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Home My WebLink AboutItem 7.1 City Invest Policy Assessment CITY CLERK File # D[3J~[QJ-[5][l2] SUBJECT: Report Prepared By PFM Asset Management LLC (PFM) Assessment and Review of the City's Investment Portfolio and Procedures and Adoption of An Updated City Of Dublin Investment Policy Report Prepared by Paul S. Rankin, Administrative Services Director f~ A TT ACHMENTS: 1) Report prepared by PFM Asset Management LLC 2) Redline Version of Proposed Changes to Current Investment Policy ~) . esolution Adopting an Updated Investment Policy RECOMMENDATIO... N:. Staff recommends that the City Council receive the report and adopt the /l. Resolution, which approves an updated Investment Policy. FINANCIAL STATEMENT: The receipt of the report does not have a direct financial impact. DESCRIPTION: On December 5, 2006 the City Council approved a consulting agreement with PFM Asset Management LLC. The work to be performed was part of a higher service level for the budget of the Administrative Services Department for Fiscal Year 2006-2007. The goal was to ensure: I) The adopted investment policy is consistent with recent legislation; 2) Identify best practices that would strengthen the management of public funds; and 3) Make recommendations on ways to measure and report portfolio results incorporating the City's established objectives regarding the safety, liquidity and yield. Due to Staff turnover in the Finance Division finalizing the report was delayed. The process of obtaining third party review of the City investment portfolio has been beneficial. It offered an opportunity to review practices with consultants who have extensive expertise in managing public funds. In addition to the written report the Consultant had an opportunity to provide Staffwith educational information. Pages 2 and 3 of the report contain an Executive Summary of the report. The key findings and recommendations made by the Consultants were as follows: I. As of March 31, 2007 the City s in compliance with the requirements in the California Government Code. 2. The City is in compliance with the City of Dublin Investment Policy. 3. The portfolio is being managed in a generally safe and prudent manner. 4. The Consultant has made recommendations on changes to enhance the effectiveness of the overall investment program. 5. Where appropriate the recommendations were incorporated into a model investment policy presented by the Consultant. ------------------------------------------------------------------------------------------------------------- COpy TO: Richard Babbe, PFM Page 1 of3 ITEM NO. 7./ G:\Investments\PFM Investment Review\Agenda Report\agenda _ stmtPFMRpt.doc Section II of the Report prepared by PFM (pages 3-5) addresses changes in the Government Code related to investments. The Consultants have also reviewed the content of the Quarterly Investment Report, provided to City Council. Based on their review the Consultants have not recommended any change in the types of investments made by the City. However, they have suggested modifying the investment approach in the following areas: 1) CONSIDER BENCHMARK: It is recommended that the City use a Performance Benchmark as an evaluation tool. (Report page 9) This would provide an objective measure of how the City portfolio is performing. On page 40 of the report a recommended suitable benchmark is the Merrill Lynch 1-3 year U.S. Treasury Index. The Consultants have noted that in order to be an appropriate benchmark the portfolio must seek to replicate the index in the area of duration maturities of the securities held. 2) DIVERSIFICATION: A policy goal that the City limit purchases of anyone Federal Agency issuer to no more than 40% of the portfolio. This will create diversity within the portfolio. At the time of their review Federal Home Loan Bank (FHLB) securities represented 33% of the portfolio (Report page 13 - Chart "Issuer Distribution"). By striving to limit the portfolio to no more than 40% per issuer, the City will avoid an over concentration with a single agency. 3) LIMIT CALLABLE SECURITIES: A policy goal is recommended to strive towards limiting callable federal agency securities to no more than 25% of the portfolio (Report pages 14-15). As of March 31, 2007 approximately 43% of the portfolio was invested in callable securities. Although callable securities offer potential for added value (i.e. higher rates) it is only achieved with added risk, primarily in terms of reinvestment risk. As interest rates fall it is likely to be called, which forces reinvestment in a lower interest rate environment. PFM recommends the City seek as a goal to have no more than 25% of its portfolio in vested in callable securities. Further they would encourage the City to emphasize more restrictive call provisions, such as semi-annual calls or one-time calls. 4) GRAPHICS IN REPORT: In order to improve the ability for the reader to interpret the quarterly investment report, PFM suggests that the City consider the inclusion of charts and graphs. (Report page 10) The Consultant noted that in order to achieve this efficiently that it may be appropriate to evaluate this enhancement as part of investment accounting software. Staff installed SymPro investment software in June 2007 and will incorporate graphic information in future reports. 5) REPORTING YIELD: The Consultants have recommended that the quarterly investment report disclose the yield to maturity at cost rather than at current yield (Page 10). Prior to the installation of the investment tracking system there was no amortization of premiums and discounts. By amortizing the premiums and discounts the true yield earned on the investment is reflected over the entire life of the security. 6) AMOUNT INVESTED MORE THAN 1 YEAR: The Consultants evaluated the historical portfolio balances and core portfolio. (Report Section V pages 25-26). The results from the PFM model suggested that the City can potentially increase the portion of the portfolio allocated for more than one year. The Consultants noted that from January 2002 - March 2007 approximately 53% of the portfolio was invested short term for one year or less. It is important to acknowledge that the Consultant review was based on history. Any adjustment must take into consideration future cash flow needs. For example, large capital projects such as Heritage Park Acquisition; Shannon Community Center; Dublin Blvd I Dougherty Road Intersection Improvements; Fallon Interchange; etc. can result in a material change to the City cash flow needs in a rather compact Page 2 of3 timeframe. For this reason Staff will need to evaluate projected future differences in cash flow compared to past historical trends. 7) SELECTION OF SECURITIES: Procedural changes are recommended by the Consultants in the purchase of securities and documenting the system of internal controls. PFM has suggested that Staff should seek additional brokers from which purchases can be made. The City currently purchases from two brokers. It is recommended that all brokers be pre-qualified and meet certain criteria. Further PFM recommends that to the extent possible, that Staff endeavor to purchase securities using a more proactive bidding from brokers, when practical. The City needs would be described and at least two brokers would be asked to submit their possible offerings for the portfolio. For example, they may be requested to provide available securities with a maturity between 12 and 18 months and no call provision. This is contrasted with the current practice of selecting from lists of broker offerings. 8) INVESTMENT POLICY: The Consultant made recommendations on various modifications to the current City Council Investment policy. Attachment 2 contains a redline version of the proposed revisions to the Investment Policy. The focus of several of the changes were primarily editorial to provide a format more consistent with the standards followed by public agency treasurers. Exhibit A of the Resolution (Attachment 3) to this Staff report contains a clean version of the proposed investment policy. An Appendix has also been added, which will assist readers with key investment related terminology. With these modifications the policy will reflect the current law as well as best practices. RECOMMENDATION: Staff recommends that the City Council receive the report, and adopt the Resolution, which approves an updated Investment policy. Page 3 of3 City of Dublin Assessment and Review of the City's Investment Portfolio, Policy and Procedures July 20, 2007 ft PFM Asset Management LLC 50 California Street, Suite 2300 San Francisco, CA 94111 (415) 982-5544 California Offices San Francisco · Los Angeles · Newport Beach \ t '1'6 AA,^c-",(V\eJ- i ~-2.'-07 7" ~f~ Table of Contents Executive Summary I Review of Investment Policy and Reports II Portfolio Review III Portfolio Management IV Core Portfolio Analysis V Review of Investment Procedures VI Current Market Conditions VII Portfolio Strategy VIII Potential Supplemental Resources IX Appendices X A. Sample Investment Policy B. Liquidity Factors C. APT Investment Policy Standards D. White Paper on the outsourcing of the investment function City of Dublin - Policy and Portfolio Review 3Db~~ Investment Advisors to the Public Sector I. EXECUTIVE SUMMARY PFM Asset Management LLC (PFM) was hired in December 2006 to provide an independent review of the City of Dublin's ("City") investment program, including a review of the City's investment policy and procedures, current portfolio, and investment strategies and performance results for the City's portfolio. The objectives of our review were to: 1) assess the current status of the City's investment program and 2) provide recommendations to improve the future safety and performance of the City's investment program. Any recommendations provided were to ,be consistent with the City of Dublin's specific needs and objectives. As part of our scope of work for this engagement, we were asked to address the following areas: · Review the City's Investment Policy ("Policy") to determine its compliance with the California Government Code and to recommend potential improvements. · Review the City's investment reports to determine compliance with California Government Code standards and to identify potential improvements to assist with the management of the portfolio and their use as a management oversight tool. · Review the City's investment portfolio to determine its compliance with both the California Government Code and the City's Investment Policy along with the portfolio's risk characteristics. · Analyze the City's historical cash flows to assist the City with the allocation between short- term and core assets and to assist with the selection of an appropriate target duration for the portfolio. · Review the City's investment procedures to identify any potential improvements in the City's portfolio management practices and internal controls. · Assist the City with the development of a long-term investment strategy based on the City's investment objectives and current and expected market conditions. · Identify the need and the impact of potential supplemental resources Summary of Findings We would like to thank the City Staff for their generous help in gathering information and answering our questions. Their involvement was essential to the entire review process. Our review findings, which are discussed in more detail in the body of the report, found: · The City's Policy and reports are in compliance with the California Government Code. There are recommendations regarding possible revisions to the policy to reflect current law and a format based on best practices. · The City's portfolio, as of March 31, 2007, was in compliance with all applicable sections of the California Government Code, as well as the City's Investment Policy. City of Dublin - Investment Program Review 1 LfVfJqcg Investment Advisors to the Public Sector ~ · The portfolio is being managed in a generally safe and prudent manner. There are recommendations regarding the portfolio's long-term investment strategy and procedural items, including processes used to purchase securities and enhancement of written procedures. · Staff has done a good job managing the portfolio given available resources. However, additional resources are needed to help Staff enhance its management of City's assets given the growth of the City's portfolio over time. Our recommendations are based upon PFM's expertise as an investment advisor to public agencies and our understanding of the best investment practices of public agencies nationwide. These recommendations should be kept in context. The fact that suggestions for change have been made is not intended to imply that the practices used in the past were imprudent or incorrect. Rather, the recommendations were developed to assist those responsible for investing the City's assets to prudently enhance the management of the City's portfolio. The City will need to evaluate which of our recommendations are appropriate to implement considering the City's own investment objectives, staff expertise and available resources. City of Dublin - Investment Program Review 2 ?~ l' Investment Advisors to the Public Sector II. REVIEW OF INVESTMENT POLICY AND REPORTS We reviewed the City's Investment Policy adopted September 20, 2005 ("Policy"). The Policy was evaluated according to the following four factors that we believe contribute to the overall effectiveness of an investment policy. · Compliance. While a governing board may impose additional requirements based upon its investment objectives and preferences, an investment policy must, at a minimum, comply with the requirements of the California Government Code. · Comprehensiveness. An investment policy should be comprehensive to ensure that the key aspects of the investment program are properly addressed. The Association of Public Treasurers of the United States and Canada ("APT US & C")l certification standards are used to evaluate a policy's comprehensiveness. · Balance. An investment policy should provide a balance between investment restrictions, which help protect the agency's assets, and investment flexibility, which permits the investment staff to adapt to changing market conditions and investment needs. · Clarity. An investment policy should express the governing board's investment objectives with sufficient clarity, so that both the agency's investment staff and other interested parties (participants or broker/dealers) clearly understand the investment policy's intent. Overall, the City's Policy is in compliance with the Government Code and provides adequate controls. However, we identified certain aspects of the Policy that, in our opinion, could be improved to the City's benefit. Our recommendations are divided into two types: 1) Government Code Comments and 2) Modifications To Be Considered To Reflect Best Practices. The comments are listed below by comment type and Policy section. A sample policy is attached as Appendix A to illustrate what revisions would need to be made to the City's Policy to incorprorate our recommendations. The City should evaluate the implementation of each of the recommendations within the context of the City's own investment objectives and preferences. Government Code Comments The Policy's overall requirements conform to, or are more restrictive than, the Government Code's requirements. However, we identified a couple of inconsistencies between the Policy I Founded in 1965, APT US & C represents 2,000 public treasury and [mance officials in local, county and state/provincial governments throughout North America. The APT US & C's mission is to advance the public treasury profession by providing its membership with training, technical publications, and a forum to discuss and exchange ideas. Additional information is available at www.aptusc.org. The California Municipal Treasurers Association ("CMT A") is one of 17 state associations of treasurers affiliated with APT US & C. City of Dublin - Investment Program Review 3 "l Investment Advisors to the Public Sector Co0fJ1ct and the Government Code, listed below by Policy section, that the City should address when the Policy is next reviewed and adopted by the City Council. IlL 5 Prudence. The Policy currently states that the City adheres to the "Prudent Person Rule." However, Government Code Section 53600.3 states that persons authorized to make investment decisions on behalf of the City are subject to the "Prudent Investor Standard." While we do not believe this will change how the portfolio is being managed, we recommend the City update the Policy to conform to the current Government Code language. IV. Delegation of City Treasurer to Carry Out Investment Duties. The Policy currently states that "Quarterly Reports of said transactions, if any, shall be provided to the City CounciL" However, when investment activity is delegated by the Council to the Treasurer under Government Code Section 53607, the Government Code requires the Treasurer to "make a monthly report of those transactions to the legislative body." While the Government Code requires a monthly report of transactions be provided to the City Council, it does not specify any additional detail regarding the content of the report or when the monthly report is to be provided to the City Council. Unless the City Council requires additional detail or the report on a monthly basis, we believe the current listing of transactions (sales, maturities, and purchases) within the City's Quarterly Treasurer's Investment Report is consistent with the Government Code's objective of keeping the City Council informed about all investment transactions. Accordingly, we are not recommending any changes to the City's current practices, but we do recommend that the Policy section on reporting include a requirement that the Quarterly Report include a list of investment transactions. Additional Government Code Changes Since the Policy's 2004 revision, there have been several changes to the Government Code's provisions governing local agency investments. While these changes do not require the City to revise its Policy, we wanted to bring them to the City's attention with our recommendations. SB 787. Effective January 1, 2004, the Government Code's requirements for commercial paper under section 53601(g) were revised in two ways. First, the section was revised to replace specific references to the rating agencies with the industry term Nationally Recognized Statistical Rating Organization ("NRSRO"). Second, the section was revised to provide specific requirements for the purchase of Asset Backed Commercial Paper ("ABCP"). While not expicitly stated, the purchase of ABCP was previously allowable under the Government Code requirements. As revised, the Code clarified this issue and established specific criteria for the purchase of ABCP. If the City retains commercial paper as a permitted investment, we recommend the City incorporate these revisions into its Policy. AB 285. Effective September 30, 2004, Government Code Section 53646 was revised to make the previously mandated investment policy and reporting requirements optional. While no longer required, we believe these practices are supportive of a prudent investment City of Dublin - Investment Program Review 4 Investment Advisors to the Public Sector fIr[) a,z approach. Consequently, we recommend that the City maintain its current reporting and policy review requirements. The value of these practices was recognized by the addition of Section 53646(k) to the Government Code: "In recognition of the state and local interests served by the actions made optional in subdivisions (a) and (b), the Legislature encourages the local agency officials to continue taking the actions formerly mandated by this section. However, nothing in this subdivision may be construed to impose any liability on a local agency that does not continue to take the formerly mandated action." Although it made certain reporting requirements optional, AB 285 did not change the reporting requirements under Government Code Section 53607, which were discussed above. AB 969. Effective January 1, 2005, the Government Code was revised to provide explicit recognition and specific requirements for shares of beneficial interest issued by joint powers authorities under Section 53601(0). As the California Asset Management Program ("CAMP") is covered by this Government Code section and is currently one of the City's permitted investments, we recommend the City update its Policy to incorporate the Government Code's current provisions. AB 2011. Effective January 1, 2006, the Government Code was revised to include Section 53601.8, which explicitly allows local agencies, until January 1, 2012, to utilize placement services for Time Certificate of Deposit ("CD") purchases. The Bill also placed a 30 percent overall limitation on CDs purchased under this subdivision along with negotiable CDs purchased under 53601(h). In practice, a deposit placement service allows a bank to break down a large CD deposit into multiple pieces, each less than $100,000 to ensure FDIC protection, that are then placed with other banks within its network. The other banks simultaneously send an equal amount of funds back to the original bank. This allows a bank to accept and receive the benefit of large local agency deposits for lending or other purposes without the burden collateralizing those deposits (the original bank only retains $100,000 of the local agency's deposit, which is covered by deposit insurance). The process is managed by the bank and is largely transparent to the local agency (although the local agency must approve participation in the placement service). Due to the illiquid nature of CDs and the availability of other investment options, we generally recommend local agencies limit their use of CDs. Consequently, we are not recommending the City adopt the Government Code's new provisions. Modifications To Be Considered To Reflect Best Practices In addition to the Government Code related comments shown above, we identified some additional changes to the Policy for the City's consideration. While those directly involved in the investment program have a clear understanding of the Policy's intent, there were aspects of the language and structure of the Policy that, in our opinon, could result in misunderstandings among City of Dublin - Investment Program Review 5 Investment Advisors to the Public Sector egDb 48 outside parties reading the Policy. In addition, we believe that the Policy would be enhanced by including references to some key requirements of the Government Code. While it is not necessary to include the entire Government Code in the Policy, we recommend referencing key Government Code requirements within the Policy to minimize the possibility that key requirements could be over looked or misunderstood. Although not required, we believe the recommendations listed below, by Sample Policy section, will strengthen the Policy's investment controls without adversely impacting investment flexibility and will futher clarify the Policy's requireJ;llents for those parties involved in the investment process. These recommendations are not based on the current securities in the portfolio; they are offered as suggestions to improve the Policy and are representative of best practices for the management of public funds. The City should review and consider which recommendations are appropriate to be included in its Policy given the structure and staffing used by the City to manage investments and the City's overall investment objectives. Objectives. As currently written, the Policy's objectives section describes a wide range of the Policy's requirements, including the City's overall objectives,' investment types, diversification, prudence and public trust. To help clarify the Policy's requirements, we recommend simplifying the objectives section to focus specifically on the City's overall objectives and move the other Policy topics to their own separate sections. Delegation of Authority. In addition to the Policy's current requirements, we recommend that the Policy reference two additional provisions from Section 53607. These provisions include that investment authority is delegated for a period of one year, which may be renewed upon review, and that the designated officer assumes responsibility for all investment transactions. Prudence. To help clarify the Policy's requirements, we recommend moving the Prudence topic from the Objectives section to its own separate section. As noted above, we also recommend the City update the Policy to reflect the Government Code's Prudent Investor Standard under Government Code Section 53600.3. Ethics and Conflicts of Interest. To help clarify the Policy's requirements, we recommend moving the Public Trust topic from the Objectives section to its own separate section. Internal Controls. While maintaining the Policy's basic intent, we are suggesting two reVISIOns. First, we recommend including the concept of reasonable assurance, which contends that any controls should be reasonable relative to the benefit obtained. Second, we recommend deleting the Policy's reference to any specific procedures. Conceptually, we recommend that the Policy focus on overall policies and not describe specific procedures in order to avoid having to send the Policy to the City Council to modify internal procedures. Authorized Financial Dealers and Institutions. As discussed elsewhere in the report, we are recommending that, to the degree practical, the City increase the number of brokers the City of Dublin - Investment Program Review 6 Investment Advisors to the Public Sector q~ Cf<g City uses to purchase investments. In line with this recommendation, we recommend that the Policy broaden the criteria use to select brokers, but still provide minimum criteria for determining suitable firms. Authorized and Suitable Investments. The Policy's current structure may create the potential for misunderstandings regarding the Policy's investment requirements. For example, permitted investments are described in general terms in Section III. 1 Safety, but the Policy does not clearly delininate the City's own standards. Accordingly, we recommend that the list of permitted investments be moved to its own separate section with all permitted investments clearly described. As part of this restructuring, we also recommend incorporating the Policy's diversification and risk tollerance provions into this section to clarify the Policy's requirements. With regards to the Policy's requirements for specifc investment types, the Policy defaults to the Government Code's basic requirements. We recommend the Policy incorporate additional restrictions on certain investment types to further protect the safety of the City's portfolio with out creating undue limitaions on the Treasurer's investment flexibility. Our comments are listed below by investment type. Federal Agency Obligations. To promote diversification and limit the portfolio's exposure to certain types of risks, we recommend that the City establish additional criteria on its purchase of Federal Agency securities. First, we recommend that the City limit purchases of anyone Agency issuer to 40 percent of the overall portfolio. Second, to manage the portfolio's exposure to call risk, we recommend the City add a new requirement to limit the portfolio's allocation to Federal Agency securities that still can be called to a maximum of 25 percent of the overall portfolio. As the current portfolio would not meet the new limitation for callable securities, we recommend that the requirement be listed as a goal that the Treasurer should strive towards to allow the Treasurer time to adjust to the new standard without having to sell any existing securities. While we believe that it will be to the City's long-term benefit to limit the percentage of callable securities in the portfolio, we do not believe it is necessary to make any immediate changes to the City's portfolio. Bankers' Acceptances. In addition to the City's current criteria, we recommend adding an additional requirement restricting purchases to those institutions that have a short-term debt rated A-I, or its equivalent by a Nationally Recognized Statistical Rating Organization ("NRSRO") to limit the portfolio's exposure to credit risk. To further limit the portfolio's exposure to anyone corporate issuer, we recommend the City establish an overall 20 percent limit for the securities of anyone corporate issuer that would apply across bankers' acceptances, commercial paper, and negotiable certificates of deposit. Commercial Paper. As noted previously, we recommend the City incorporate the Government Code's current requirements for the purchase of commercial paper. City of Dublin - Investment Program Review 7 Investment Advisors to the Public Sector lD~'1~ Negotiable Certificates of Deposit and Time Certificates of Deposit. As currently written, the Policy does not clearly differentiate the purchase criteria for negotiable and time certificates of deposit. Given the very different investment characteristics of these two investment types, we recommend the City establish separate criteria for each investment type. Given the illiquid nature of time certificates of deposit and the availability of other investment types, we further recommend that the City limit the purchase of time certificates of deposit to 10 percent of the portfolio and a maximum maturity of one year. While bankers' acceptances, commercial paper and negotiable certificates of deposit are useful and generally safe investments, they each have a certain degree of credit risk as corporate obligations. The City should consider whether to retain these investment types as permitted investments in the Policy based on the City's ability to evaluate.and monitor credit risk with either internal resources or through an external investment advisor. Money Market Funds. Before investing funds in any pooled investment program, it is considered prudent to have read and understand the pool's applicable disclosure document. As a minimum of due diligence, we recommend that the City add a provision to the Policy that the Treasurer maintain on file the current disclosure document for any pool in which the City invests funds (LAIF, CAMP and money market funds). While retaining money market funds, we recommend that the City delete mutual funds from its list of permitted investments. While money market funds strive to maintain a stable net asset value, mutual funds have variable net asset values. As a result, an investor in a mutual fund should expect that the price per share of a mutual fund will vary each day and therefore the investor is highly likely to experience either a gain or a loss each time funds are withdrawn. Due to this risk, along with the wide availability of alternative investments, we do not believe mutual funds are an appropriate investment for most public sector investors. Additional Investment Types. The City's current list of permitted investments provides a reasonable degree of investment flexibility which should allow the City to safely meet its investment objectives. In addition to the investments currently permitted by the City's Policy, there are three other investment types permitted by the Government Code that we frequently see in other local agency investment portfolios, these are: medium-term corporate notes, municipal securities and repurchase agreements. We believe that when used properly, each of these investment types can be a valuable investment option as part of a diversified portfolio. However, each of these investment types has its own unique characteristics that need to be evaluated before investing. Consequently, we are not recommending that the City add any of these investment types to the Policy's list of permitted investments at this time. However, we are available to discuss these investment types with the City and the suitability for the City's portfolio. City of Dublin - Investment Program Review 8 HUb ~<b Investment Advisors to the Public Sector Authorized Investments for Bond Proceeds. The investment of bond proceeds is briefly alluded to the Policy's current Scope section. To further clarify the Policy requirements, we recommend the Policy incoprorate a new section addressing the investment of bond proceeds. Prohibited Investment Practices. To further clarify the Policy's requirements and avoid any possible confusion, we recommend adding a new section to the Policy, which would describe which securities are specifically prohibited for purchase by the City. Safekeeping and Custody. Custody of the City's assets is only briefly alluded to in the current Policy's Selection of Institutions section. To strengthen and clarify the Policy's requirements, we recommend creating a new section on this topic outlining overall requirements for custody of the City's assets. Peiformance Benchmarks. We recommend the City add a Performance Benchmark section to the Policy. This is an APT recommended section. The practice of measuring a portfolio's performance against an appropriate benchmark is an important tool for evaluating the portfolio. A properly selected performance benchmark provides an objective standard of the City's return expectations and risk preferences. Comparing the portfolio's return against a performance benchmark functions as an important management oversight tool. If the portfolio consistently under-performs the benchmark, this could indicate the portfolio manager is not effectively managing the City's investments. At the same time, if the portfolio consistently outperforms the benchmark by wide margins, this might indicate that the portfolio manager is taking on more risk than the City feels is prudent. In either case, significant deviation with the benchmark raises a red flag that warrants further investigation and explanation. We do not recommend listing a specific benchmark in the Policy. This will provide the City with the ability to change its benchmark to adapt to changing investment objectives without revising its Policy. Investment Reports Overall, the City's Quarterly Investment Report is comprehensive and exceeds what is required by the Government Code. As noted above in the Policy review section, the Government Code's reporting requirements under Section 53646 were made optional. However, we recommend that the City maintain its current reporting practices. While in compliance with Government Code standards, we recommend the City implement several changes to the City's Quarterly Investment Report to enhance its usefulness as an oversight tool.. However, to reduce the burden on City Staff, we recommend waiting until the City's new portfolio software has been fully implemented before making any changes. · We recommend the City show the securities' Yield to Maturity at Cost rather than Current Yield. The "Current Yield" shown on Union Bank's custody statement is simply the portfolio's annual interest income divided by the security's current market value. The current yield does not accurately reflect the security's return to maturity. In contrast, City of Dublin - Investment Program Review 9 12UbqiS Investment Advisors to the Public Sector Yield to Maturity at cost is the rate of return, based on the original cost, the annual interest receipts, maturity value, and the time period from purchase date to maturity. · Based on the City Council's preferences, the City may want to consider adding graphs to the report showing sector, issuer and maturity distributions. Graphic information is often more quickly understood. · Depending on what reports are available from its new portfolio software, the City may want to consider incorporating additional information to the report on the callable securities in its portfolio, such as the percentage of securities that are callable or the portfolio's maturity distribution, to help track the portfolio's call exposure. City of Dublin - Investment Program Review 10 13U6 4~ Investment Advisors to the Public Sector III. PORTFOLIO REVIEW The purpose of PFM's review was to assess the compliance of the City's portfolio with the California Government Code and the City's Policy. In addition, using the information contained in the City's March 31, 2007 Treasurer's Report, we independently analyzed the portfolio's characteristics. From our review, we determined that the portfolio is in compliance with the California Government Code and the City's Policy. A summary compliance matrix of the California Government Code Section 53601, the City's Policy, and the City's investment portfolio is shown below. Portfolio percentages were calculated using the par values of the securities in the City's portfolio as of March 31, 2007. Inve$tment7J7ype U.s. Treasury 100% Same 0% Yes obligations State of Californ 100% Not permitted 0% N/A obligations Debt issued by 100% California local Not permitted 0% N/A governments Federal Agency 100% Same 62.6% Yes obligations 5 years Bankers' 40% total Acceptances 30%/issuer Same 0% Yes 180 days 25% Commercial "A1/P1/F1" Same 0% Yes Paper "A" on issuer's LT debt Time CDs 100% Same 0% Yes ollateralized Negotiable Certificates of 30% Same 0% Yes Deposit Repurchase 100% Agreements 1 year Not permitted 0% N/A 102% Collateral Reverse 20% Repurchase 92 days Not permitted 0% N/A Agreements City of Dublin - Investment Program Review 11 (4L1b1~ Investment Advisors to the Public Sector GOy'tense Limitations: Oity of %,Minim Requirements Credit, IIII~~ Corporate 30% Medium Term 5 years Not permitted N/A Notes "A" or better 20% 10% per fund Restricted to U.S. Mutual Funds "MA" by two Treasuryl Federal 0% Yes NRSRO or $500 Agency funds million 20% $500 million in Money Market "MA" by two assets AN D 7.7% Yes Funds NRSRO "MA" by two OR $500 million NRSRO Obligations backed by a first security interest in 100% Not permitted 0% N/A acceptable collateral Mortgage-backed 20% Issue min: "M" Not permitted 0% N/A securities Issuer min: "A" 29.8% LAIF $40 million Same ($34.1 Yes million) Local 100% Government Investment Same 0% Yes Investment Pools Adviser Requirements California County 100% Not permitted 0% N/A Investment Pools Maximum 5 year maximum Maturity maturity without Same Yes Board approval SectorlIssuer Distribution The charts shown below summarize the distribution, as measured by par value, of the portfolio assets by security type, issuer and credit quality. Unless noted otherwise, the percentages are based on the City's overall portfolio, totaling $114.6 million, as of March 31, 2007. The portfolio is of high-credit quality and is diversified among a variety of issuers, though with limited sector diversification. The portfolio is concentrated in the Federal Agency sector, which City of Dublin - Investment Program Review 12 Investment Advisors to the Public Sector /56611/ represents 62% ($71.7 million) of the total portfolio. The balance of the City's portfolio is invested in the State of California's Local Agency Investment Fund (LAIF), 30% ($34.1 million), and money market funds, 8% ($8.8 million). The portfolio currently holds no U.S. Treasury securities or other investment types permitted by the City's Policy. Sector Distribution As of March 31, 2007 Agency 62% The portfolio is diversified across a number of issuers. Among Federal Agency issuers, 33% of the overall portfolio ($37.7 million) is invested in Federal Home Loan Bank issues. The next largest Agency allocation is Freddie Mac (FHLMC), which comprises 12% of the overall portfolio ($14.0 million). Ideally, we would encourage more diversification among the Agency issuers. As a goal, we would encourage that no more than 25% of the overall portfolio be invested with anyone Agency issuer. While the portfolio's allocation to Federal Home Loan Bank issues is above this goal, we do not believe that the current allocation is excessive given the issuer's credit quality. However, to avoid an over concentration in anyone issuer, we recommend the City adopt a 40% per issuer limit for Federal Agency securities. Issuer Distribution As of March 31, 2007 BofA 8% FFCB 5% FHLMC 12% City of Dublin - Investment Program Review 13 J&;lSb1'8 Investment Advisors to the Public Sector Credit Risk The portfolio has limited credit risk. The portfolio's credit quality, as measured by Standard & Poor's ratings, is very high. 70% of the portfolio ($80.5 million) is invested in securities rated "AAA" or "AAAm." The remaining 30% of the portfolio ($34.1 million) is invested in LAIF, which is not rated. While we have not conducted our own analysis of its credit quality, LAIF is generally considered safe. While permitted by Policy, the portfolio currently has no corporate credit exposure (commercial paper, bankers' acceptances, or negotiable certificates of deposit). As previously noted in the Policy review section, the City should evaluate the suitability of these investment types for the City's portfolio, considering the City's ability to evaluate and monitor corporate credits either internally or by using an external advisor. Credit Quality Distribution As of March 31, 2007 Unrated (LAIF) 30% Call Risk Callable Federal Agency securities provide the opportunity to capture additional yield compared to non-callable securities with no additional credit risk. The potential added yield, however, comes with other types of risk. There is always reinvestment risk involved with purchasing callable securities. In the event interest rates fall, the security is more likely to be called, which could force the investor to reinvest the funds in a lower interest rate environment. The use of callable securities in a portfolio also increases the difficulty of managing the portfolio's duration2, given the inherent uncertainty in a callable security's maturity. A significant allocation to callable securities can result in drastic swings in a portfolio's maturity structure and duration, which can increase the portfolio's relative interest rate risk. 2 Two terms that will be used frequently in this report are Weighted Average Maturity ("W AM") and Duration. While the terms are sometimes used interchangeably, they represent slightly different concepts. In basic terms, a portfolio's W AM is a weighted average of the final maturities of the securities in a portfolio. Duration is the weighted average of the cash flows of a security or portfolio, including coupon payments and maturities. W AM is a measure of the timing of maturities while Duration is a measure of portfolio risk as represented by its price volatility. The longer the duration of a security or portfolio the greater its price volatility. City of Dublin - Investment Program Review 14 ....