Example

81

You Provide Quality, Timely, Transparent Reporting

Habit #7

82

Clearly Communicating Information to Your Audiences

• Know Your Audiences: • Governing Body• Management• Auditors• Rating Agencies• GFOA (CAFR)• Peers• Taxpayers

• Be Completely Transparent

• Keep it Simple – Charts/Graphs/Tables

• Provide Details to the Appropriate Audiences

• Demonstrate How the Investment Portfolio is Meeting Objectives

83

"When performance is measured, performance improves. When performance is measured and reported, the rate of improvement accelerates.“ Thomas S. Monson

Your Investment Report Should Be on Your Website

84

GIOA Sample Investment Policy

The [Officer] shall prepare an investment report at least quarterly which provides an analysis ofthe investment program. The report shall be delivered to the [Governing Body] and OversightCommittee at least quarterly and placed on the [Entity’s] website after the [Governing Body’s]approval.

The investment report shall include at least all of the following:

▪ Portfolio Summary: weighted average maturity/duration, weighted average book yield, assetallocation by type, maturity distribution, allocation by ratings, aggregate par value, book value,and market value, and net asset value.

▪ Individual Investments: issuer, CUSIP or identifier, purchase date, maturity date, purchaseyield, par value, book value, market value, credit ratings.

▪ Compliance Matrix: stating the compliance or non-compliance of investments or parameters.

▪ Transactions: a listing of the transactions for the reporting period.

85

Summary

86

Compliance

87

WAM and Yield History

88

Yield Pipeline

89

Interest Rate Shock

90

Sector History

91

Sector Yield/WAM Contribution

92

Issuer Exposure

93

Securities’ Ratings History

94

Investment Income and Book Return

95

Historical Book Return

96

Historical Total Return

97

Activity

98

You Have a Repeatable, Structured Process Based Upon:

2 Things We Know Well and 1 We Don’t:

✓Longer Duration Provides Higher Returns Over the Long Run

✓Your Cash Flows Don’t Always Repeat, But They Usually Really Rhyme

✓Your Can’t Time the Market

99

FTN Main Street Disclosure

100

Piper Jaffray Disclosure

The material contained herein is not a product of any research department of Piper Jaffray & Co. or any of its affiliates. Nothing herein constitutes a recommendation of any security or regarding any issuer; nor is it intended to provide information sufficient to make an investment decision. The information provided is herein not intended to be and should not be construed as a recommendation or "advice" within the meaning of Section 15B of the Securities Exchange Act of 1934.

The information contained in this communication has been compiled by Piper Jaffray & Co. from sources believed to be reliable, but no representation or warranty, express or implied, is made by Piper Jaffray & Co., its affiliates or any other person as to its accuracy, completeness or correctness. All opinions and estimates contained in this communication constitute Piper Jaffray & Co.'s judgment as of the date of this communication, are subject to change without notice and are provided in good faith but without legal responsibility. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur.