Cash Flow Analysis in Portfolio Management January 13

Cash Flow Analysis in Portfolio Management January 13, 2011 Presented by: Carlos Oblites, Senior Managing Consultant PFM Asset Management LLC

Do Current Investments Meet Cash Flow Needs? PFM $25 million $20 million Current Investments Cash Flow Needs $20 $15 million $10 million $5 million $0 $5 $9 $6 $5 $0 Liquid 0 -1 Years 1 -2 Years 2 -5 Years Investment Advisors to the Public Sector 2

Do Current Investments Optimize Earnings? PFM $25 million $20 million Current Investments Cash Flow Needs $20 $15 million $10 million $5 million $0 $5 $9 $6 $5 $0 Liquid 0 -1 Years 1 -2 Years 2 -5 Years Investment Advisors to the Public Sector 3

How Much Liquidity is Enough? PFM • Cost of insufficient liquidity – – Delayed payments Additional interest costs Transaction costs Bad press • Cost of excess liquidity – Lost investment income – Bad press • Understanding cash flow is critical! 4 Investment Advisors to the Public Sector 4

Cash Flows PFM • Most Crucial Questions – How much to keep liquid? = “Will I have it available when I need it? ” – How much to lock up in longer maturity securities? = “Will I earn a good return it? ” Investment Advisors to the Public Sector 5

What to Do? PFM Returns Earnings “I think we’re all in agreement that it’s time to abandon the “waiting for a miracle strategy. ” 6 Investment Advisors to the Public Sector 6

Approach PFM • Determine Cash Flow Needs – Consider all funds – Determine amount of cash needed for expenditures – Consider the timing of receipts and expenses • Categorize your funds – Funds that needs to be kept liquid – Funds available to invest longer = “core balance” Investment Advisors to the Public Sector 7

Cash Flow Information Sources • Bank statements PFM All Accounts--Historical Cash Balance • General ledger balances January February March April May June 2006 128, 696 271, 752 253, 689 91, 298 159, 316 231, 776 233, 711 256, 840 354, 342 172, 293 2008 • Capital project spending 62, 132 2007 143, 452 312, 719 398, 301 334, 999 335, 778 206, 748 2009 311, 183 322, 314 411, 459 372, 365 479, 918 279, 289 2010 • Budgets 146, 653 302, 354 382, 075 627, 762 352, 203 523, 190 378, 193 July August September October November December 2006 238, 846 155, 024 157, 220 41, 327 131, 154 2007 • Investments 142, 743 270, 991 155, 720 259, 047 301, 516 97, 385 171, 371 2008 269, 545 254, 939 252, 113 262, 490 150, 764 187, 172 2009 234, 185 384, 253 333, 707 357, 302 243, 477 233, 042 2010 270, 991 155, 720 259, 747 301, 516 97, 385 171, 371 Investment Advisors to the Public Sector 8

Sample Cash Flow Report (in $1, 000’s) Revenues Tax receipts Investment income Other income Total Revenues Expenses Accounts Payable Insurance Premiums General Admin. Total Expenses Monthly Net Cash Beg Balance End Bal PFM July August September October 10, 000 350 1, 000 11, 350 4, 000 50 400 4, 450 300 10 410 0 15 165 500 0 75 575 0 1, 000 65 1, 065 0 400 65 465 3, 000 75 6, 075 10, 775 2, 000 12, 775 3, 385 12, 775 16, 160 (55) 16, 160 16, 105 (5, 910) 16, 105 10, 195 Investment Advisors to the Public Sector 9

Macro Forecasting Process PFM Analysis of Historical Monthly Cash Flows 40, 000 35, 000 30, 000 25, 000 20, 000 15, 000, 000 10 Jan-03 Oct-02 Jul-02 Apr-02 Jan-02 Oct-01 Jul-01 Apr-01 Jan-01 Oct-00 Jul-00 Apr-00 Jan-00 Oct-99 Jul-99 Apr-99 Jan-99 5, 000 Investment Advisors to the Public Sector 10

Computation of Growth PFM • Fund balances sometimes show growth trends Analysis of Historical Monthly Cash Flows 40, 000 35, 000 30, 000 25, 000 20, 000 15, 000 10, 000 Historic Monthly Balance 11 Jan-03 Oct-02 Jul-02 Apr-02 Jan-02 Oct-01 Jul-01 Apr-01 Oct-00 Jul-00 Apr-00 Jan-00 Oct-99 Jul-99 Apr-99 Jan-99 5, 000 Jan-01 Average Monthly Increase: $205, 118 Historic Annual Growth Rate: 9. 9% Average Portfolio Growth Investment Advisors to the Public Sector 11

Balance Projections PFM • Historic data can be used to predict future investable balances Projected Portfolio Growth 45, 000 40, 000 35, 000 30, 000 25, 000 20, 000 15, 000 10, 000 Actual Monthly Balances 12 Jan-05 Sep-04 May-04 Jan-04 Sep-03 May-03 Jan-03 Sep-02 May-02 Jan-02 Sep-01 May-01 Jan-01 Sep-00 May-00 Jan-00 Sep-99 May-99 Jan-99 5, 000 Projected Monthly Balances Investment Advisors to the Public Sector 12

Core Portfolio PFM • Most governments have a “core” or stable portion of the portfolio Analysis of Portfolio Historical Liquid Funds Historical Core Funds 13 Jan-05 Sep-04 May-04 Jan-04 Sep-03 May-03 Jan-03 Sep-02 May-02 Jan-02 Sep-01 May-01 Jan-01 Sep-00 May-00 Jan-00 Sep-99 May-99 Jan-99 45, 000 40, 000 35, 000 30, 000 25, 000 20, 000 15, 000 10, 000 5, 000 Projected Liquid Funds Projected Core Funds Investment Advisors to the Public Sector 13

How to Invest it? PFM • Determined by: 1. Cash flow needs 2. California Government Code 3. Investment policy 4. Investment objectives 5. Current market conditions Investment Advisors to the Public Sector 14

Key Investment Objectives Protect principal PFM Provide necessary liquidity to cover both ongoing and unexpected cash needs Maximize earnings recognizing need for safety and liquidity, and subject to restrictions specified by Government Code and the local governing body 15 Investment Advisors to the Public Sector 15

And If These Are Bond Proceeds? PFM 1. Determine if issue will meet spend-down exceptions per arbitrage rebate regulations 2. Identify investment options (legal, bond covenants, policy) 3. Formulate investment strategy based on rebate status 16 Investment Advisors to the Public Sector 16

Selecting Maturities for Project Funds PFM • Things to consider: – What is the project schedule? – What are future rate expectations? • Does it make sense to buy longer investments if interest rates are rising? Investment Advisors to the Public Sector 17

Selecting Maturities for General Funds PFM • Things to consider – Are there any investment restrictions? – What is your target average maturity? – What is your benchmark to measure performance? Investment Advisors to the Public Sector 18

Additional Considerations PFM • Before you buy, you must make sure that the investments comply with your public agency’s preferences. – Social issues – Prior history with particular investment Investment Advisors to the Public Sector 19

Specific Goals PFM • Assure steady income stream = Enhance portfolio yield • Grow the portfolio value = Enhance portfolio total return Investment Advisors to the Public Sector 20

Risk and Return of Different Duration Targets PFM Risk/Return of Various Benchmarks 10 Years Ended 12/31/2010 Duration Overall Return Cumulative Value of $50, 000 Quarters With Negative Returns LAIF 0. 50 Years 2. 85% $66, 225, 462 0 out of 40 1 Year Treasury Index 0. 99 Years 3. 16% $68, 230, 632 3 out of 40 1 -3 Year Treasury Index 1. 85 Years 3. 92% $73, 448, 512 5 out of 40 1 -5 Year Treasury Index 2. 57 Years 4. 46% $77, 394, 911 11 out of 40 3 -5 Year Treasury Index 5. 51 Years 5. 50% $85, 399, 058 15 out of 40 Merrill Lynch Index © 2011 PFM Asset Management LLC Investment Advisors to the Public Sector 21

PFM Target: Average Maturity or Duration 2. 00 High Average Maturity Band years 1. 75 Target 1. 50 1. 25 Low Average Maturity Band 0. 75 Time Investment Advisors to the Public Sector 22

Implementation PFM • Based upon expected cash flows and investment policy, four decisions must be made: – Sector selection – Credit quality – Average maturity or duration – Maturity position (yield curve strategy) Investment Advisors to the Public Sector 23

Maturity Positioning PFM • Once you know your target duration, choose a portfolio structure that will capitalize on market conditions. – Match cash flows exactly—great for most liquid portions of portfolio – Laddered – Bullet – Barbell Investment Advisors to the Public Sector 24

Portfolio Structure: “Match Cash Flows Exactly” PFM $20 million Cash Flow Needs Current Investments $15 $15 million $10 million $9 $9 $6 $6 Liquid 0 -1 Years $5 million $0 1 -2 Years 2 -5 Years Investment Advisors to the Public Sector 25

Portfolio Structure: “Laddered” PFM $20 million Laddered $15 million $12 mm $10 million $5 million $0 $0 0 -1 Yr 1 -2 Yrs 2 -3 Yrs 3 -4 Yrs $0 4 -5 Yrs Investment Advisors to the Public Sector 26

Portfolio Structure: “Bullet” PFM $40 million $36 mm $35 million Bullet $30 million $25 million $20 million $15 million $10 million $5 million $0 $0 0 -1 Yr $0 1 -2 Yrs $0 $0 2 -3 Yrs 3 -4 Yrs 4 -5 Yrs Investment Advisors to the Public Sector 27

Portfolio Structure: “Barbell” PFM $40 million Barbell $35 million $30 million $25 million $20 million $18 mm $15 million $10 million $5 million $0 $0 0 -1 Yr $0 $0 1 -2 Years 2 -3 Years 3 -4 Years 4 -5 Years Investment Advisors to the Public Sector 28

Yield Curves: “Positively Sloped” PFM U. S. Treasury Yield Curve Yield 3 m 2 y 5 y 10 y 30 y Time to Maturity Investment Advisors to the Public Sector 29

Yield Curves: “Inverted” PFM U. S. Treasury Yield Curve Yield 3 m 2 y 5 y 10 y 30 y Time to Maturity Investment Advisors to the Public Sector 30

Yield Curves: “Flat” PFM U. S. Treasury Yield Curve Yield 3 m 2 y 5 y 10 y 30 y Time to Maturity Investment Advisors to the Public Sector 31

Actual U. S. Treasury Yield Curves PFM U. S. Treasury Yield Curve November 3, 2010 vs. January 4, 2011 11/3/2010 Change 3 month 0. 12% 0. 13% + 0. 01% 6 month 0. 15% 0. 18% + 0. 03% 1 year 0. 20% 0. 26% + 0. 06% 2 year 0. 33% 0. 62% + 0. 29% 3 year 0. 47% 1. 02% + 0. 55% 5 year 1. 11% 2. 01% + 0. 90% 10 year 2. 57% 3. 33% + 0. 76% 30 year Fed holding short rates near zero 1/4/2011 4. 04% 4. 41% + 0. 37% Source: Bloomberg What structure does this environment call for? Investment Advisors to the Public Sector 32

PFM Yield Curve Getting Steep Once More 3. 5% Difference in Yield between 10 -year and 2 -year U. S. Treasury Notes January 2007 through January 2011 3. 0% 291 bps 2. 5% 271 bps 2. 0% 1. 5% 1. 0% 0. 5% Jan 11 Oct 10 Jul 10 Apr 10 Jan 10 Oct 09 Jul 09 Apr 09 Jan 09 Oct 08 Jul 08 Apr 08 Jan 08 Oct 07 Jul 07 Apr 07 -0. 5% Jan 07 0. 0% Source: Bloomberg Investment Advisors to the Public Sector 33

PFM Treasury Yields Rebound From Record Lows 2 -Year U. S. Treasury Yields December 31, 2009 – January 4, 2010 1. 17% 1. 2% 1. 0% 0. 8% 0. 62% 0. 6% 0. 4% 0. 33% 0. 2% Dec 09 Mar 10 Jun 10 Sep 10 Dec 10 Source: Bloomberg Investment Advisors to the Public Sector 34

Key Concepts PFM • Determine how much is liquid, how much is core • Reduce unnecessary liquidity—but mind the current environment • Keep communication lines open with all parties involved: – Project Manager – Investment Manager – Budget Manager • After ensuring safety and correct liquidity level, invest it! Optimize! Investment Advisors to the Public Sector 35

Cash Flow and Investing • PFM Questions? idity Insufficient Liqu Bad Returns Risky Investments Volatile Markets Investment Advisors to the Public Sector 36