-:- ':::PFlV{" Investment Advisors to the Public Sector 11Lfb ~fs Currently, the City's portfolio has a fairly high degree of call risk with 43% of the portfolio ($49.2 million) invested in securities that are still callable. An additional $13.5 million of the portfolio is invested in callable securities, which are no longer callable ("Busted" calls). In addition to the total amount of callable securities, a portfolio's call risk is influenced by the call structure of the securities in the portfolio. For example, a continuously callable security (a security that can be called at any time, subject to a notice requirement) represents more call risk than a one-time callable security (a security that is only subject to call on one specific date). Currently, the portfolio's largest allocation is to continuously callable securities, 26% ($30.2 million). Portfolio Distribution by Call Type As of March 31, 2007 Not Callable 45% Busted 12% Onetime 7% Semi-Annual 2% Quarterly 8% Anytime 26% While the Government Code does not specify any limits to callable securities, we typically recommend that public agencies limit their call exposure to 20-30 percent of their overall portfolio. In the Policy section, we recommended the City adopt a 25 percent limit on callable securities. In addition to an overall limit, we would encourage the City to emphasize more restrictive call provisions, such as semi-annual calls or one-time calls. The use of callable securities is also discussed in the portfolio management section of this report. Maturity Distribution The following chart shows the current maturity distribution of the investment portfolio. A significant portion 37% ($42.9 million) of the City's portfolio is in securities maturing in one day, LAIF and the money market funds. Another 9% of the portfolio ($10.5 million) is in Federal Agency securities maturing in one year or less. The portfolio's weighted average maturity is 1.27 years. The remaining portfolio is distributed in securities with maturities out to five years. In compliance with the City's Policy and the Government Code, none of the securities in the portfolio either now or at the time of purchase had a maturity exceeding five years. City of Dublin - Investment Program Review 15 Investment Advisors to the Public Sector Portfolio Maturity Distribution to Final Maturity As of March 31, 2007 70% l 60% 50% 40% 37% 30% 20% J 10% 0% >. , l/) III co l/) .c 0 ' .c C , ~c 0 ...... o 0 ::2: ,::2: N N ...... , co 15% 9% 11% 0% l/) l/) l/) l/) l/) l/) .c .c .c .c .c .c C C C C C C 0 0 0 0 0 0 ::2: ::2: ::2: ::2: ::2: ::2: co N 00 v 0 0 (") v v lC) co co , , . . . ^ 0 co N 00 v (") (") v v lC) l/) .c C o ::2: 00 ...... , N ...... l/) .c C o ::2: v N , 00 ...... l/) .c C o ::2: o (") , v N i <8 tb1~ The following chart shows the maturity distribution of the portfolio to the next call date. If all of the callable securities in the portfolio were called at their next call date, 79% ($91.6 million) would mature or be called within the next year. Portfolio Maturity Distribution to Next Call Date As of March 31, 2007 70% 66% 60% 50% 40% 30% 20% 10% 0% 0% 0% 0% >. , l/) l/) l/) l/) l/) l/) l/) l/) l/) l/) III COl/) .c .c .c .c .c .c .c .c .c .c 0 I .c - C C C C C - - c c c c c , >.- 0 0 0 0 0 0 0 0 0 0 ..- III C 00 ::2: ::2: ::2: ::2: ::2: ::2: ::2: ::2: ::2: ::2: .::2: N 00 v 0 co N 00 v 0 0 N ..- ..- N (") (") v v lC) co co I N . , I I I I , ^ co 00 v 0 co N 00 v ..- ..- N (") (") v v lC) City of Dublin - Investment Program Review 16 tqUb4~ Investment Advisors to the Public Sector While it is unlikely that all the callable securities in the portfolio would be called on their next call date, the chart illustrates the potential impact of the large percentage of callable securities in the portfolio on the portfolio's maturity distribution. The portfolio's effective maturity distribution will vary between final maturity and next call date depending on interest rate conditions. In stable or rising interst rate enviornments, callable securties are less likely to be called and the portfolio's duration will lengthen towards final maturity. However, in a fluctuating or falling interest rate environment, there is greater liklihood that securities will be called and the portfolio's duration will shorten towards next call date. To understand the potential impact on a portfolio, it is important to consider how the interest rate environment may change over the entire time the security may be called, not just the interest rate environment at the time of purchase. Liquidity In contrast to a maturity distribution, which illustrates when a security is scheduled to mature, liquidity is a measure of the ease with which a specific investment can be sold and turned into cash. Securities with better liquidity are easier to sell and trade at a narrower "bid/ask spread," which is generally the price or yield difference between where the broker/dealer community buys and sells the particular security. To simplify analysis of liquidity risk, PFM has assigned each investment holding a liquidity factor. These liquidity factors are based on our assessment of the relative liquidity of different security types and structures. For example, securities like U.S. Treasuries have the best liquidity and are assigned the lowest liquidity factor of 1. LAIF and money market funds are assigned a liquidity factor of 2. Securities with poor liquidity, such as private placements or certain structured products, have a higher liquidity factor (9 or 10). Conventional corporate securities fall in between at a liquidity factor of 5. Appendix B includes a list of the liquidity factors assigned by PFM to various security types. City of Dublin - Investment Program Review 17 Investment Advisors to the Public Sector ~D&Jb"r Portfolio Liquidity Distribution March 31, 2007 70% l 60% 50% 40% 37% 30% 20% 10% 0% 0% 2 46% 16% 0% 0% 0% 0% 0% 0% 3 4 5 6 7 8 9 10 Liquidity Factor The chart above shows the distribution of the portfolio's assets by liquidity factor. The City's portfolio has a weighted average liquidity rating of 3.9, indicating a moderate exposure to liquidity risk. We do not believe this level of liquidity risk represents a problem. While Federal Agency securities are generally highly liquid investments, the portfolio's liquidity risk is a little higher than it might otherwise be due to the high percentage of callable securities in the portfolio. On a relative basis, we rate callable securities a 6, as they tend to be smaller issues and have larger bid/ask spreads than other non-callable Federal Agency issues. City of Dublin - Investment Program Review 18 ~''D 'i Investment Advisors to the Public Sector IV. PORTFOLIO MANAGEMENT In the prior section, we analyzed the portfolio's overall characteristics as of March 31, 2007. This section is an analysis of the portfolio's performance over the past five years. The purpose of our analysis was to help the City understand the factors that have influenced the portfolio's performance, safety and liquidity over this time period. Overall, the portfolio appears to have performed relatively well over the time period analyzed. However, by understanding the factors that have influenced the portfolio's performance in the past, the City may be able to safely enhance the portfolio's long-term performance. Portfolio Performance Performance is best evaluated in relation to an objective benchmark that reflects the portfolio's desired objectives and risk characteristics. A portfolio's absolute level of return offers little useful information for performance evaluation unless considered in relation to a benchmark. It is difficult to evaluate performance if the only available information is that a portfolio has earned a return of 4%. However, knowing that a particular portfolio has earned 4% while portfolios with similar characteristics earned 6% over the same holding period provides a much clearer picture of performance. One of the key benefits of using a performance benchmark is that significant variations between the benchmark and the portfolio can serve to highlight changes to how the portfolio is being managed. Ideally, we recommend evaluating performance on a total return basis rather than yield. Total return takes into consideration the amortized cost of each security, interest income, realized gains or losses, plus any appreciation or depreciation in market price as of the end of the period. In contrast, yield only describes the portfolio's current yield at the end of the period. However, as total return information was unavailable for the portfolio, we used the portfolio's current yield as reported on the City Treasurer's Quarterly Investment Report for the periods September 30, 2001 through March 31, 2007. As the City does not have a designated performance benchmark, we compared the portfolio's yield to both LAIF's quarterly apportionment rate and a 24-month rolling average of the 2-Year U.S. Treasury yield, as illustrated by the chart of the following page. We used the LAIF rate to represent a shorter-term investment strategy, as it is a short-term investments vehicle used by the City's and many other California local agencies. Many public agencies use LAIF as a baseline by for evaluating their portfolio's own performance, as its performance data is readily available. We used the 24-month rolling average of the 2-Year U.S. Treasury yield as a benchmark to represent an intermediate-term investment strategy. With an average maturity of one-year, this benchmark has an average maturity comparable, but slightly shorter, than the portfolio's average maturity over the time period analyzed. Although the Federal Agency securities in the City's portfolio would have higher yields than comparable maturity U.S. Treasury securities, we used a U.S. Treasury benchmark as the yields are widely available and they serve as a base line yield for other evaluating other investments. City of Dublin - Investment Program Review 19 Investment Advisors to the Public Sector ~~"b~ City Portfolio Yield VS. LAIF vs. the 24-Month Rolling Average of the 2-Year U.S. Treasury Yield September 30,2001 through March 31,2007 6.0% 5.0% 4.0% 3.0% I I 2.0% I' 1.0% . Sep-01 Mar-02 Sep-02 Mar-03 Sep-03 Mar-04 Sep-04 Mar-OS Sep-05 Mar-06 Sep-06 Mar-07 -City Yield -LAIF - 2-Year U.S. Treasury (24-Month Rolling Avg.) Source: U.S. Treasury Department and LAIFwebsite. While these comparisons are not ideal, they provide a basis to understand the factors that inflience the portfolio's performance. Over the time period analyzed, the quarter-end yield on the City's portfolio averaged 3.42% compared to 3.23% for the 2-Year U.S. Treasury benchmark and 2.95% for LAIF. The remainder of this section will look at specific aspects of the City's portfolio and their impact of the portfolio's performance. Portfolio Average Maturity. In general, a longer-term portfolio will out-perform a shorter- term portfolio over time. During the period analyzed, the portfolio's Weighted Average Maturity (WAM) varied between 0.99 years and 2.16 years. As of March 31, 2007, the portfolio's WAM was 1.27 years. In comparison, LAIF's WAM was 0.46 years, as of March 31,2007 and the 2-year U.S. Treasury benchmark had a W AM of 1.0 year. City of Dublin - Investment Program Review 20 Investment Advisors to the Public Sector ;;\ 3 fJb C(g Overall Portfolio WAM and WAM for Non-Pool Investments September 30,2001 through March 31, 2007 4.0 3.5 3.0 2.5 2.0 I 1.5 r 1.0 t 0.51 - j -Overall Portfolio WAM - Non-Pool Investments WAM Sep-01 Mar-02 Sep-02 Mar-03 Sep-03 Mar-04 Sep-04 Mar-OS Sep-05 Mar-06 Sep-06 Mar-07 Given the City's portfolio longer W AM, we would expected, as was the case, the portfolio would have a higher average return than either LAIF or the 2- Year Treasury benchmark. Although we would expect the portfolio's average return to be higher over an entire interest rate cycle, we would not necessarily anticipate that the portfolio would have a higher return at all times. For example, as of March 31, 2007, the portfolio's yield was only 4.55% compared 5.17% for LAIF. The current difference in yields does not imply that there are any problems with the City's portfolio, it reflects the normal pattern of a longer-term investment strategy. Because on average it takes longer for the securities in the City's portfolio to turn over, the yield of the City's portfolio will tend to lag current interest rate trends, both up and down, compared to a shorter-term portfolio like LAIF. With interest rates rising rapidly over the past several years, the yield on LAIF, as it is a shorter-term portfolio, adjusted more rapidly to current interest rate levels. Individual Securities. While the performance and risk characteristics of the City's portfolio are a function of all of the securities in the City's portfolio, it is the City's investments in individual (non-pooled) securities that differentiate the portfolio's performance and risk characteristics. Other than deciding to invest or not invest its funds, the City has no control over the pooled (LAIF and money market funds) investments in its portfolio. However, the City can directly determine the performance and risk characteristics of its own portfolio by the types of other investments it purchases. To help understand the impact of the City's investment choices on the portfolio's performance, we looked at certain aspects of the individual investments purchased by the City. Investment Maturities. Looking at all of the individual securities purchased between September 30, 2001 and March 31, 2007, the City emphasized intermediate- to longer- term securities. As illustrated by the following chart, 87% of the securities purchased in the time period analyzed had maturities of two years or longer. City of Dublin - Investment Program Review 21 Investment Advisors to the Public Sector . 2 y~ 1~ Security Purchases by Final Maturity September 30,2001 through March 31, 2007 40% 38% 1Il CIl lQ 30% .c o ... :s II.. lIS ;:; {!. 20% ... o "# 10% 1% 0% 0-1 Years 1-2 Years 2-3 Years 3-4 Years 4-5 Years With a normal, upwardly sloping yield curve, longer-term securities will provide higher yields than shorter-term term securities. The following chart illustrates the average U.S. Treasury yield curve for the 10-year ending March 31, 2007. Average U.S. Treasury Yield Curve Ten Years Ending March 31, 2007 5.25% 5.00% 4.75% 4.50% 4.25% 4.00% 3.75% 3.50% o ~ M ..: >- I ..- ..: >- N ..: >- I ('I') ..: >- ,..:. ..: >- .n ..: >- 6 ..- o ~ I co While longer-term securities generally provide higher yields compared to shorter-term securities, a security's interest rate risk also increases with its duration. The following chart illustrates how the market value fluctuations of a security, due to changes in interest rates, increase with the security's duration. By purchasing longer-term securities, the City obtained higher yields on average, but it also increased the portfolio's exposure to interest rate risk. City of Dublin - Investment Program Review 22 Investment Advisors to the Public Sector t.~1.J ~~ Value of $1 Million Investment if Interest Rates Go Up 1 % in Six Months CI) 3.00% :::I ~ c: 1.00% CI) $995,200 C) c: ~ -1.00% 1 YearTSY ... c: CI) ~ -3.00% CI) Q. -5.00% -7.00% An additional aspect of buying longer-term securities is that, unless they are sold or called prior to maturity, they will influence the portfolio's yield for an extended period. As a consequence, the portfolio's yield will be more stable over time, but will tend to lag the direction of current interest rate levels both up and down. This can be a benefit when interest rates are trending downward, but can hurt a portfolio's return when interest rates are trending upward. As shown in the chart below, the portfolio still contains a large percentage of longer-term securities that were purchased between 2002 and 2005 when interest rates were considerably lower than current levels. Distribution of Portfolio Securities by When Purchased As of March 31, 2007 30% 22% 20% 10% " o o N co o o N ll) o o N '<t o o N M o o N While purchasing longer-term securities helped increase the portfolio's yield relative to short-term investments when they were originally purchased, they are now lowering the portfolio's average yield as they have lower yields compared to current interest rate levels. When these longer-term securities mature or are called, they can be reinvested City of Dublin - Investment Program Review 23 Investment Advisors to the Public Sector 2(" ii6 '1'6 into new securities at the then current interest rate levels, which will move the portfolio's overall yield towards current interest rate levels. Callable Securities. Historically, the portfolio has had a significant allocation to callable Federal Agency securities. During the period analyzed, callable securities represented 88% of the securities purchased compared to only 12% for non-callable securities. While callable securities generally offer a yield advantage over non-callable securities, they also carry the risk that they will be called during the holding period. If called, the proceeds will then need to be reinvested in a lower interest rate environment. During the period analyzed, the City had $117.9 million of securities called. As illustrated by the following chart, the majority of the securities were called between 2002 and 2004 when interest rates were well below their longer-term historical averages. As a result, while the purchase of callable securities allowed the City to initially increase the yield on its portfolio, the portfolio's long-term return may have been reduced when the City was forced to reinvest a significant number of called securities when interest rates were very low. Called Securities (par) ys. 2-Year U.S. Treasury Yield As of March 31, 2007 U) c ~ 'E ~ III Gl ~ .t: := (,) Gl en "t:l .S! iii o - o Gl .a ~ ... ~ 0 0% Sep-01 Mar-02 Sep-02 Mar-03 Sep-03 Mar-Q4 Sep-04 Mar-05 Sep-D5 Mar-06 Sep-06 Mar-O? 30 6% _ Called 25 5% -2-Year UST 20 4% 15 3% "t:l Qj >= 10 2% 5 1% City of Dublin - Investment Program Review 24 Investment Advisors to the Public Sector 27tJb't<<i ~. v. CORE PORTFOLIO ANALYSIS As part of our review, we analyzed the City's historical portfolio balances to help the City determine an appropriate allocation between short- and longer-term funds. From our analysis, we believe that there may be opportunities for the City to allocate a greater portion of the City's overall assets towards longer-term investments, which could increase the portfolio's long-term performance. PFM has developed a sophisticated core portfolio analysis model to assist public entities in developing an optimal investment strategy. The objective of this model is to determine what portion of a portfolio is needed to provide short-term liquidity and what portion, if any, can be invested in a longer-term core portfolio. In other words, the model determines the optimal portfolio allocation between short-term investments (e.g., pools, commercial paper, overnight repurchase agreements and very short-term Federal Agency discount notes) and longer-term investments (e.g., U.S. Treasury and Federal Agency notes). The model approaches this task by analyzing the changes in a portfolio's average monthly balance over some historical time period, typically two years, and determining if these changes follow a predictable