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Portfolio Strategies

Portfolio Strategies. California Municipal Treasurers Association September 29, 2010. Rick Phillips President & Chief Investment Officer 702-932-5330 rphillips@mainstreetcap.com. Municipal Investment Managers www.MainStreetCap.com. Municipal Investment Program Foundation.

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Portfolio Strategies

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  1. Portfolio Strategies California Municipal Treasurers Association September 29, 2010 Rick Phillips President & Chief Investment Officer 702-932-5330 rphillips@mainstreetcap.com Municipal Investment Managers www.MainStreetCap.com

  2. Municipal Investment Program Foundation 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 mitigatecredit 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. Municipal Investment Managers www.MainStreetCap.com 2

  3. Three Main Portfolio Management Decisions • Interest Rate Risk: • 1year time horizon/cash flow need: • Cash • Two 6 month securities • One 1 year security • One 2 year security and sell it in 1 year • Credit Risk: Treasury, Agency, Corporate, ABS • Prepayment/Optionality Risk: Callables, MBS Legal vs Suitable Municipal investment portfolios are one of the only places in government where incremental revenues can be prudently generated without collecting taxes or fees; thus benefiting their citizenry. Municipal Investment Managers www.MainStreetCap.com 3

  4. Blue Chip Economist GDP Forecast vs Actual Forecasted rate 1 year ahead Source: Federal Reserve Municipal Investment Managers www.MainStreetCap.com 4

  5. Blue Chip Economist Forecast Tsy 3M & 10Y vs Actual Average Rate for the Year Source: Federal Reserve Municipal Investment Managers www.MainStreetCap.com 5

  6. Still In Tough Times Municipal Investment Managers www.MainStreetCap.com 6

  7. Where Are We Now? Municipal Investment Managers www.MainStreetCap.com 7

  8. U.S. Quarterly GDP Are We Heading For A Double Dip? ? 1990 2000 2010 Municipal Investment Managers www.MainStreetCap.com 8

  9. Are We There Yet? Municipal Investment Managers www.MainStreetCap.com 9

  10. How Does This Bear Compare? Municipal Investment Managers www.MainStreetCap.com 10

  11. GDP Comparisons to Past Recessions Dec 2009 5.4% 1982 1975 Bloomberg Estimates 2010> • “PIMCO’s New Normal” • Increased Govt • Less Credit • More Savings • Less Spending • Lower GDP Mar 2009 -6.4% Municipal Investment Managers www.MainStreetCap.com 11

  12. Unemployment Rate Comparison to Past Recessions Oct 2009: 10.1% 1982: 10.8 Bloomberg Estimates 2010> Municipal Investment Managers www.MainStreetCap.com 12

  13. Monthly Retail Sales – Consumers=70% of Economy Billions Municipal Investment Managers www.MainStreetCap.com 13

  14. Monthly Job Gain/Loss Cumulative Job Gain/Loss 125K to 150K/Month to Meet Population Growth +/- 1.2 million Census Workers During 2010 Municipal Investment Managers www.MainStreetCap.com 14

  15. So Make Up Your Mind! Municipal Investment Managers www.MainStreetCap.com 15

  16. Temporary Workers Thousands Municipal Investment Managers www.MainStreetCap.com 16

  17. Municipal Investment Managers www.MainStreetCap.com 17

  18. U.S. Households & Nonprofits Net Worth Net Worth dropped from $66Tril to $48Tril (26.5%) and has rebounded $5.5 Tril (11.4%) Billions U.S. has 5% of World’s Population and 20%-25% of the World’s Net Worth!! Municipal Investment Managers www.MainStreetCap.com 18

  19. MGM Apple S&P 500 Municipal Investment Managers www.MainStreetCap.com 19

  20. Credit Card Delinquency Rates BofA Cap One Percent Discvr Amex Municipal Investment Managers www.MainStreetCap.com 20

  21. 1-5 Yr Corporate Bond Spreads 2009 CMTA Conference Percent Municipal Investment Managers www.MainStreetCap.com 21

  22. Municipal Investment Managers www.MainStreetCap.com 22

  23. Monthly Foreclosures U.S. Home Ownership Rate 300K 200K Percent of Households Approx 114 Mil U.S. Households 3 Million More Foreclosures Est. ? What % of Homes in the U.S. which have no Mortgage? Municipal Investment Managers www.MainStreetCap.com 23

  24. California vs U.S. Home Ownership Rate U.S. Percent CA Municipal Investment Managers www.MainStreetCap.com 24

  25. Case Shiller 20 City Home Price Index Homes Increased 106.3% from Jan 2000 to April 2006 CPI Increased 18.5% from Jan 2000 to Apr 2006 Municipal Investment Managers www.MainStreetCap.com 25

  26. Existing Home and New Home Sales (Annual Rates) Tax Credit New Homes (Thousands) Existing Homes (Millions) Approximately 800,000 New Households Formed Each Year Municipal Investment Managers www.MainStreetCap.com 26

  27. www.usdebtclock.org Municipal Investment Managers www.MainStreetCap.com 27

  28. U.S. Annual Federal Budget Surplus/Deficit CBO Estimates 2010-2020 Before Health Care! Municipal Investment Managers www.MainStreetCap.com 28

  29. U.S. National Debt Marketable Debt: $7.9 Tril Non-Marketable Debt: $5.6 Tril (Social Security, Medicare, Etc.) CBO Estimates 2010-2015 Municipal Investment Managers www.MainStreetCap.com 29

