Presented by:

Barbara BoswellFinance DirectorCity of Lancaster

David Witthohn, CFA, CIPMDirectorCutwater Asset Management

Drivers of Portfolio Performance

California Society of Municipal Finance Officers (CSMFO)

February 21, 2013

2222

Last

sav

ed: T

hurs

day,

July

19, 2

012

at 7

:29

PM

Cash Flow Forecasting

Do you really need most of your funds within the next 24 hours?

71.0%

10.0% 8.0% 8.0%3.0%

0.0% 0.0%0%

10%

20%

30%

40%

50%

60%

70%

80%

0 - 3 months 3 - 6 months 6 - 12 months 1 - 2 years 2 - 3 years 3 - 4 years 4 - 5 years

Maturity Distribution – to final

3

Target Duration: Risk/Return Tradeoff

Normally, the yield curve provides higher returns for longer maturities, but these incremental increases are much smaller for securities that are more than 10 years to maturity.

Source: Bloomberg4

What is a Cash Flow Forecast?

• Projection of anticipated receipts

• Projection of anticipated disbursements

• Estimate of investable cash balances•Liquid funds

•Core funds

5

Why Prepare a Cash Flow Forecast?

• Improves investment earnings

• Ensures liquidity for disbursements

• Identifies short-term cash deficits

• Warns of impending budget problems

6

Major Impediments to Forecasting

• Tendency to think in budget years

• Difficulty distinguishing between fund balance and cash balance

• Inadequate time and/or staff

• Unpredictability of revenues and expenditures

• Lack of information and communication

• Lack of adequate technology

7

Types of Cash Forecasts

Annual Forecasts• Estimates monthly cash position

• Determines cash available for investments

• Provides a useful monthly overview for investment decision-making

• Prepared for this fiscal year and next one- to two-fiscal years

8

Types of Cash Forecasts

Project-based Forecasts• Provides monthly data on status of capital projects

• Helps fine tune monthly and weekly forecasts

• May require input from contractors or in-house project managers

9

Tools for Cash Flow Forecasting

• Historical data from general ledger

• Historical data from bank statements

• Current year budget

• Capital project spending projections

• Other major departments’ budgets

• Schedule of investment maturities and coupon payments

10

Identify Revenues and Expenditures

Major revenue types• Property tax

• Sales and use tax

• User fees

• Federal and state assistance

• Grants

• Bond proceeds

• Other

Major expenditure types• Payroll (net)

• Withholding and benefits

• Debt service

• Capital expenditures

• Materials and supplies

• Overhead (e.g., utilities)

• Other

11

Forecasting Receipts

• Identify 4-5 categories for major sources of revenue• Compile historical data of actual monthly receipts• Identify significant changes• Identify non-recurring items from prior years and for

coming year• Develop analysis of monthly receipts as a percent of

annual• Adjust historical distribution for known differences

12

Projected Monthly Receipts

Jan Feb Mar Apr May Jun Total

Property Tax $2,775 $975 $0 $895 $2,855 $0 $15,000

Sales Tax $718 $293 $319 $212 $771 $351 $2,661

Water $209 $209 $209 $209 $209 $209 $2,508

State $2,017 $0 $0 $2,017 $0 $0 $8,068

Other $45 $45 $45 $45 $45 $45 $540

Total $5,764 $1,522 $573 $3,378 $3,880 $605 $28,777

Receipts Forecast

13

Forecasting Disbursements

• Establish reasonable number of categories

• Compile historical data of actual monthly disbursements

• Identify significant changes

• Identify non-recurring items from prior years and for coming year

• Develop analysis of recurring monthly disbursements as a percent of annual

• Include debt service payments

14

Projected Monthly Disbursements

Jan Feb Mar Apr May Jun Total

Payroll $1,130 $1,103 $1,103 $1,103 $1,144 $1,144 $13,614

Payables $65 $65 $65 $65 $65 $65 $780

Capital Projects $32 $33 $50 $23 $44 $47 $456

Debt Service $23 $0 $0 $46 $0 $0 $86

Other $25 $25 $25 $25 $25 $25 $540

Total $1,275 $1,226 $1,243 $1,262 $1,278 $1,281 $15,476

Disbursement Forecast

15

Creating a Cash Flow Forecast

• Beginning balance of cash and investments

• Monthly revenue projections

• Monthly expenditure projections

• Projected net change

• Projected cumulative balance of cash and investments

16

Jan Feb Mar Apr May JunBeginningBalance $3,200

Projected Receipts $5,764 $1,522 $573 $3,378 $3,880 $605 Projected Disbursements $1,275 $1,226 $1,243 $1,262 $1,278 $1,281