pattern. Because of their reliance on tax receipts, we have found that most governments have a very predictable cash flow pattern. We refer to this predictable pattern as the portfolio's seasonality. If the portfolio possesses seasonality then the model can be quite valuable in projecting investable balances and in the portfolio structuring process. We applied the model to the City of Dublin's portfolio using the portfolio's historical balances for the quarters ending December 31, 2001 through March 31, 2007. These balances were entered into the core portfolio analysis model, which allocated the portfolio between two pieces, the core portfolio and the short-term portion. The core portfolio represents the minimum balance that the portfolio has historically maintained and the level which the portfolio balance is not expected to fall below. This is the portion of the portfolio that could potentially be invested longer-term to achieve higher returns over time. The short-term portfolio represents that portion of the portfolio that is needed to cover daily disbursements and predictable cash needs such as payroll. This portion of the portfolio would be invested in, for example, LAIF, overnight repurchase agreements, very short-term Federal Agency discount notes, or commercial paper. The short-term portion includes a cushion factor that has been built into the model to provide additional protection against unexpected cash needs. This cushion can be adjusted depending upon the City's comfort level with the data. For the City, we assumed an initial cushion of 20% of the average portfolio balance. The following chart shows a potential allocation between the short-term portion of the portfolio and the core portfolio. To be conservative, the analysis assumed a 20% short-term cushion and no growth in portfolio balances (the portfolio's actual annual growth rate was 5.1 % from March 2002 to March 2007). City of Dublin - Investment Program Review 25 Investment Advisors to the Public Sector 2<attt1 City of Dublin-All Accounts (Total) Analysis of Core Portfolio 140 120 W 100 ,g 80 E 60 ~ 40 20 T-- N N N C') C') C') ~ ~ ~ lD lD lD <0 <0 <0 I'- I'- I'- co co co m 0 9 0 0 9 0 0 9 0 0 9 0 0 9 0 0 9 0 0 9 0 0 ~ :> ~ :> ~ :> ~ :> ~ :> ~ :> ~ :> ~ m :i 0 m :i 0 m :i 0 OJ :i 0 m :i 0 m :i 0 m :i 0 m :2: ..., z :2: ..., z :2: ..., z :2: ..., z :2: ..., z :2: ..., z :2: ..., z :2: !ill Historical Short-term Portfolio . Historical Core !ill Projected Short-term Portfolio ITJ Projected Core The model identified a core balance of approximately $91.1 million. As of March 31, 2007, only $61.2 million (53%) of the total portfolio was invested in securities with a final maturity greater than one year. In general, the City has maintained a significant portion of its portfolio in shorter- term investments. Between December 31, 2001 and March 31, 2007, the City maintained an average of 53% of its portfolio in securities with a final maturity of one year or less. Allocation of Assets December 31, 2001 -March 31, 2007 100% 750/0 D Liquidty 500/0 11III Core 2501'0 00/0 Dee-01 Sep-02 Jun-03 Mar-04 Dec-04 Sep-OS Jun-06 Mar-07 The model's results suggest that, on average, the City may be able to increase the portion of its portfolio allocated to the "core," longer-term, portion of the portfolio. Decreasing excess liquidity can help improve returns over time. However, the specific allocation between the short- term and core portions of the City's portfolio will depend on the City's specific cash flow patterns and the nature of the invested funds. For example, unlike tax receipts, the timing of both the receipt and expenditure of impact fees are driven by project schedules and not cyclical cash flow patterns. City of Dublin - Investment Program Review 26 Investment Advisors to the Public Sector ~ot~'1~ VI. REVIEW OF INVESTMENT PROCEDURES As part of our review process, we were asked to review the City's procedures for conducting investment transactions and the City's internal controls. We did not identify any areas of special concern, however, we believe the City could improve in its investment practices in these two areas. Our specific comments and recommendations are described below by topic. Investment Transactions From our discussions with City Staff, we understand that the City currently utilizes two brokerage firms for all of its investment purchases. These firms send the City their available investment offerings and corresponding rates on a routine basis. When the City is ready to make an investment, it reviews the current offerings provided by the brokers and then the City Staff selects a security that it believes best suits the City's investment needs. While this purchase process is fairly common among other municipalities, the downside to the City's current procedure is that it puts the City in the position of being "sold to" by the brokerage community. The City only sees those securities that the firms have in inventory or "new issue" Federal Agency obligations that are still trading in syndicate. While a bit difficult to quantify, there is a definite opportunity cost related to not seeing the broader market. For example, we notice that the City's portfolio appears to contain a large number of "new-issue" securities. New- issue securities are securities that are being offered for sale for the first time by the issuer through their underwriters. Once these securities are sold for the first time, they will go on to trade in the "secondary market." Brokers often encourage the purchase of new issue securities as their compensation is typically higher for these securities than from the sale of securities through the secondary market. However, from the investor's standpoint, it is often possible to obtain securities with similar characteristics through the secondary market that trade more cheaply (i.e., at higher yields) than comparable new issue securities. Furthermore, the current process does not necessarily encourage active competition among the City's brokers. In our experience, shopping competitively for securities can make a significant difference in price. These differences are not the result of one firm being a "better" broker than the other, but are affected by inventory holdings, market expectations and volume of other activity. To obtain the best price and execution for our client's, PFM's policy is to competitively bid each trade to a minimum of 3 broker/dealers, and in some cases as many as 10 or more. The following is a Bloomberg screen illustrating how prices for the same Federal Agency security can vary widely among different firms. City of Dublin - Investment Program Review 27 Investment Advisors to the Public Sector Saved Searches Edit l!l Hide Dealers 0 Shalll C..rs Issuer ,S12~ eM) 500.000 soo.ooo 500.000 500.000 SUBJECT 888.000 FN11A DISCllJNT 197.826 FN11A DISCOJNT 100.000 FN11A DISCIllJNT 100.000 FN11A DISClllNT SO.OOO FN11A DISCOUNT 65.217 FNMA DISClllNT 221.802 FNMA DISCOUNT 37.369 SO.OOO 3Z9.225 19.280 SO.OOO 25.00D SO.OOO 3.5SO All 0-7 8-30 Source: Bloomberg; Yields as of 3/9/06 Opllons View Ma turi ty so DsclCpn 02111108-02115108 .. 02111108-02115108 .. 02l1ll08-ll2l15l08 .- 02/11/08-02115108 _ I 3Dq, er'i AGD Offerings: DEFAULT "" COMMINGLED Yi21d Dlr TYP Tickir 5.093-5.090 LEH AGO FNON 5.093 115 AGO FNON 5.082-5.085 IlR AGO FNON 0.000 GS AGO FNON 5.090 IlRRC AGO 5.12B L1JS AGO 5.lI? IlRRC AGO 5.117115 AGO 5.10& CSFB AGO 5.093 GC AGD 5.081 JPM AGO High Yield: 5.125% - Low Yield: 5.003% Difference in offers: 12.2 bps (0.122%) The following table is a summary of the information from the Bloomberg screen. Barclays Capital an Stanley SSB Credit Suisse First Boston FTNF Goldma 5.125% 5.120% 5.119% 5.106% 5.103% 5.097% 5.003% The difference between the highest and lowest yields is 12.2 basis points (0.122%), which represents $12,200 in additional earnings per year on a $10 million investment. The price variance will not always be this wide; however, given the size of the City's portfolio and the volume of its investment transactions, any improvement to the City's purchasing practices could have a significant benefit. While we ideally would prefer to see the City use of a true competitive purchase process among multiple brokers competing on each trade, we recognize that is not practical given the City's limited resources and limited staff time. However, we would encourage the City to modify its current practices in a couple of respects. 1. Add one or two firms (in addition to current two) to the City's approved list. 2. Request price quotes on every transaction. These recommendations are described in more detail on the following page. City of Dublin - Investment Program Review 28 Investment Advisors to the Public Sector ?>'Db 'I~ Additional Brokers. By expanding its list of approved brokers, the City could increase its market access and encourage more competition among its brokers. The City will likely find that some broker-dealers have market niches and are more competitive in certain types of securities (e.g. Federal Agency discount notes, callable Federal Agencies, or intermediate- term (1- to 3-year) securities). While there is no ideal or optimal number of trading partners, the size of the City's portfolio would suggest that adding at least one or two more firms to the current two firms the City uses would be appropriate. There might be some benefit of increasing the number of brokers the City uses beyond that number, but the incremental benefit would likely be more than offset by the time the City would spend managing its broker-dealer relationships given the City's limited resources. Given our extensive resources, PFM is able to maintain a list of over 50 brokers, dealers, banks, and other qualified financial institutions that are approved for transaction execution. Our list of approved brokers is updated as situations warrant and is reviewed at least quarterly. PFM has established policies and procedures to evaluate and monitor firms' credit worthiness and their ability to effectively and adequately perform the duties necessary for trade execution. This review includes an assessment of many important factors including market presence, capitalization, company history, profitability and management, sales coverage, and special circumstances. PFM regularly reviews broker relationships and adds or deletes firms based on credit considerations, product availability, trade execution, timeliness of information, and quality of service. For the City's own list of approved brokers, we recommend that the City establish a process for "qualifying" broker dealers and then review the approved list at least once each year to eliminate non-competitive firms and to consider any additions. Some cities employ a formal RFP process to select brokers while others conduct more informal reviews. Depending on the City's preferences, either procedure could be used effectively. In either case, the primary objectives of the process should be to ensure the suitability ofthe selected firms and that City Staff is not overwhelmed by firms trying to serve as the City's broker. The following are some suggested criteria for ensuring capital adequacy, financial strength and market focus of the City's brokers: 1) "Primary" dealers and regional dealers that qualify under Securities and Exchange Commission Rule 15C3-1 (uniform net capital rule) Firm capital of no less than $10,000,000 2) 3) 4) 5) Registered as a dealer under the Securities Exchange Act of 1934 Member of the National Association of Securities Dealers (NASD) Registered to sell securities in California City of Dublin - Investment Program Review 29 Investment Advisors to the Public Sector 3t.1>~~ 6) The firm and assigned broker have been engaged in the business of effecting transactions in U.S. Government and Federal Agency obligations for at least five (5) consecutive years. 7) The assigned broker handles institutional accounts 8) The ability to provide additional research and analytics 9) A minimum of three references from other California public agency clients 10) Acknowledge having read and understood the City's investment policy Purchasing Procedures. Rather than selecting investments based on the inventory lists provided by its brokers, we recommend that the City actively solicit prices from among its approved brokers. When the City is ready to make an investment, we recommend the City . request its brokers provide pricing for securities indicating desired maturity range, sector, and any other criteria (such as callable and non-callable). As discussed more fully in the portfolio management section, we believe that the City's selection of investments should be driven by the City's long-term investment strategy rather than what the brokers currently have in inventory. Rather than complicating the process, a competitive purchasing process and an expanded list of broker-dealers may make the placement of trades easier. Based on its desired criteria, the City could solicit offers from all of its approved broker-dealers, but would not need to obtain quotations from every party. A cutoff time could be set and only offers received up to that point in time would be considered. The process would not prevent brokers from offering other options, but would focus the offerings the City received for its review. Internal Controls The City's current Policy indicates that the City should have a set of written internal control procedures. However, the City's current written investment procedures only address internal controls as a peripheral issue. From our discussion with City Staff, it appears that in actual practice the City Staff employs a reasonable set of procedures to provide internal controls on the investment process, such as separation of duties and approval processes for transactions. However, these internal control practices were not well documented. Accordingly, we recommend that the City establish a set of written internal control procedures. The purpose of developing internal controls is to recognize and work to prevent situations that could result in losses of public funds arising from fraud, employee error, and misrepresentation by third parties, unanticipated changes in financial markets, or imprudent action by City Staff and officers. The internal controls should be designed to provide reasonable assurance that these objectives are met. The concept of reasonable assurance recognizes that (I) the cost of a control should not exceed the benefits likely to be derived, and (2) the valuation of costs and benefits requires estimates and judgments by management. City of Dublin - Investment Program Review 30 Investment Advisors to the Public Sector ~~16 ~ The following list represents the typical areas that are addressed in most written internal control procedures. The development of internal controls should recognize the City's unique circumstances. 1. Control of collusion 2. Separation of transaction authority from accounting and record-keeping 3. Custodial safekeeping arrangements 4. Clear delegation of authority to subordinate staff members 5. Written confirmation of transactions for investments and wire transfers 6. Wire transfer procedures While we recommend that the City's Policy require a system of internal controls, we recommend that the actual procedures be documented separately in the City's written investment procedures to allow City Staff the flexibility to modify the procedures, when necessary, without having to seek formal City Council approval. As with many local agencies, we would encourage the City to review its internal control procedures with its auditor on an annual basis. City of Dublin - Investment Program Review 31 Investment Advisors to the Public Sector ~cf~q~ VII. CURRENT MARKET OVERVIEW This section provides a general description of economic trends as of May 2007. This overview is used to provide background for Section VIII. of this report, which identifies potential investment strategies for the City's portfolio. Economic Update Modest growth and small improvements in inflation balanced the effects of a continued housing slowdown and kept interest rates in a tight range in April, as they have been trading for several months. Solid stock market gains, continued employment growth, and rising personal income improved the outlook for the economy, while overall prices reacted mildly to rises in oil prices and wages. 2-Year U.s. Treasury Yields April 1, 2006 - May 1, 2007 5.50% II Ii j Aug Sep Oct Nov Dee Jan Feb Mar Apr May 06 06 06 06 06 07 07 07 07 07 5.25% 5.00% 4.75% 4.50% 4.25% May Jun Jul 06 06 06 Source: Bloomberg As the above chart shows, fixed-income markets have been range-bound since August 2006. And in April 2007, the 2-Year U.S. Treasury Note completed another month of directionless trading. An inverted yield3 curve presented little opportunity to affect returns by managing duration. With the Federal Reserve on hold and no significant change in the outlook for the economy, there has been little to move the market one way or the other. U.S. Treasuries finished the month nearly unchanged from March, as an early month sell-off in the face of a strong March employment report (released April 6) was followed by a slow recovery in prices fueled by strong demand. The spread between 2- Year and 1 0- Year Treasuries (3 basis points) was actually a bit narrower than at the end of March. 3 An "Inverted" Yield Curve refers to the atypical market condition in which longer-term investments have lower yields than shorter-term investments. City of Dublin - Investment Program Review 32 ;~~q~ Investment Advisors to the Public Sector Source: Bloomberg Minutes of the March Federal Open 'Market Committee ("FOMC") meeting, released on April 11, reinforced the market stasis with the Fed governors restating their outlook for moderate growth, and inflation somewhat above the Fed's presumed target. Equities made new highs despite the uncertain economic outlook. The Dow Jones Industrial Average reached a record high, surpassing the 13,000 mark; the S&P reached its highest level in seven years. Meanwhile international equities once again out-performed the U.S. market, driven by solid growth in many world economies. The Morgan Stanley Capital International Inc. Europe, Australasia and the Far East ("MSCI EAFE") Equity Index had a return of 4.4% and the MSCI Emerging Markets Index gained 4.6% for the month, while in the U.S. markets many top performers benefited from high exposure to non-U.S. markets. Industrials, materials and technology have all recently done well despite domestic weakness. In the U.S., large cap stocks out-performed small cap stocks for the month. Strong first quarter corporate profits supported the equity market spurt and made the sharp February-March sell-off appear as a mirage on the horizon. The Economy Growth of 2% or so appears to be the likely scenario for the first half of the year. The preliminary Gross Domestic Product report for the first quarter, released April 27 showed the economy expanding at 1.3%, its slowest pace since March, 2003. Besides housing, other drags on output were slowing business investment and exports and a run-off in inventories (which detracts from overall current output). This forecast is not so slow as to cause the Fed to prime the pump by easing, but it could dampen demand-induced price pressures. Housing remained weak as new home sales rose a less than expected 2.6% in March following a drop in February. The annual rate of existing home sales also fell by 8.4% in April. The National Association of Home Builders projected that the number of houses started by builders would fall to a 10-year low in 2007 as the industry works to sell down its inventory. Consumer spending ticked higher after a very weak January, with March retail sales (reported April 16) up 0.7 %. Auto sales and consumer confidence remain at levels consistent with moderate growth, while personal income has recently shown some strength, as it rose 0.7% in March and stood 5.7% over a year ago. City of Dublin - Investment Program Review 33 3l.4Gb ~ Investment Advisors to the Public Sector The labor markets delivered a mixed message as the April employment report recorded only 88,000 new jobs, the lowest level in two years. In contrast unemployment remains low at 4.5%, up from 4.4% in March. Manufacturing strengthened with Durable Goods orders reported up 3.4% in March, nearly 1.0% above the level economists had projected. The Institute for Supply Management factory index rose to 54.7, signifying renewed growth after several months oflackluster activity. Inflation remained the "predominant concern" of Fed policy makers according to minutes of the deliberations released in mid-April. Core consumer price inflation is now running 2.5% above the year earlier levels and other measures that exclude food and energy persist above the Fed's stated comfort range of 1-2%. A rebound in energy and commodity prices in April added to concerns. Outlook Much of the market remains at odds with the Fed's apparent policy. Intermediate-term interest rates reflect a strong belief that the Fed will soon cut the overnight rate, but Fed governors' speeches and minutes of recent FOMC meetings suggest otherwise. Rather the Fed is likely to maintain the current policy stance until inflation recedes. Economic growth at the rate of 2-2.5% for the balance of the year is not likely in and of itself to result in easing. Further economic weakness or marked declines in core inflation would seem to be the predicate for such a step, while a strengthening economy without signs of milder inflation could actually bring back talk of further tightening. Interest Rates As discussed above, there remains a high degree of uncertainty regarding the continued strength of the economy and the timing and direction of the Fed's next interest rate changes. The following chart is based on a Bloomberg survey of investment firms regarding the forecasts for Federal Funds Rate through September 2008. While most firms felt that the Fed would be cutting interest rates by the end of 2007, there was a wide range of forecasts among the firms. City of Dublin - Investment Program Review 34 Investment Advisors to the Public Sector ~ 7>>bcy6 ~ Bloomberg Survey Federal Funds Forecasts and Meeting Dates as of April 2007 6.00% 5.50% 5.00% 4.50% 4.00% 3.50% Mar Jun 07 07 Sep 07 Dee 07 Mar 08 Jun 08 Sep 08 While intermediate-term interest rates are down from their June 2006 highs they remain above their 10-year historical averages. 