  30. What Do All These Companies Have In Common? Berkshire Hathaway, Inc. Municipal Investment Managers www.MainStreetCap.com 30

  31. “Subprime Nation – USAAA or USBBB?” *Congressional Budget Office Estimates Avg Rate: Main Street Estimate CNBC Municipal Investment Managers www.MainStreetCap.com 31

  32. Treasury Debt Analysis 32% 0-1Yr! As of 12/09 Avg Interest Rate Does Not Include TIPS Source: TreasuryDirect.gov Bloomberg: 3352Z US <Equity> DDIS Municipal Investment Managers www.MainStreetCap.com 32

  33. Do Your Part! Municipal Investment Managers www.MainStreetCap.com 33

  34. Foreign Holders of U.S. Debt Holders of U.S. Debt China Tsy Holdings $889 Bil (1/2010) 900Bil 500Bil 2009 2005 Municipal Investment Managers www.MainStreetCap.com 34

  35. Social Security 2010 $706 Billion Out $677 Billion In $2.5 Trillion in the “Trust Fund Lock Box” (12/09) Municipal Investment Managers www.MainStreetCap.com 35

  36. Federal Reserve Balance Sheet $1.25 Tril Target Fed MBS Purchases Trillions And We Thought Y2K Was Big! Municipal Investment Managers www.MainStreetCap.com 36

  37. Consumer Price Index CPI Weights Bloomberg CPI Forecast Japan or Argentina? Yes! Municipal Investment Managers www.MainStreetCap.com 37

  38. Japan CPI NIKKEI Stock Index -75% from Peak .4% Avg Past 20 Yrs Deflation for 15 Years Municipal Investment Managers www.MainStreetCap.com 38

  39. Argentina CPI Argentina Pesos to Dollar Devalued by 380% Percent Inflation 2002 Municipal Investment Managers www.MainStreetCap.com 39

  40. Municipal Portfolio Structure: Typical Allocation Liquidity Portfolio: Develop a 12-Month Rolling Cash flow: Lowest Bank Balance + Lowest Revenue Collected – Highest Disbursements Don’t “buy” too much “liquidity insurance” – GASB 31 Municipal Investment Managers www.MainStreetCap.com 40

  41. Suitable Interest Rate Risk vs Return Treasury Yields 12/89 to 12/09 Sweet Spot Main Street Sharp Ratio = (Yield – Risk Free Rate) / Duration 3Mon T-Bill Data Source: Bloomberg Municipal Investment Managers www.MainStreetCap.com 41

  42. A Suitable Level of Interest Rate (Budget) Risk • What is the appropriate average maturity or duration for an Operating Fund? • Between 1 and 2 years • An entity generally has to budget interest income 12 to 18 months in advance of the entity’s fiscal year end for the next fiscal year’s budget. • For example, if the portfolio has a 6 month average maturity, budgeting interest income is challenging due to the fluctuation of interest rates (portfolio turns over 3Xs). • If the portfolio has a 1.5 year average maturity, then the existing book yield gives a good approximation of next fiscal year’s interest income (portfolio turns over 1x). Municipal Investment Managers www.MainStreetCap.com 42

  43. The Market Was Expecting Higher Rates Last Year (and the Year Before!) Current Fed Funds Futures First rate hike expected Apr 2012 Last year’s Fed Funds Futures (9/29/09) Municipal Investment Managers www.MainStreetCap.com 43

  44. 2009 “The Roll Down” 2010 Municipal Investment Managers www.MainStreetCap.com 44

  45. Proactive Management vs Buy and Hold Buy 2 yr T-note at .45% and sell in 1 year at .25% Investment return equals .65%, with rates unchanged Return is 2.6 times the current 1 year T-bill’s buy and hold return of .25% Breakeven: (.25% + .65%)/2=.45% Yr1 Yr2 2Yrs What does the 1yr rate need to be in 12 months? ? Municipal Investment Managers www.MainStreetCap.com 45

  46. The Market Usually Moves Before The Fed… 2Yr T-Note Fed Funds 2005 2005 2004 2003 But There Can Be Head Fakes 2Yr T-Note Fed Funds 1994 1992 1993 Municipal Investment Managers www.MainStreetCap.com 46

  47. Fed Funds vs 2 Yr T-Note Current Cycle: 3/07 to 3/10 2Yr T-Note “Extended Period”????????? Fed Funds 2yr T-Note Municipal Investment Managers www.MainStreetCap.com 47

  48. Corporate Spreads Global Financial Crisis LTCM Data Source: Bloomberg Municipal Investment Managers www.MainStreetCap.com 48

  49. 1-3 Corporate Bond ETF vs 1-3Yr Tsy ETF Total Returns from 3/09 Mkt Low Corp Tsy Corporates % Return Treasuries Municipal Investment Managers www.MainStreetCap.com 49

  50. A Suitable Level of Credit Risk—ML 1-5 A-AAA Index By Industry Suggestion: Many Inv Policies allow up 5% per issuer: Limit holdings to 1% per issuer (per ratings) and by sectors. Index Sectors: Finance 52% Industrial 43% Utilities 3% There are160 different issuers in the index Source: Bloomberg as of 4/10/09 Municipal Investment Managers www.MainStreetCap.com 50

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