Net Receipts(Disbursements) $4,489 $296 ($670) $2,116 $2,602 ($676)

CumulativeBalance $7,689 $7,985 $7,315 $9,431 $12,033 $11,357

17

Cash Flow Forecast

Estimate Timing of Investments

• Schedule of current investments

• List of maturity dates

• Schedule of income payments

18

Required Liquidity

• Look at the projected net cash flows and hold the amount required to meet the largest negative month and add a margin of safety

• Establish a required minimum cash balance that you would prefer to have available.

19

Comprehensive Cash Flow Forecast

Beg. Balance Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Total

Beg. Balance 19,534,000

Property Tax Revenues 519,000 2,766,000 442,000 498,000 496,000 181,000 8,702,000Other Revenues 1,134,000 1,134,000 1,168,000 1,202,000 1,134,000 1,285,000 11,648,000Payroll and Payables (1,386,000) (1,395,000) (1,427,000) (1,354,000) (1,455,000) (1,550,000) (11,829,000)Capital Projects (95,000) (105,000) (65,000) (150,000) (180,000) (45,000) (4,235,000)Debt Service 0 0 0 0 0 (1,430,000) (3,245,000)

Projected Net Change 172,000 2,400,000 118,000 196,000 (5,000) (1,559,000)

Portfolio Income & Maturity 0 0 0 250,000 1,525,000 1,023,000

Projected Cash Balance 19,534,000 19,706,000 22,106,000 22,224,000 22,420,000 22,415,000 20,856,000

Required Liquidity 10,000,000 10,000,000 10,000,000 10,000,000 10,000,000 10,000,000 10,000,000

Core Portfolio 9,534,000 9,706,000 12,106,000 12,224,000 12,420,000 12,415,000 10,856,000

20

Review Cash Forecast

• Compare actual versus forecast

• Identify reasons for variances

• Adjust assumptions if warranted

• Follow up with department heads on capital project slippage

• Update database for accurate future projection

• Retain documentation for future reference

21

22222222

Last

sav

ed: T

hurs

day,

July

19, 2

012

at 7

:29

PM

Portfolio Management

How Did We Get Here?

23

Active Management Strategies

There are three primary drivers of performance for high quality short-term fixed income portfolios:

Duration management

Sector allocation

Security selection

24

25252525

Last

sav

ed: T

hurs

day,

July

19, 2

012

at 7

:29

PM

Duration Management

Cash Flow Analysis

To determine how much money you have to invest in your core portfolio and for how long, you need to analyze some basic cash flow projections. Here is an illustration of what that could look like.

Dec-1

0

Mar

-11

Jun-

11

Sep-1

1

Dec-1

1

Mar

-12

Jun-

12

Sep-1

2

Dec-1

2

Mar

-13

Jun-

13

Sep-1

3

Dec-1

3

Mar

-14

Jun-

14

Sep-1

4

Dec-1

4

Mar

-15

Jun-

15

Sep-1

5 $-

$20

$40

$60

$80

$100

$120

$140

Cash Flow Illustration

Liquid Funds Core Funds

Mill

ion

s $

Historical Cash Flows Projected Cash Flows

26

Traditional Portfolio Structure

Utilizes traditional money market sectors

Manages liquidity and credit risks

Enables timely reinvestment of cash flows

Captures best duration risk-adjusted returns with the “reserve” portion of the portfolio

Allocates to government and high quality sectors, ensuring liquidity if needed

Insulates portfolio return from interest rate volatility, enhancing portfolio performance

Liquidity Portion of Portfolio

1 to 3 Year Portion of Portfolio

30%

70%

27

3-month Treasury Bill 6-month Treasury Bill 1-Year Treasury 1-3 Year Treasury Index