2-Year u.S. Treasury Yield May 1997 to May 2007 8% 5% I 1 I 1 1 1 I I - - --t - -- - - - -1- - --t - - -1-- - -- t-- - -1- - -1- - - I I I 1 I I 1 1 --t----t- --t----t---I----t------ ---1- 4.67%a5 1 I I 1 I 1 I of 5/4/07 1.. _ _ .J _ _ _1_ _ _ L _ _ _1_ __ 1 1 I I 1 Average: 4.15% 7% 6% 4% 1% I 1 I I I --~--~-- ~--~--- 1 1 I 1 1 I 1 --+--~---~--+--~ --4--~--- Iii I 1 I I 1 --L-- ---L--L--J---L--L-~~-- ___ I i I I I 1 1 I I 1 1 1 I 1 1 3% 2% 0% May May May 97 98 99 Source: Bloomberg May 00 May 01 May 02 May 03 May 04 May 05 May 06 May 07 Overall, the yield curve remains sharply inverted with short-term investments out yielding longer-term investments. City of Dublin - Investment Program Review 35 Investment Advisors to the Public Sector 5.40% 5.20% 5.00% 'tl a; >= 4.80% 4.60% 4.40% u.s. Treasury Yield Curves May 4, 2006 VS. March 30, 2007 VS. May 4, 2007 . . . ,. .... ................................. .... .................................. ...--. ....... . . , ., ... May ~. 20~ . . . . . . .................................................. . . , , . . . , . . . . .'. . . . . . . to- . . . . . . . . . . . . . ~ . . . . . . .'. . . . . . .'. . . . . . . to- . . . . . . . . . . . . . .'. . . . . . . . , . . . . . . . MaY,4. 2007 ....J-...,.. , , ............. , , , , , I ' ,..... . . . ,. . . . . , . . . . . . , . . . . ..:- . ...;... -. ..:.. .. .. .:. .. . . ..;.. ... :......,...,.. 'I : : : : March 30. 2007 : . . . . . . . . . . , . . . . ... ............................_.... ......-................1 May 4. 2007 I March 30.2007 I'" May 4. 2006 . 3m 6m 1yr 2yr 3yr 5yr Maturity Source: Bloomberg City of Dublin - Investment Program Review 10yr 3~~~< 36 Investment Advisors to the Public Sector 3tft~ q1 VIII. PORTFOLIO STRATEGY This section is a discussion of the factors that the City should consider as part of developing and implementing a long-term strategy for the City's portfolio. In the first part ofthe section, we will review strategy concepts and in the second part of the section we will describe how the long-term strategy could be implemented given current and expected market conditions. The portfolio strategy discussion in this section is intended to apply to the City's general funds and reserves. While the basic concepts can be applied to other types of funds, certain funds, such as bond proceeds or impact fees may have additional investment criteria that determine how the funds are managed. Investment Management Approaches There are two basic portfolio management approaches: passive and active. A passive management approach is where a portfolio manager will purchase investments based on a set of criteria then will hold those investment to maturity. In contrast, an active portfolio manager will buy and sell investments from the portfolio in response to changing market conditions and cash flow requirements to improve returns and manage the portfolio's risks profile. Like many other public agencies, the City employs a "passive" investment approach. Using funds from maturities, calls or additional revenues, the City routinely invests in a combination of individual securities and pooled funds (LAIF and money market funds) based on its assessment of current market conditions and anticipated liquidity requirements. Investments are made with the intention that each security will be held to maturity. While an active management approach can provide greater opportunity to increase returns and manage risks, an active management style is more complex and requires more of the portfolio manager to be effective. The advantage of passive strategy is that it reduces the staff time, investment expertise and resources needed to manage a portfolio on an ongoing basis. Our comments in the remainder of this section are based on the assumption that the City will continue to employ a passive management approach. Given the City's available resources, a passive management approach represents a prudent investment approach. If implemented in a disciplined manner, this approach should continue to work well for the City. Long-term Investment Strategy There is no one best investment strategy that will perform best in all market conditions or that represents the best balance between risk and return for all public agencies. However, we believe that a well thought out long-term investment strategy applied in a disciplined manner is the best way for the City to achieve its long-term investment objectives. While the portfolio has been reasonably safe and appears to have provided reasonable performance over time, we believe the portfolio's performance and risk profile could be improved through the consistent implementation of a long-term investment strategy. In our City of Dublin - Investment Program Review 37 Investment Advisors to the Public Sector L1D~ qg ~ review of the portfolio, we noticed wider variations in the portfolio's average maturity and allocation between short-term and core funds than we would normally expect in a similar sized municipal portfolio. In addition, while the portfolio credit quality is very high, the portfolio's exposure to call risk and the interest rate risk of individual securities was also higher than what we might normally recommend. These factors suggest that the management of the City's portfolio could benefit through a consistent long-term investment strategy. The first step in developing a long-term investment strategy is for the City to clearly define its objectives for the portfolio. Government Code (Section 53600.5) indicates that Safety, Liquidity and Yield, in that order, are the primary investment objectives for California public agencies. For its own portfolio, the City will need to determine what it considers to be appropriate levels of safety, liquidity and yield, along with its other investment objectives. The following are some of the parameters that the City could use to help develop a long-term strategy for its portfolio: · Liqudity Requirements. The City should define what portion of its overall portfolio needs to be kept liquid and what portion of the portfolio represents core funds that could be invested for an extended period. · Target Duration. A portfolio's duration is the primary determinant of its performance and interest rate risk over time. The City should select a target duration for its core portfolio that reflects its risk-return preferences. · Sector Allocation. Diversification among sectors and issuers is considered a prudent approach to managing a portfolios's risk. A well-diversified portfolio limits the portfolio's exposure to anyone source of risk. We would recommend the City look for opportunities to further diversify its portfolio. · Relative Value. Rather than focusing simply on yield, we would encourage the City to evaluate its investment choices based on the relative value of different investment choices. A well thought out long-term investment stratgey will provide a framework to guide investment decisions and ensure the portfolio is managed in a manner consistent with the City's investment objectives. Liquidity Requirements. The City should always ensure that it has sufficient funds available to meet its reasonably expected cash flow requirements. However, by maintaining excess liquidity, the City reduces the potential long-term return on its portfolio. While in the current market, with an inverted yield curve, shorter-term investments are currently out-yielding longer-term investments; longer-term investments have historically provided higher average returns over time. As noted in the core portfolio analysis section, the City's allocation to short-term investments is higher than would appear to be necessary. The base case run (0% growth, 20% liquidity cushion) of the model identified a core balance of approximately $91.1 million compared to only $61.2 million that was invested in securities with a final 'maturity greater than one year, City of Dublin - Investment Program Review 38 Investment Advisors to the Public Sector L4-( Db ~<<' as of March 31, 2007. We recommend the City revaluate its liquidity requirements to determine an appropriate allocation for short- and longer-term funds with the objective of reducing excess liquidity in the portfolio over time. Target Duration. Setting the target duration of the portfolio is a critical element of any investment plan, as duration is the single greatest determinant of a portfolio's expected rate of return and volatility. For this reason, it is important to carefully consider the impact of duration when developing the investment strategy. While a certain portion of the portfolio will always need to be maintained in short-term investments to provide needed liquidity, the core portion of the portfolio represents funds that could be invested for an indeterminate period. For these funds, the City should select a target duration that best reflects the City's risk-return preferences. The following chart illustrates historical returns for selected Merrill Lynch Total Return indices over the past ten years ending March 31, 2007. On an absolute basis, as a portfolio's duration increases, its expected return and interest rate risk also increase. Source: Bloomberg-Merrill Lynch Indices While longer-term portfolios have historically provided higher average returns, they also have greater interest rate risk and return volatility. As a practical matter, a more volatile investment strategy could result in larger market value fluctuations and larger realized losses if a security needed to be liquidated during a period of increasing rates. The following chart illustrates the difference in total return volatility for three of the indices. City of Dublin - Investment Program Review 39 Investment Advisors to the Public Sector ~€b q~ Annualized Quarterly Returns 1 0 Years Ending March 31, 2007 c 25% r ... :::l ... Q) D:: ni ... o ~ " 5% Q) .!::! ni :::l s:: s:: <C -5% -LAIF 15% -1-3 Year Treasury Index - 3-5 Year Treasury Index Source: Merrill Lynch Global Indices -15% ,..... 0> o N 00 0> o N 0> 0> o N o o o N ..- o o N N o o N ('I) o o N "'" o o N I.C) o o N <0 o o N There is no one target duration that is the best for all portfolio's or municipalities. We recommend that the City determine what it considers appropriate target duration for the portfolio based on its own requirements and risk-return preference. As a starting point, many of the municipalities we work with use the Merrill Lynch 1-3 Year U.S. Treasury Index (approximately 1.6 years) as their target duration. Over time, a portfolio managed to this index should provide higher returns than LAIF with less interest rate risk than a longer-term portfolio. Once the City has selected a target duration for its portfolio, the City can improve returns and manage risk by how it manages the portfolio's duration. As illustrated in the chart below, the basic concept is that the City should try to maintain the portfolio's duration within a band of 20% +/- of its target duration. In a rising interest rate environment, allowing the portfolio's duration to drift shorter relative to its target duration can reduce the portfolio's interest rate risk and market value depreciation. Conversely, in a falling interest rate environment, lengthening the portfolio's duration relative to its target duration can help lock in attractive yields and capture additional market value. appreciation. City of Dublin - Investment Program Review 40 Investment Advisors to the Public Sector tf~'1~ ~ .;: =- .... s:: ell 0 ~.. (I) E 1:>>= EO (1)- > ~ Upper Limit Target Expect Higher Rates Lower Limit Time While managing the portfolio's duration can help improve returns and control risks, the wider a portfolio's duration varies from its target duration, the greater the likelihood that the portfolio's performance will deviate from its desired level of risk and return over time. When we analyzed the portfolio's average maturity, used as a proxy for duration, ofthe non-pooled portion of the City's portfolio, we noticed that it varied considerably over time from between 1.30 years and 3.40 years with an average maturity of2.58 years. Sector Allocation. Currently, the non-pool portion of the City's investment portfolio is invested entirely in the Federal Agency sector. While the overall portfolio also contains investments in LAIF and money market funds, we encourage the City to further diversify the portfolio, as a prudent investment strategy. Although actual market conditions should determine individual investment choices, having informal sector targets can help encourage portfolio diversification. While U.S. Treasury securities typically offer a lower yield than comparable maturity Federal Agency securities, the addition of U.S. Treasury securities to the portfolio would contribute to the portfolio's overall objectives of safety and liquidity. Accordingly, we recommend that over time the City gradually add some (10-25%) U.S. Treasury securities to the portfolio, because (i) it would improve portfolio diversification - a prudent portfolio management concept, (ii) U.S. Treasury Securities are the safest, most liquid investments, and (iii) the potential that some kind of geo-political action, corporate debacle, or stock market meltdown would result in a "flight to quality" that strongly favors performance of the Treasury sector. The City should monitor the spread (yield difference) between the U.S. Treasury and Federal Agency sector. U.S. Treasuries should be added to the portfolio when the spread is relatively narrow. As they are currently permitted under the Policy, the City may also want to consider utilizing commercial paper, bankers' acceptances and negotiable certificates as deposit, when appropriate given market conditions. These securities types can be a useful component of a diversified portfolio and, if used appropriately, can safely increase a portfolio's return. City of Dublin - Investment Program Review 41 Investment Advisors to the Public Sector l.1 ~ Ub &t~ However, before the City adds any corporate securities to its portfolio, we recommend the City evaluate its ability to analyze and monitor corporate credit quality on an on-going basis. While corporate securities are a useful investment option, public agencies have encountered problems in the past when they have either failed to pay attention to a security's fundamentals or failed to closely monitor the corporate sector. Without this commitment to carefully evaluate and monitor its corporate credits, we would recommend the City remove corporate securities from its list of permitted investments. Relative Value. The concept of relative value is a tool that the City can use to help with its investment decision. While the liquidity requirements, sector allocation and target duration concepts described above relate to how the overall portfolio is managed, the concept of relative value relates to the selection of individual securities. Although the long-term investment strategy should drive investment decisions, there is generally more than one investment option that would be suitable at any point in time. Selecting securities by yield alone will not always result in the best overall investment selection; it can also result in taking on more risk in a portfolio than is consistent with the portfolio's overall objectives. The basic idea with relative value is to select the security that offers the best combination of risk and return among the available options. Maturity. In a normal upwardly-sloping yield curve environment, the longer the maturity of a security the higher its yield. However, the longer the maturity (duration) of a security the greater its interest rate risk. For example, during the quarter ending June 30, 2004, the City purchased $31.0 million (par) of Federal Agency securities in the following maturity ranges: 0-1 Years 1-2 Years 2-3 Years 3-4 Years 4-5 Years While the longer-term securities offered higher yields, the added yield may not have adequately compensated the City for the additional interest rate risk. For example, at the time, buying a 2-Year U.S. Treasury provided an additional 61 basis points (0.61%) in yield compared to a I-Year U.S. Treasury. However, buying a 4-Year U.S. Treasury compared to a 3-year U.S. Treasury only provided 33 basis points (0.33%) in additional yield for the same incremental increase in maturity. On a relative basis, the 2- Y ear security offered more value for the risk. City of Dublin - Investment Program Review 42 4-'5. Db it t Investment Advisors to the Public Sector 3-Mo. 1-Yr. 2-Yr. 3-Yr. 4-Yr. 5-Yr. 1 Source: u.s. Treasury Department While the longer-term investment offered less relative value, they may still have been the better investment option if they better suited the City's investment objectives for the portfolio's target duration or portfolio structure. The key point is that yield alone does not provide the best basis for making decisions. The City should carefully evaluate each investment decision to make sure it is consistent with its long-term strategy and that it offers good value relative to its other investment options. Sector Spreads. As part of a diversified portfolio, we recommended that the City consider adding U.S. Treasury securities or other sectors to its portfolio. However, just as the risk-return relationship varies along the yield curve, the risk-return relationship will also vary between investment sectors. As part of its investment decision making process, the City should look to allocate securities among the different sectors based on which sector offers the best relative value at the time. For example, over time the yield spread (difference) between U.S. Treasury and Federal Agency securities may be as wide as 50 basis points (0.50%) and as narrow as 5 basis points (0.05%) for different maturities. The following charts illustrate fluctuating yield spreads between a 2-year U.S. Treasury and a 2-Year non-callable Federal Agency security over the past year. City of Dublin - Investment Program Review 43 lflD Ub tf ~ Investment Advisors to the Public Sector 2-Year Federal Agency vs. 2- Year U.S. Treasury March 31, 2006 - March 31, 2007 5.8 - Two Year Treasury 5.6 - Two Year Agency 5.4 5.2 5.0 4.8 4.6 4.4 4.2 Mar 06 May 06 Jul06 Sep 06 Jan 07 Mar 07 Nov 06 Yield Spread 2-Year Federal Agency vs. 2- Year U.S. Treasury March 31. 2006 - March 31, 2007 40 30 20 10 Mar 06 j- Nov 06 I Jan 07 I Mar 07 May 06 Jul06 Sep 06 Consistent with its overall investment strategy, the City should look to add U.S. Treasury securities to its portfolio when yield spreads are narrow and emphasize Federal Agency securities when yield spreads are wide. Callable Securities. Evaluating whether the price of a callable security is fair is significantly more complicated than evaluating the fairness of prices of other types of securities. It is imperative to understand the value of the underlying imbedded option in order to properly evaluate whether a particular callable is offered at fair value. This involves the Option Adjusted Spread ("OAS") analysis, shown below. The OAS, which is available on Bloomberg, measures the yield spread of a fixed income instrument that is not attributable to imbedded options. Even though they appear to offer higher yields than "bullet" (non-callable) maturity structures, many callable structures are offered at ridiculously expensive valuations. These "expensive" issues have total return profiles City of Dublin - Investment Program Review 44 Investment Advisors to the Public Sector t-tl~qr; which will significantly under-perform appropriately valued non-callable Agency securities. Sample Bloomberg OAS Screen OPTION-ADJUSTED SPREAD ANALYSIS FNMA MEO TERM NT FNNT 5.55 11/03 alculate I Price IOAS (bPllvolatilityl (P, 0, Vl Iii Pl 1l1_:I.'Illrl. .. OJ ~.. Vl IEIIiIil Option Value: 0.07 (2 BPl I , I @ II OAS 0 a II on To Method 11/17/2000 Mty Yld - .-w Sprd .. M Dur 2.90 0.38 3.02 Risk 2.77 0.35 2.88 Cnvx -0.05 0.00 0.11 Model U! L=Lognormal Assumptions B=Black-Derman-Toy N=Normal Mean Reverting R=Lognormal w/Mean Rev Exercise Premium I II p~~ on :609-279-3000 L ':inga:~~!~92041g~~2~g9'7~~~-6000TO~~~~~:B9DD Suo Paulo: 11-3048=4500 1778-421-0 21h1un-OO 14'33'DD Callable securities are a useful component of an overall strategy. However, we encourage the City to carefully evaluate its purchases of callable securities to ensure that it is receiving appropriate compensation in the form of additional yield and that the total level of call risk in the portfolio does not detract from the City's overall investment strategy. Investment Strategy Recommendations In the first part of this section, we discussed some of the parameters we think that the City should consider as part of developing a long-term strategy for the portfolio. In this second part of the section, we will look at the implementation of a long-term investment strategy in the context of current market conditions. As market conditions are subject to change, the City should continually evaluate current market conditions and the impact on its investment decisions. As discussed in the market review section, there is currently a high degree of uncertainty regarding the future strength of the economy and the timing and direction of the Fed's next interest rate change. While many economists expect the economy to slow moderately in future quarters, the Fed remains focused on inflationary pressures. In the near-term, it appears that the Federal Reserve is likely to leave interest rates unchanged. Until there is a significant change in the economy or a clearer indication of the Fed's next move, intermediate-term interest rates are likely to remain volatile within a general trading range. Short-term portfolio. The primary objective with a short-term portfolio is to safely optimize the return among available investment options while providing needed liquidity. The City City of Dublin - Investment Program Review 45 Investment Advisors to the Public Sector 11~ Ob.tt1 should continue to evaluate the relative yields of its available short-term investment alternatives, including LAIF, money market funds and open market securities. Currently, LAIF is likely to be the best investment alternative for the City's short-term funds. However, when interest rates were trending higher between 2003 and 2006, it was often possible to pick up additional return compared to LAIF by investing in short-term Federal Agency Discount Notes or commercial paper, because the LAIF apportionment rate will tend to lag current interest rates. However, as interest rates have been in the same general treading range for the past nine months, there has been less opportunity to out-yield LAIF by investing in other short-term securities. For example, as of May 10,2007, LAIF's quarter-to-date yield was 5.23% with a daily yield of 5.24%. For comparison, 1- to 3-month Federal Agency Discount Notes were yielding between 5.13% and 5.17%. The rates for 1- to 3-month commercial paper rates were slightly higher ranging between 5.25% and 5.27%. While commercial paper rates were slightly higher than LAIF, the relative difference is not compelling considering the additional credit risk associated with commercial paper. Core Portfolio. Unlike short-term funds, the core portfolio should have a longer-term focus. More than simply maximizing current yield, the core portfolio should be managed in a manner that builds long-term value. While it is important to carry out the overall strategy for the portfolio in a consistent and disciplined manner, tactical decisions for the portfolio can and should consider current and expected market conditions. In the current market, there are two market elements that have been strongly influencing our tactical investment decisions: the inverted yield curve and the market's uncertainty about future interest rate levels. Currently, the yield curve is sharply inverted with short-term securities out-yielding longer-term investments. From a yield basis, short-term investments currently offer a better value. However, short-term investments are more vulnerable to a decline in interest rates, which could hurt the portfolio's long-term performance. While there is a high degree of uncertainty regarding near-term interest rates, the market's expectation is that interest rates will fall over the longer-term. Given current market conditions, we recommend that the City try to maintain the portfolio's duration near, but slightly short of, its target duration. While short-term rates are currently higher than longer-term rates, investing only in short-term investments could expose the portfolio to a decline in rates and could hurt the portfolio's long-term return. For new intermediate-term investments, we recommend the City emphasize securities in the 3-year and under maturity range. We do not believe that longer-term securities currently represent good value relative to their additional interest rate risk. The following chart compares the current U.S. Treasury yield curve (blue line) to the 10-year trading range (grey vertical lines) and the 10-year average (red diamonds) for different maturity U.S. Treasuries. While shorter-term yields are currently well above their historical averages, longer-term rates are at or below their historical averages. City of Dublin - Investment Program Review 46 Investment Advisors to the Public Sector ~ Tb 1~' u.s. Treasury Yields Ten Years Ended May 4, 2007 8% 7% 6% 5% 'C Qj 4% >= 3% 2% 1% 0% - Current Yield Curve I 10-Year Trading Range ------------------- . AverageYield 1 2 3 5 10 30 Maturity (Years) As interest rates have been somewhat volatile, within a general range, we recommend that the City monitor the market and purchase any new intermediate-term investments when interest rates are at favorable points of the recent trading range. The following chart shows how interest rates have been trading within a general trading range over the past 9-months. 2-Year u.s. Treasury Yields May 1, 2006 - May 11, 2007 5.50% Nov Dee Jan 06 06 07 5.25% 5.00% 4.75% 4.50% 4.25% May 06 06 Source: Bloomberg City of Dublin - Investment Program Review 47 Investment Advisors to the Public Sector 51)00 qg Given the market's expectation that interest rates will decline over the next year or two, we recommend the City emphasize non-callable investments. If rates were to decline significantly, a high percentage of the City's portfolio could be called, which could result in the City having to reinvest those funds in a lower interest rate environment. For those callable securities the City does purchase, we recommend that they offer good call protection to minimize the City's exposure to call risk. We noticed that two callable securities purchased by the City in the first quarter of 2007 were both one-time calls. As a long-term goal, we recommended that the City further diversify the portfolio by adding U.S. Treasury securities. However, as the yield spread (the yield difference between securities with the same maturity) between Federal Agency and U.S. Treasury securities has widened recently, we recommend that the City waits until the yield spread narrows somewhat before adding U.S. Treasury securities. The following chart is a Bloomberg screen showing the yields on 2-year Federal Agency and U.S. Treasury securities and the yield spread over time. 2-Year Federal Agency Yield versus 2-Year U.S. Treasury Yield May 15, 2006 VS. May 14, 2007 '1:1 co ~ a. en '1:1 Qi >= Urt ~ Mean .25 Off Avg - .OJ Medi"n. .26 Stl)ev .04 Off Avg Stl)ev -.64 Percentile 29.89 High (07114/06) .33 low (11127106) .16 Sell Data Page II 19 HS - Historical Spread 111II '--_I SPREAD SUMMARY OCCURRENCES Source: Bloomberg While we believe the investment strategy recommendations outlined above have the potential to help the City add value and manage investment risks, they should be considered within the context of the City's overall investment objectives, staff time, and available resources. We strongly suggest that any changes to the portfolio be implemented gradually over time. Optimizing a portfolio of this magnitude is not an overnight process, but rather a series of steps that make improvements in a prudent and timely manner. We would be pleased to further discuss alternative investment options with the City. City of Dublin - Investment Program Review 48 Investment Advisors to the Public Sector 5l6b'if! IX. POTENTIAL SUPPLEMENTAL RESOURCES As part of our program review, we were asked to assess whether or not the City's investment program would benefit with the allocation of additional resources. While City Staff has done a good job managing the current portfolio, we believe that from our discussions with City Staff, that City resources seemed to be stretched. When compared to other public agencies with similar sized portfolios, we believe that additional resources are needed to enhance the City's management of its investments. Portfolio Accounting System A system to track the investment portfolio and facilitate investment reporting and analysis is a necessary element of managing investments. Based on our discussions with City Staff, we understand that the City is currently using excel for this purpose. While excel is a useful tool, it has significant limitations as a portfolio accounting system. Given the size and complexity of the City's portfolio and best practices for reporting, we recommend the City consider acquisition of specialized software that can assist with portfolio reporting, tracking and analysis. At a minimum, the system should be able to provide basic information about portfolio holdings, average returns, projected interest earnings and scheduled maturities along with information required for the City's investment reporting purposes. There are a number of portfolio accounting systems available across a wide price range. It is our understanding from City Staff that they plan to implement a leased software solution from a vendor that supports many public agencies including several with portfolios in the same range as the City. Sources of Market Data To help enhance the management of its portfolio, the City should also consider improving its access to current market information. There are a number of sources available. The best choice for the City will depend on: · Portfolio composition, · Technical capabilities of the investment staff, · Trading strategy, and · Budget. The following list highlights some of the sources of market data typically used by governmental entities. · Broker/Dealers. We understand that the City's brokers are the sources of most of the City's current market data. Brokers and dealers can be a good source of market information, especially those that make a market in a particular security. One of the best ways to determine the value of a security is to find out what an interested party would pay City of Dublin - Investment Program Review 49 Investment Advisors to the Public Sector S)~~g for it. However, the City should be cautious of any conflict of interest the broker may have. . The Internet. There are a wide range of websites offering market data, such as Bloomberg.com, the Wall Street Journal online (online.wsi.com) and the U.S. Treasury Department (www.treas.gov). The benefit of these websites is that they provide easy access to economic and market data. However, the range, timeliness and cost of the data varies widely. Furthermore, the sites currently available do not provide the same depth of information or the analytical tools available on a Bloomberg terminal. · Dow Jones Telerate. One widely used product in the financial markets is Telerate. This is an on-line, interactive workstation containing market pricing, news and commentary. It provides accurate, current market pricing. One of the benefits of the Telerate product is its flexibility. The subscriber can easily customize pages to meet specific investment needs. However, it does not provide the depth of analytical tools available on a Bloomberg terminal. . Bloomberg Financial System. Bloomberg is arguably the most complete and accurate source of financial data and news available today. It provides current market rates on virtually every publicly traded security, sophisticated analytics, and communication links which have become the industry standard. Most portfolio managers find it indispensable. Some of the ways that Bloomberg Financial System could aid the City in making investment decisions is by (1) recognizing optimal times to purchase securities, (2) access to broker inventories, (3) independent pricing of securities, (4) analytics to compare securities, and (5) identifying alternative securities to those shown by broker-dealers. It is the Mercedes Benz of the financial information/analytic tools and priced accordingly. If the City plans to invest in corporate securities, we would also recommend the City utilize a Credit Service. The City will need to verify the credit standing of trading partners, repo counterparties and security issuers not only at the time the security is purchased but for the life of the issue as well. Most institutional investors subscribe to credit services provided by one of the large national credit rating organizations; Standard & Poor's, Moody's or Fitch. The fees vary based on the scope of information required. Another option the City may want to consider as a method of enhancing the management of its investment portfolio is through the use of a professional investment advisor. Using an external investment advisor can help increase returns and manage the inherent risks of the investment process. For the City's information, we attached a white paper in Appendix D, that we prepared, that describes the factors to consider in the outsourcing of the investment management function. City of Dublin - Investment Program Review 50 Investment Advisors to the Public Sector ?3Db tt-t ApPENDIX A SAMPLE STATEMENT OF INVESTMENT POLICY FOR THE CITY OF DUBLIN I. POLICY The purpose of this document is to identify various policies and procedures that enhance opportunities for a prudent and systematic investment policy. This document also serves to organize and formulize investment related activities. II. SCOPE It is intended that this policy cover all funds and investment activities under the direct authority of the City of Dublin, as set forth in the California Government Code, sections 53601 et seq. Cash held by the City shall be pooled in order to more effectively manage City cash resources. All pooled funds are accounted for in the City's Comprehensive Annual Financial Report and include: Funds General Fund Special Revenue Fund Capital Project Funds Internal Service Funds Enterprise Funds Agency Funds III. OBJECTIVES The overall program shall be designed and managed with a degree of professionalism worthy ofthe public trust. The primary objectives, in order of priority, of the City's investment activities shall be: 1) Safety. Safety of principal is the foremost objective of the investment program. The City's investments shall be undertaken in a manner that seeks to safeguard the principal of the funds under its control by maintaining an appropriate risk level. 2) Liquidity. The City's investment portfolio will remain sufficiently liquid to enable the City to meet its reasonably anticipated cash flow requirements. 3) Yield. Yield should become a consideration only after the basic requirements of safety and liquidity have been met. The City seeks to attain a market average rate of City of Dublin - Investment Program Review A-I Investment Advisors to the Public Sector ~..tfoo ~ return on its investments throughout economic cycles, consistent with constraints imposed by its safety objectives and cash flow considerations. IV. DELEGATION OF AUTHORITY As authorized in Government Code Section 53607, The Council delegates its authority to invest funds of the City for a one-year period to the City Treasurer and/or any duly appointed Deputy City Treasurer who shall thereafter assume full responsibility for those transactions until the delegation of authority is revoked or expires. Subject to review, the Council may renew the delegation of authority each year. The City Treasurer and/or any duly appointed Deputy City Treasurer shall make all investment decisions and transactions in strict accordance with state law and this investment policy. The Adminiustrative Services Director shall be designated as the City Treasurer and the City Manager and/or Finance Manager shall be designated as the Deputy City Treasurer. The City recognizes that in a diversified portfolio, occasional measured losses may be inevitable and must be considered within the context of the portfolio's overall return and the cash flow requirements of the City. Authorized individuals acting in accordance with written procedures and the investment policy, and exercising due diligence, shall be relieved of personal responsibility for an individual security's credit risk or market price changes, provided deviations from expectations are reported in a timely fashion and appropriate action is taken to control adverse developments. V. PRUDENCE Pursuant to Government Code Section 53600.3, all persons authorized to make investment decisions on behalf of the City are trustees and, therefore, fiduciaries subject to the prudent investor standard: "When investing, reinvesting, purchasing, acquiring, exchanging, selling, or managing public funds, a trustee shall act with care, skill, prudence, and diligence under the circumstances then prevailing, including, but not limited to, the general economic conditions and the anticipated needs ofthe agency, that a prudent person acting in a like capacity and familiarity with those matters would use in the conduct of funds of a like character and with like aims, to safeguard the principal and maintain the liquidity needs of the agency." VI. ETHICS AND CONFLICTS OF INTEREST All participants in the investment process shall act as custodians of the public trust. Investment officials shall recognize that the investment portfolio is subject to public review and evaluation. The overall program shall be designed and managed with a degree of professionalism that is worthy of the public trust. Thus, employees and officials involved in the investment process shall refrain from personal business activity that conflicts with proper execution of the investment program, or impairs their ability to make impartial investment decisions. Additionally, the City Treasurer and the Deputy City of Dublin - Investment Program Review A-2 ?:SUbet~ Investment Advisors to the Public Sector Treasurer shall file applicable financial disclosures as required by the Fair Political Practices Commission (FPPC). VII. INTERNAL CONTROLS The Treasurer is responsible for establishing and maintaining an internal control structure designed to ensure that the assets of the entity are protected from loss, theft or misuse. The internal control structure shall be designed to provide reasonable assurance that these objectives are met. The concept of reasonable assurance recognizes that (1) the cost of a control should not exceed the benefits likely to be derived; and (2) the valuation of costs and benefits requires estimates and judgements by management. Periodically, as deemed appropriate by City Management and/or the City Council, an independent analysis by an external auditor shall be conducted to review internal controls, account activity and compliance with policies and procedures. VIII. AUTHORIZED FINANCIAL DEALERS AND INSTITUTIONS The Treasurer shall seek to conduct the City's investment transactions using a competitive bid process whenever possible. It shall be the City's policy to purchase securities only from authorized institutions and firms. No deposit of public funds shall be made except in a qualified public depository as established by state laws. The Treasurer shall maintain a list of authorized broker/dealers and financial institutions which are approved for investment purposes. These may include primary or regional dealers that qualify under Securities & Exchange Commission Rule 15C3-1 (uniform net capital rule). The City requires each firm that will be used for the purchase or sale of securities to be evaluated by the Treasurer prior to any investments. The firms shall submit current financial statements, and annual audited financial statements each year thereafter, which are to be evaluated by the Treasurer. At a minimum, the firm must be financially sound and have been in business a minimum of three years. In addition, the firms must provide: proof of National Association of Security Dealers membership, proof of state registration or exemption, and certificate of having read the City's investment policy. IX. AUTHORIZED AND SUITABLE INVESTMENTS The City's investments are governed by Government Code, Sections 53600 et seq. Within the investments permitted by the Government Code, the City seeks to further restrict eligible investments to the investments listed below. In the event an apparent discrepancy is found between this Policy and the Government Code, the more restrictive parameters will take precedence. Percentage holding limits listed in this section apply at the time the security is purchased. Any investment currently held at the time the Policy is adopted which does not meet the new Policy guidelines can be held until maturity, and City of Dublin - Investment Program Review A-3 Investment Advisors to the Public Sector Sl#Jb ,~ shall be exempt from the current Policy. At the time of the investment's maturity or liquidation such funds shall be reinvested only as provided in the most current Policy. An appropriate risk level shall be maintained by primarily purchasing securities that are of high quality, liquid, and marketable. The portfolio shall be diversified by security type and institution to avoid incurring unreasonable and avoidable risks regarding specific security types or individual financial institutions. I. United States Treasury Issues. United States Treasury notes, bonds, bills, or certificates of indebtedness, or those for which the faith and credit of the United States are pledged for the payment of principal and interest. There is no limitation as to the percentage of the portfolio that may be invested in this category. 