1-5 Year Treasury Index

3-5 Year Treasury Index

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

3.50%

4.00%

4.50%

5.00%

0

2

4

6

8

10

12

14

16

18

20

1.81%

2.11%2.24%

2.75%

3.36%

4.38%

0 0

4

6

11

14

Return Number of Negative Quarters

Analyzing the Risk/Return Tradeoff

Source: Bloomberg

Return vs. Number of Negative QuartersJanuary 1, 2003 to December 31, 2012

28

Reduces Volatility of Returns

Source: Bloomberg29

30303030

Last

sav

ed: T

hurs

day,

July

19, 2

012

at 7

:29

PM

Duration Management - Looking Forward

Dec-05

Jan-06

Feb-06

Mar-06

Apr-06

May-06

Jun-06

Jul-06

Aug-06

Sep-06

Oct-06

Nov-06

Dec-06

Jan-07

Feb-07

Mar-07

Apr-07

May-07

Jun-07

Jul-07

Aug-07

Sep-07

Oct-07

Nov-07

Dec-07

Jan-08

Feb-08

Mar-08

Apr-08

May-08

Jun-08

Jul-08

Aug-08

Sep-08

Oct-08

Nov-08

Dec-08

Jan-09

Feb-09

Mar-09

Apr-09

May-09

Jun-09

Jul-09

Aug-09

Sep-09

Oct-09

Nov-09

Dec-09

Jan-10

Feb-10

Mar-10

Apr-10

May-10

Jun-10

Jul-10

Aug-10

Sep-10

Oct-10

Nov-10

Dec-10

Jan-11

Feb-11

Mar-11

Apr-11

May-11

Jun-11

Jul-11

Aug-11

Sep-11

Oct-11

Nov-11

Dec-11

Jan-12

Feb-12

Mar-12

Apr-12

May-12

Jun-12

Jul-12

Aug-12

Sep-12

Oct-12

Nov-12

Dec-12

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7-Year Average 2.17

Lengthen Duration

Shorten Duration

Duration Management

Source: Bloomberg31

Yield Curve - top of the interest rate cycle

The curve is inverted, enticing investors to stay short.

Source: Bloomberg

Lengthen Maturity

-40 Basis Points

32

Yield Curve - bottom of the interest rate cycle

The curve is steeply sloped, enticing investors to extend maturities, lower quality or take on extension risk.

Source: Bloomberg

71 basis points

33

34343434

Last

sav

ed: T

hurs

day,

July

19, 2

012

at 7

:29

PM

Sector Allocation

Sector Allocation - Treasury, Agency & Corporate

Source: Bloomberg 35

Sector Allocation – Treasury, Agency & Corporate

Source: Bloomberg 36

Sector Allocation - Treasury to Agency Spreads

Source: Bloomberg 37

Sector Allocation – Corporate MTN

Source: Bloomberg 38

Disclaimer: All securities shown in this presentation are shown for the purpose of instruction only and are not recommendations to buy or sell a specific security. Cutwater Asset Management acts solely as an investment advisor and not as a broker dealer.

Sector Allocation – Corporate MTN

Source: Bloomberg 39

Commercial Paper – “the other corporate”

40

41414141

Last

sav

ed: T

hurs

day,

July

19, 2

012

at 7

:29

PM

Security Selection – Security Structure

Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-120.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7-Year Average 2.17%

Buy Callables

Buy Non-callables

Security Selection - Structure

Source: Bloomberg 42

Security Selection - Structure

The structure of a callable security greatly affects both the bond’s duration and performance. Extension risk is a big issue with callable securities.

Source: Bloomberg

235 days

1,695 days

43

How Many Callables is Too Many?