2. Federal Agency Obligations. Federal agency or United States government-sponsored enterprise obligations, participations, or other instruments, including those issued by or fully guaranteed as to principal and interest by federal agencies or United States government-sponsored enterprises. There is no limitation as to the percentage of the portfolio that may be invested in this category. However, the Treasurer should strive to limit the portfolio's exposure to anyone federal agency issuer to 40 percent of the overall portfolio and limit the portfolio's exposure to federal agency securities that are still callable to 25 percent of the overall portfolio. 4. Bankers' Acceptances. Bankers' acceptances, otherwise known as bills of exchange or time drafts, that are drawn on and accepted by a commercial bank. Bankers' acceptances must be secured by the irrevocable primary obligation of the accepting domestic bank. Purchasers are limited to issuers whose short-term debt is rated "A-I" or higher, or the equivalent, by a Nationally Recognized Statistical Rating Organization (NRSRO). Bankers' acceptances cannot exceed a maturity of 180 days. A maximum of 40 percent of the portfolio may be invested in this category. The amount invested in bankers' acceptances with anyone financial institution in combination with any other debt from that financial institution shall not exceed 20 percent of the overall portfolio. 5. Commercial Paper. Commercial paper of "prime" quality of the highest ranking or of the highest letter and number rating as provided for by a NRSRO. The entity that issues the commercial paper shall meet all of the following conditions in either paragraph (A) or paragraph (B): (A) The entity meets the following criteria: (i) Is organized and operating in the United States as a general corporation. (ii) Has total assets in excess of five hundred million dollars ($500,000,000). (iii) Has debt other than commercial paper, if any, that is rated "A" or higher by a nationally recognized statistical- rating organization. City of Dublin - Investment Program Review A-4 Investment Advisors to the Public Sector ~1ro ~~ (B) The entity meets the following criteria: (i) Is organized within the United States as a special purpose corporation, trust, or limited liability company. (ii) Has program wide credit enhancements including, but not limited to, over collateralization, letters of credit, or surety bond. (iii) Has commercial paper that is rated "A-I" or higher, or the equivalent, by a nationally recognized statistical-rating organization. Eligible commercial paper shall have a maximum maturity of 270 days or less and not represent more than 10 percent of the outstanding paper of an issuing corporation. A maximum of 25 percent of the portfolio may be invested in this category. The amount invested in commercial paper of anyone issuer in combination with any other debt from that issuer shall not exceed 20 percent of the overall portfolio. 6. Negotiable Certificates of Deposit. Negotiable Certificates of Deposit (NCDs) issued by a nationally- or state-chartered bank, a savings association or a federal association, a state or federal credit union, or by a state-licensed branch of a foreign bank. Purchases are limited to institutions which have long-term debt rated "AA" or better and/or have short-term debt rated at least "A-I" or higher, or the equivalent by a NRSRO. A maximum of30 percent of the portfolio may be invested in this category. The amount invested in NCDs with anyone financial institution in combination with any other debt from that financial institution shall not exceed 20 percent of the overall portfolio. 7. Time Certificates of Deposit. Time Certificates of Deposit (TCDs) placed with commercial banks and savings and loans. The purchase of TCDs from out-of-state banks or savings and loans is prohibited. The amount on deposit shall not exceed the shareholder's equity in the financial institution. To be eligible for purchase, the financial institution must have received a minimum overall satisfactory rating for meeting the credit needs of California Communities in its most recent evaluation, as provided Government Code Section 53635.2. TCDs are required to be collateralized as specified under Government Code Section 53630 et. seq. The Treasurer, at his discretion, may waive the collateralization requirements for any portion that is covered by federal insurance. The City shall have a signed agreement with the depository per Government Code Section 53649. TCDs may not exceed one (1) year in maturity. A maximum of 10 percent of the overall portfolio may be invested in this category. 9. Money Market Funds. Shares of beneficial interest issued by diversified management companies that are money market funds registered with the Securities and Exchange Commission under the Investment Company Act of 1940 (15 U.S.C. Sec. 80a-l and following). The company shall have met either of the following criteria: (A) Attained the highest ranking or the highest letter and numerical rating provided by not less than two NRSROs. (B) Retained an investment adviser registered or exempt from registration with the Securities and Exchange Commission with not less than five City of Dublin - Investment Program Review A-5 Investment Advisors to the Public Sector ~~Ib.~~ years' experience managing money. market mutual funds with assets under management in excess of five hundred million dollars ($500,000,000). A maximum of 20 percent of the overall portfolio may be invested in this category. For due diligence, the Treasurer shall maintain on file a copy of the current Prospectus for any mutual fund in which the City has funds invested. 10. State of California Local Agency Investment Fund (LAIF). A maximum of 75 percent of the portfolio, not to exceed the LAIF imposed limit, may be invested in this category. For due diligence, the Treasurer shall maintain on file a copy of LAIF's current Answer Book. 11. California Asset Management Program (CAMP). Shares of beneficial interest issued by a joint powers authority organized pursuant to Government Code Section 6509.7 that invests in the securities and obligations authorized in subdivisions (a) to (n), inclusive of to Government Code Section 53601. For due diligence, the Treasurer shall maintain on file a copy of CAMP's current Information Statement. There is no limitation as to the percentage of the portfolio that may be invested in this category. x. AUTHORIZED INVESTMENTS FOR BOND PROCEEDS Bond proceeds shall be invested in securities permitted by the applicable bond documents. If the bond documents are silent as to the permitted investments, bond proceeds will be invested in securities permitted by this Policy. Notwithstanding the provisions of Policy, the percentage or dollar portfolio limitations listed elsewhere in this Policy do not apply to bond proceeds. In addition to the securities listed in Section IX above, bond proceeds may be invested in structured investment products if approved by the Treasurer. XI. PROHIBITED INVESTMENT PRACTICES AND INSTRUMENTS The City shall not make investments for the purpose of trading or speculation as the dominant criterion such as anticipation of appreciation of capital value through changes in market rates. Securities are purchased with the intent to hold to maturity. Any investment in a security not specifically listed as an Authorized and Suitable Investment above, but otherwise permitted by the Government Code, is prohibited without the prior approval ofthe City Council. Section 53601.6 of the Government Code specifically disallows investments in inverse floaters, range notes, or interest-only strips that are derived from a pool of mortgages. City of Dublin - Investment Program Review A-6 PFl\f Investment Advisors to the Public Sector ?~ao'~ XII. TERM OF INVESTMENT Funds of the City will be invested in accordance with sound treasury management principles. It is the objective of this Policy to provide a system which will accurately monitor and forecast revenues and expenditures so that the City can invest funds to the fullest extent possible. The maximum maturity of individual investments shall not exceed the limits set forth under Authorized and Suitable Investments. With respect to bond reserve funds, the Policy authorizes investing beyond five years if prudent in the opinion of the Controller. Other than bond reserve funds, no investment shall exceed a maturity of five years from the date of purchase unless the Council has granted express authority to make that investment either specifically or as a part of an investment program approved by the Board no less than three months prior to the investment. XIII. SAFEKEEPING AND CUSTODY Investment securities are to be purchased when possible in book-entry form in the City's name. All security transactions entered into by the City shall be conducted on a delivery- versus-payment (DVP) basis. All cash and securities in the City's portfolio shall be held in safekeeping in the City's name by a third party bank trust department, acting as agent for the City under the terms of a custody agreement executed by the bank and the City. All investment transactions will require a safekeeping receipt or acknowledgment generated from the trade. A monthly report will be received by the City from the safekeeping institution listing all securities held in safekeeping with current market data and other information. The only exception to the foregoing shall be depository accounts and securities purchases made with: (i) local government investment pools; (ii) time certificates of deposit, and, (iii) money mutual funds, since the purchased securities are not deliverable. Term and non-negotiable instruments, such as certificates of deposit, can be held by the Treasurer, or in safekeeping as the Treasurer deems appropriate. XIV. PERFORMANCE BENCHMARK The Treasurer shall monitor and evaluate the portfolio's performance. A comparison of the portfolio's performance against a performance benchmark shall be included in the Treasurer's quarterly report. The Treasurer shall select an appropriate, readily available index to use as a performance benchmark. xv. REpORT INFORMATION The Treasurer shall submit a monthly report of transactions to the City Council. In addition, the Treasurer shall render a quarterly report to the City Council. The quarterly report will be submitted within thirty days following the end of the quarter covered by the report. At a minimum, the quarterly report shall include the following: City of Dublin - Investment Program Review A-7 Investment Advisors to the Public Sector (,otb .,g a) Type of investment b) Issuer c) Date of maturity d) Par and dollar amount invested e) Current market value as date of the report f) Source of market value information g) A list of investment transactions h) A statement of compliance with the investment policy i) A statement as to the ability of the City to meet its expenditure requirements for the next six months XVI. REVIEW OF INVESTMENT POLICY This policy shall be subject to review by the City Council on an annual basis, by the second Council meeting in June. Any recommended modifications shall be presented by Staff to the City Council for their consideration and adoption. City of Dublin - Investment Program Review A-8 Investment Advisors to the Public Sector ~(~ 1'$ ApPENDIX B LIQUIDITY FACTORS PFM assigned a liquidity factor to each security based on the type of security and a historical assessment of relative liquidity. For example, U.S. Treasuries would receive the highest liquidity factor of 1. The lowest liquidity factor of 10 is assigned to negotiated private placements, while a conventional corporate Medium Term Note is a 5. Listed below are liquidity factors assigned to various combinations of issuers and security types. Security Tvpe LiQuiditv Factor U.S. Treasuries 1 Pools and Mutual Funds 2 Federal Agencies Discount Notes 2 Coupon Issues >= $50 million 3 Coupon Issues < $50 million 4 Floating Rate Notes 5 Callable Notes 6 Structured Notes 8 Money Market Securities BAs, CDs, CP (A-lIP-I) 4 BAs, CDs, CP (A-21P-2) 5 Corporate Obligations Corporate Notes/Bonds 4 Medium- Term Notes (MTN) 5 Private Placements (144A) 6 Floating Rate Notes 6 Asset Backed Securities 6 Structured Notes 9 Municipal Securities 6 Reverse/Repurchase Agreements 6 Mortgage Backed Securities 7 Private Placements (Negotiated) 10 @ 2007 PFM Asset Management LLC City of Dublin - Investment Program Review B-1 Investment Advisors to the Public Sector ~'2'bq~ ApPENDIX C APT INVESTMENT POLICY STANDARDS. PFM uses the Association of Public Treasurers of the United States and Canada (APT) standards for Investment Policy Certification as one tool for evaluating investment policies. While it is not necessary to include all elements of the APT's model policy in every investment policy, the certification standards provide a useful benchmark for evaluating the comprehensiveness of an investment policy. The following chart compares the components of the APT model investment policy recommended with the elements found by PFM in the City's current investment policy. The APT is an association of treasurers and finance professionals from municipalities throughout the United States and Canada. Additional information on the APT and its model investment policy and certification standards can be found at its web site: www.aptusc.org. APT US&C Certification Standards Policy Scope Prudence Objectives Delegation of Authority . Investment Procedures Ethics and Conflicts of Interest Authorized Financial Dealers and Institutions Authorized and Suitable Investments Investment Pools/Mutual Funds Master Repurchase Agreements Collateralization Safekeeping and Custody Diversification Maximum Maturities Internal Control Performance Standards Reporting Investment Policy Adoption Glossary City of Dublin Yes Yes In Subsection Yes Yes Yes In Subsection Yes Partially No Not Applicable Yes Partially Yes Yes Yes No Yes Yes No (Not Recommended) City of Dublin - Investment Program Review C-l Investment Advisors to the Public Sector ~~oo <It~. ApPENDIX D F ACTORS TO CONSIDER IN THE OUTSOURCING OF THE INVESTMENT MANAGEMENT FUNCTION Introduction The purpose of this paper is to look at the factors a public agency should consider in deciding whether to outsource or to retain in-house the investment management of its operating and reserve funds. Outsourcing investment management is recognized as a viable and often beneficial approach for public agencies to use in managing their investments. Faced with the complexity and challenges of investing public funds, many governmental entities have turned to investment advisers to assist in the management of their operating funds. This trend accelerated in the mid-90's after the widely publicized losses by public sector investors. Since that time, tighter budgets and limited resources have encouraged public officials to turn to outside professionals to free up staff time for other responsibilities and to enhance investment returns. When evaluating whether to use an external investment advisor, a public agency should consider what level of portfolio management skills and resources are required to protect its assets and obtain the maximum benefit from its investments. Furthermore, the public agency should consider whether outsourcing or retaining portfolio management in-house would provide the best solution from a cost! benefit standpoint. Portfolio Complexity The first thing the public agency should consider in evaluating the use of an external investment manager is the complexity of its investment portfolio - that is, what level of portfolio management is needed to effectively manage its portfolio. For example, a simple portfolio requires very little in the way of portfolio management. Typically, the investment choices are few and there is less benefit to be derived in devoting significant resources to managing the portfolio. However, as the complexity of a portfolio increases, so too does the level of portfolio management expertise required to obtain the maximum benefit from the portfolio. With a more complex portfolio, a higher level of portfolio management expertise is needed to evaluate investment options, both to improve returns and to avoid the risks inherent in the investment process. There are three portfolio attributes we will review that contribute to a portfolio's complexity: 1) size, 2) permitted investments, and 3) management approach. The first attribute of a portfolio's complexity is the size ofthe portfolio. In general, the larger the portfolio, the greater the available investment options and the greater the potential economic benefit to be derived. For example, public agencies with small portfolios typically need to keep a larger percentage of. the portfolio liquid thereby limiting their ability to make longer-term investments. In addition, investment economies of scale make it more difficult to develop a diversified portfolio with a small portfolio. Both of these factors tend to limit the available City of Dublin - Investment Program Review D-l Investment Advisors to the Public Sector ~i.f~ 1~ investment options and the resulting complexity of a small portfolio. In many cases, public agencies with small portfolios will invest in short-term pooled investment programs, such as LAIF or money market mutual funds. In this manner, the public agency can keep its funds liquid and still receive the benefit of a professionally managed, diversified investment portfolio at a nominal cost. However, due to the short-term nature of these pools, they typically offer lower returns than what would be available through directly investing in longer-term securities. In contrast, public agencies with larger portfolios generally need to keep a smaller percentage of the portfolio liquid and have the option of investing a greater amount of their funds in higher yielding, longer-term securities, thereby increasing the potential yield on the portfolio. As the size of the portfolio increases, it is also more practical to make individual investments rather than simply