Report Date: 12/31/07Wtd. Avg. Wtd. Avg. Weighted

Issuer / Maturity Call Acquisition % ofDays to Days to YTM Maturity Maturity Average Security Coupon Date Date Cost PortfolioFinal Call (Purchase Y) to Final Call Yield

FHLB 3.100% 01/08/08 1,000,000.00 8 3.100% 0.86 0.86 0.334%FHLMC 4.890% 02/01/08 429,959.00 32 5.000% 1.48 1.48 0.232%FHLB-Called 4.570% 04/29/08 01/29/08 359,507.00 120 29 5.000% 4.65 1.12 0.194%FHLB 5.000% 06/27/08 125,000.00 179 5.000% 2.41 2.41 0.067%FNMA 3.250% 08/15/08 371,528.00 228 3.000% 9.13 9.13 0.120%FHLB-Called 4.600% 08/22/08 02/05/08 374,415.00 235 4.850% 9.49 9.49 0.196%FHLB 4.010% 09/17/08 03/17/08 347,995.00 261 4.860% 9.79 9.79 0.182%FHLB 4.570% 10/17/08 349,839.00 291 4.630% 10.98 10.98 0.175%FHLB 4.100% 11/26/08 02/26/08 348,218.00 331 4.700% 12.43 12.43 0.176%FNMA 4.550% 12/01/08 06/01/08 431,669.00 336 153 4.900% 15.64 7.12 0.228%FHLB-Called 5.000% 01/02/09 01/02/08 430,461.00 368 2 4.880% 17.08 0.09 0.227%FNMA-Called 4.100% 02/13/09 02/04/08 399,827.00 410 35 4.850% 17.68 1.51 0.209%FHLB 4.000% 02/23/09 02/04/08 357,265.00 420 35 4.700% 16.18 1.35 0.181%FHLB-Called 4.660% 04/13/09 01/16/08 369,290.00 469 16 4.810% 18.68 0.64 0.192%FFCB-Called 4.300% 06/09/09 01/25/08 303,205.00 526 25 4.730% 17.20 0.82 0.155%FHLB-Called 4.550% 07/14/09 01/28/08 209,365.00 561 28 4.760% 12.67 0.63 0.107%FHLB-Called 4.520% 08/26/09 01/28/08 119,538.00 604 28 4.770% 7.79 0.36 0.061%FHLMC-Called 4.500% 08/10/09 01/10/08 349,962.00 588 10 5.150% 22.19 0.38 0.194%FHLMC-Called 4.500% 08/10/09 01/10/08 159,982.00 588 10 5.150% 10.14 0.17 0.089%FHLB 4.280% 09/08/09 03/08/08 198,486.00 617 68 4.760% 13.21 1.46 0.102%FNMA-Called 4.500% 09/30/09 01/22/08 443,103.00 639 22 4.760% 30.53 1.05 0.227%FHLMC-Called 4.130% 10/09/09 01/30/08 291,661.00 648 30 4.800% 20.38 0.94 0.151%FFCB-Called 4.500% 11/13/09 02/01/08 1,404,513.00 683 32 4.320% 103.44 4.85 0.654%FFCB-Called 4.300% 11/18/09 02/01/08 98,985.00 688 32 4.880% 7.34 0.34 0.052%

Totals 9,273,773.00$ 391.37 79.41 4.507%

44

06/30/10 Final Effective Weighted

Issuer / Maturity Call Date Acquisition % of Days to Days to YTM Wtd. Avg. Wtd. Avg. Average

Security Coupon Date (if any) Cost Portfolio Final Call (Purchase Y) Maturity Maturity Yield

FNMA POOL 5.000% 11/01/10   $ 1,438,167.80 2.68% 124 0.308% 3.33 3.33 0.008%FNMA POOL 4.000% 12/01/10   $ 1,326,607.49 2.48% 154 0.164% 3.81 3.81 0.004%

FNMA POOL 4.500% 01/01/11   $ 1,630,747.40 2.30% 185 0.412% 4.25 4.25 0.009%

FNMA POOL 4.000% 06/01/11   $ 2,077,436.49 3.88% 336 0.667% 13.02 13.02 0.026%

FNMA 2.000% 08/12/13 08/12/10 $ 997,500.00 1.86% 1139 43 2.074% 21.20 0.80 0.039%

FHLB 1.000% 05/26/15 11/26/10 $ 1,000,000.00 1.87% 1791 149 1.000% 33.42 2.78 0.019%

FNMA 2.000% 12/30/15 12/30/10 $ 1,000,000.00 1.87% 2009 183 2.000% 37.48 3.41 0.037%

FNMA 4.100% 07/01/16 07/01/10 $ 1,012,434.23 1.89% 2193 1 3.889% 41.43 0.02 0.073%

FNMA 2.530% 05/04/17 08/04/10 $ 1,000,000.00 1.87% 2500 35 2.530% 46.65 0.65 0.047%

FHLMC 3.100% 05/19/17   $ 1,000,000.00 1.87% 2515 3.100% 46.93 46.93 0.058%

FNMA 2.000% 11/27/17   $ 1,000,000.00 1.87% 2707 2.000% 50.51 50.51 0.037%

FNMA 2.000% 12/18/17 09/18/10 $ 747,000.00 1.39% 2728 80 2.000% 38.02 1.12 0.028%

FNMA 3.000% 01/29/18 07/29/10 $ 1,000,000.00 1.87% 2770 29 3.000% 51.68 0.54 0.056%

FNMA 3.000% 02/12/18 08/12/10 $ 1,000,000.00 1.87% 2784 43 3.000% 51.95 0.80 0.056%

FHLB 2.500% 12/23/19 09/23/10 $ 1,000,000.00 1.87% 3463 85 2.500% 64.61 1.59 0.047%

FNMA 2.000% 02/24/20 02/24/11 $ 1,000,000.00 1.87% 3526 239 2.000% 65.79 4.46 0.037%

FNMA 3.000% 05/19/20 11/19/10 $ 1,000,000.00 1.87% 3611 142 3.000% 67.38 2.65 0.056%

FNMA 2.000% 06/16/20 06/16/11 $ 1,000,000.00 1.87% 3639 351 2.000% 67.90 6.55 0.037%

FHLMC POOL 6.000% 09/01/21   $ 1,313,080.36 2.45% 4081 4.945% 99.98 99.98 0.121%

FHLMC 4.000% 02/25/22 08/25/10 $ 1,000,000.00 1.87% 4258 56 4.000% 79.45 1.04 0.075%

FNMA 4.000% 05/28/24 08/28/10 $ 965,000.00 1.80% 5081 59 4.320% 91.49 1.06 0.078%

FNMA 5.125% 08/19/24   $ 478,514.06 0.89% 5164 4.848% 46.11 46.11 0.043%

FNMA 3.000% 09/30/24 09/30/10 $ 1,000,000.00 1.87% 5206 92 3.000% 97.14 1.72 0.056%

FHLMC 3.000% 02/02/25 08/12/10 $ 1,000,000.00 1.87% 5331 43 3.000% 99.47 0.80 0.056%

CD   12/28/10   $ 14,000,000.00 26.12% 181 2.650% 47.28 47.28 0.692%

Money Market   07/01/10   $ 13,594,074.82 25.36% 1 0.210% 0.25 0.25 0.053%

Totals $ 53,594,961.99 100.00% 1271.94 346.90 1.850%

How Many Callables is Too Many?

45

Security Selection - Structure

Mortgage backed securities may provide a performance opportunity for a small portion of the portfolio.

Source: Bloomberg 46

47474747

Last

sav

ed: T

hurs

day,

July

19, 2

012

at 7

:29

PM

Security Selection – Credit Analysis

Credit Exposure – Are you a sitting duck?

48

Practical Example – credit analysis

Lehman Brothers MTN 7 7/8% of August 2010

9/12/08 A rated

9/15/08 CCC- rated

9/16/08 D rated

3/1/08 A+ rated 6/2/08

A rated

March 17th 2008“JPMorgan scoops up troubled Bear”

CNN

“Many will say that standalone investment banks’ days are numbered”

49

Lehman Brothers Stock

Practical Example – credit analysis

50

51515151

Last

sav

ed: T

hurs

day,

July

19, 2

012

at 7

:29

PM

Risk Return Tradeoff

Drivers of Portfolio Performance

1. This is not your father’s yield curve

2. Three main drivers of performance

3. Duration is key

4. Look to new asset classes

5. Credit analysis is mandatory

6. Risk is just as important as return

7. The next major move is up

52