investing in a pooled investment program. Both of these factors tend to increase both the range of investment options available to the public agency and the complexity of managing the portfolio. The economics of managing portfolios also makes it more cost effective to spend funds towards improving a larger portfolio's management. While a 10 basis point improvement in performance represents only a $10,000 per year gain for a $10 million portfolio, it represents a $100,000 potential gain for a $100 million portfolio. Consequently, a larger portfolio provides significantly more opportunities to enhance returns when compared with the return expected from using the LAIF or other short-term investment vehicles. The second attribute that contributes to a portfolio's complexity is the range of permitted investments available to the public agency. As the types of investments and maximum permitted maturities of a public agency's investments increase, so do the investment options. This increases not only the potential investment benefits and risks, it also increases the analytical skills needed to effectively manage the portfolio. In some states, public agencies are limited to only a few investment options, such as U.S. Treasuries or the state investment pool. In these states, the analytical demands on the portfolio manager are fairly limited with the choices relatively clear cut. In contrast, the California Government Code provides a much broader range of permitted investments, including U.S. Treasury and Federal Agency securities to a variety of corporate securities, including Bankers' Acceptances, Commercial Paper, Negotiable CDs and medium-term notes. Each of these investment types offers potential opportunities for increasing investment flexibility, reducing risk through diversification and enhancing portfolio returns. Given the broad range of available investments and their varying characteristics, an effective portfolio manager needs to be able to analyze the different options to determine which investment offers the best relative return at the given point in time. For example, if the portfolio manager was comparing an investment in a U.S. Treasury with an Agency mortgage backed security, he would need to consider among other factors: the difference in credit quality, the yield spread between the two securities and whether the spread represents a good value relative to historical standards and the spreads offered between other sectors. The portfolio manager would also need to consider the prepayment risk of the mortgage backed security and the potential impact on the portfolio. The analytical issues become even more complex when evaluating City of Dublin - Investment Program Review D-2 Investment Advisors to the Public Sector lb 5't #t~~ investments with different maturities, which require factoring in different exposures to interest rate risk and the volatility of returns to the analysis. The complexity and expertise required of a portfolio manager increases even more when corporate securities are included. While higher quality corporate securities can often offer attractive yields relative to their risk, they require additional attention to credit analysis both before purchase and on an ongoing basis. A third attribute that contributes to a portfolio's complexity is the style of portfolio management used. There are two basic approaches to portfolio management: passive and active. A passive management style is where a portfolio manager will purchase investments based on a set of criteria then will hold those investment to maturity. By its very nature, a passive style of portfolio management places fewer demands on the portfolio manager. In contrast, an active portfolio manager will buy and sell investments from the portfolio in response to changing market conditions and cash flow requirements to improve returns and manage the portfolio's risks profile. An active manager will look to add value through a variety of portfolio management strategies, including: . Duration Management . Yield Curve Placement . Sector Weighting . Issue Selection and Credit Quality . Monitoring Swap Opportunities While active management is sometimes associated with higher risk, it can be just the opposite as an active manager can sell investments in anticipation of deteriorating credit quality or interest rate changes that can lead to loss of value. Given the dynamic nature of the approach, an active management style is more complex and requires more of the portfolio manager to be effective. However, when well executed, an active management approach will generally provide greater opportunity to increase returns and manage risks. When considered in combination, the greater the size of a portfolio, the range of the permitted investments, and the use of active portfolio management strategies can substantially increase the complexity of managing a portfolio. While this complexity offers more opportunities to improve returns and manage portfolio risks, it also places more demands on the public agency's portfolio manager. External versus In-House Management When an investment portfolio demonstrates sufficient complexity to warrant a higher level of portfolio management attention in order to optimize the management of portfolio, the issue for City of Dublin - Investment Program Review D-3 Investment Advisors to the Public Sector L,{,1b 1~ the public agency to evaluate is: What is the best approach to obtain the needed skills and resources? A public agency can either manage the portfolio in-house or outsource the management of its investment portfolio. The following outlines the advantages and disadvantages of outsourcing the investment function. A cost comparison between the two approaches is also provided. External Management Outsourcing investment management is recognized as a viable and useful approach to managing a public agency's investments. Outsourcing allows the public agency to obtain experience and resources that are often difficult to duplicate in-house at a reasonable cost. In addition, outsourcing investment activities will often free up staff and management time to focus on other activities that are more core to the public agency's activities. The following is an excerpt from An Elected Official's Guide to Investing published by the Government Finance Officers Association (GFOA). "Investment advisers can provide a number of benefits to governments. F or example, investment advisers can provide access to capital markets that would otherwise be beyond the government's scope of expertise. Greater access to markets allows a government to diversify their portfolio holdings by investing in a broader range of instruments. In addition, some investment advisers have expertise in specific sectors of the market, such as Federal Agency discount notes, and can enhance returns by developing investment strategies to take advantage of market opportunities in those sectors. "Governments can enhance the credit quality of their portfolio by taking advantage of the investment adviser's access to credit research for unsecured debt instruments, such as commercial paper and bankers' acceptances. Governments utilizing the services of an investment adviser with discretionary authority can benefit from economies of scale as investment advisers often generate large investment transactions for a number of clients, which tend to be more cost-effective. "Further, some governments with limited resources to devote to the investment function use advisers to complement internal resources. In these situations, investment advisers manage either the entire portfolio or a portion of the portfolio. Using the services of an investment adviser can free up staff time to pursue other duties. Still other governments with limited staff may hire an investment adviser to increase internal controls. The use of an independent third party can help the government achieve a segregation of duties for the investment function." In evaluating the use of an investment advisor, a public agency should consider both the cost and the potential benefit. Independent investment advisors are typically paid a fee based on the amount of assets under management. These fees can vary considerably depending on the type of funds being managed, cash flow requirements., number and size of accounts and performance benchmark. For a $100 million portfolio, investment management fees would typically range from between 0.08% and 0.15%. Depending on the actual services provided and the amount of City of Dublin - Investment Program Review D-4 Investment Advisors to the Public Sector ('l~ tq~ funds under management, the annual portfolio management fee would be between $80,000 and $150,000. In addition to the qualitative benefits of using an external investment advisor, an economic analysis must also weigh the incremental earnings possible because of the external investment manager's market access and the use of a systematic investment approach. For a $100 million portfolio, each 0.1 % of increased earnings equates to $100,000 per year in additional earnings. The benefits of using an external investment advisor, including improved performance and risk management, can more than exceed the cost. While the use of an external investment advisor can clearly provide significant benefits in enhancing returns and controlling investment risks, the public agency always retains the ultimate responsibility for the public's funds. Relieved of the day-to-day investment activities, the public agency's responsibility when using an external advisor is to maintain an oversight role for the funds delegated. This includes conducting adequate due diligence in selecting the investment advisor, putting into place proper control measures to ensure that the public assets are protected from fraud or misuse, working with the advisor to develop investment strategies and performance benchmarks consistent with the public agency's objectives, monitoring the advisor's activities to make sure the public agency understands the investments and how the portfolio is being managed. Internal Management Some organizations prefer to retain full control of their investment activities and perform these functions in-house. In evaluating this option, a public agency should consider whether the current level of in-house expertise and resources are adequate to obtain the best benefit from the public agency's investments, the cost involved with developing and maintaining an in-house investment operation, and whether the resources devoted to an in-house investment operation could be better allocated to other activities. In considering the cost effectiveness of in-house investment management, the public agency would need to assess its ability to establish and manage an internal investment operation at a level appropriate to the needs of its investment portfolio. A number of resources would be required. Specifically, the public agency would need the following: · Employee(s) with market and trading experience with fixed income securities and strategies · Administrative and accounting staff · Access to current market information and rates (i.e. Bloomberg, Te1erate) · Current list of approved brokers and dealers · Ability to perform credit analysis on trading partners, repo counterparties, and issuers of commercial paper and bankers' acceptances · Portfolio accounting and reporting system City of Dublin - Investment Program Review D-S Investment Advisors to the Public Sector IJ~ fib 11 · System of internal controls to ensure the integrity of the operation · Management oversight of the investment function Staffing. The minimum level of staff and the training and experience needed to safeguard funds is somewhat independent of the size of the portfolio. Generally, public agency investment operations of any size will maintain a staff of several investment professionals and administrative personnel. This provides the public agency with the resources to actively manage the portfolio and provide backup as necessary. This also permits the public agency to maintain a segregation of responsibilities between those responsible for investing the public agency's funds and those accounting for the investments. This is an important component of an internal controls system because it avoids situations that put a single individual in the position of being able to commit an irregularity and then conceal it. Typically, responsibility for the three primary investment functions is segregated into four components: trade authorization, execution, record keeping and custody. In a large operation, the segregation of responsibilities is often among departments. In a smaller government, it is acceptable to segregate duties among individuals within the same department. Staff is generally required to perform the following functions: . Portfolio strategy development · Interaction with broker/dealers · Competitive selection of investments . Trade execution · Trade confirmation · Input oftrade data to portfolio accounting and/or general ledger system · Transmittal of trade instructions to custodian bank · Reconciliation of broker confirmations · Monthly reconciliation of custodial statements · Calculation of market values of portfolio holdings (at least monthly) and repo collateral (at least weekly) · Processing collateral substitutions/coupon payments on repurchase agreements · Monitoring callable securities Although actual costs can vary considerably by geographic region, a public agency could reasonably expect to pay an experienced portfolio manager $75,000 to $95,000. An additional one to three staff positions would be needed for portfolio management backup, accounting and administrative support. The expected average cost of these positions is $40,000 per employee. Employee benefits can be estimated at 25% of salary. In total, we estimate that investment staff would cost between $143,750 and $268,750. Portfolio Accounting. System. accounting entries is necessary. A system to track the investment portfolio and generate At a minimum, the system would need to provide basic City of Dublin - Investment Program Review D-6 Investment Advisors to the Public Sector C/1tQ ~9J information about portfolio holdings, average returns, projected interest earnings and scheduled maturities. With a larger portfolio, a more sophisticated portfolio accounting system or access to an on-line system would probably be needed. A good portfolio accounting system should also assist with the preparation of investment reports for management and the governing body. These reports should include the following: · Listing of individual securities held at the end of the reporting period · Realized and unrealized gains or losses resulting from appreciation or depreciation by listing the cost and market value of securities · Average weighted yield to maturity of portfolio on investment as compared to applicable benchmarks . Listing of investment by maturity date . Percentage of the total portfolio that each type of investment represents There are a number of portfolio accounting systems available across a wide price range. Based on the experience of other public agencies, we estimate that that cost of procuring/leasing a basic PC-based portfolio accounting system would be between $5,000 and $11,000 per year. Sources of Market Data. To effectively manage its investment portfolio, the public agency would also need access to a source of current market information. There are a number of sources available. The best choice for the public agency will depend on: · portfolio composition · technical capabilities of the investment staff . budget . trading strategy The following list highlights some of the sources of market data used by other governmental entities. Bloomben~ Financial System Bloomberg is arguably the most complete and accurate source of financial data and news available today. It provides current market rates on virtually every publicly traded security, sophisticated analytics, and communication links which have become the industry standard. Most portfolio managers find it indispensable. It is the Mercedes Benz of the financial information/analytic tools and priced accordingly. A basic subscription will cost from $1,800 - $2,500 per month. Telerate Another widely used product in the financial markets is Telerate. This is an on- line, interactive workstation containing market pricing, news and commentary. It provides accurate, current market pricing. One of the benefits of the Telerate product is its flexibility. The subscriber can easily customize pages to meet specific investment needs. However, it does not provide the depth of analytical tools available. on Bloomberg. A subscription costs approximately $1,300 per month. City of Dublin - Investment Program Review D-7 Investment Advisors to the Public Sector ?Ddf; '1 ct Wall Street Journal Some investors still rely on newspapers for information on market pricing. The financial press generally reports closing prices on actively traded government obligations, mutual funds and equities. While this source of information is generally inexpensive, the time delay limits its usefulness for the institutional investor. BrokerlDealers Brokers and dealers that make a market in a particular security can also be a good source of market information. One of the best ways to determine the value of a security is to find out what an interested party would pay for it. However, a public agency should be cautious of any conflict of interest the broker may have. For instance, a public agency would not want to rely on the repo counterparty to price collateral - an independent source of market information is required. Portfolio Pricinl! Service. Most large, sophisticated investors subscribe to a security pricing service to obtain market values of portfolio holdings. These third party services provide an important control tool and can help to ensure that accounting statements and reports accurately reflect the true value of the public agency's assets. A basic pricing service costs approximately $300 - $1,000 per year. Credit Service. Access to detailed credit reports is also important. A public agency will need to verify the credit standing of trading partners, repo counterparties and security issuers. Most institutional investors subscribe to credit services provided by one of the large national credit rating organizations; Standard & Poor's, Moody's or Fitch. The fees vary based on the scope of information required, but can be expected to run $3,000 per year. In total, we estimate the annual costs of running an internal investment operation as follows: Portfolio Manager Support Staff(1-3 person) Employee Benefits (at 25% of Salary) Bloomberg System Portfolio Accounting System Portfolio Pricing Service Credit Service Total $75,000 - $95,000 $40,000 - $120,000 $28,750 - $53,750 $21,000 - $30,000 $5,000 - $11,000 $300 - $1,000 $3,000 $173,050 - $313,750 For a $100 million portfolio, these annual costs would amount to between 17.3 and 33.4 basis points. This cost estimate is only for routine costs and does not include the cost of such items as: employee recruiting, training, turnover, computer equipment, or software upgrades. In addition to these direct investment operation. costs, the analysis should also consider how the public agency would expect its portfolio to perform managed in-house versus an external manager. As previously noted, each 0.1 % difference in relative performance equates to $100,000 per year for a $100 million portfolio. City of Dublin - Investment Program Review D-8 Investment Advisors to the Public Sector 11Gb 1'$ Management Structure In evaluating the use of an external manager, a public agency should also consider the best way to structure its use of an external manager. Rather than retaining management entirely in-house or outsourcing the management of the entire portfolio, a public agency could also choose to use a combination of these approaches. For some public agencies, a combination of in-house and external management can provide the best solution to meet its specific needs. The division of portfolio management responsibilities between the public agency and the external advisor is typically based on either the investment authority given or the type of funds being managed. Management Authority There are two basic types of investment authority that can be given to the external investment advisor: Discretionary Authority and Non-Discretionary Authority. Discretionary Authority is when the external manager is given the authority to execute investment transactions, subject to general constraints set by the entity's investment policy or by the contract with the investment advisor. Non-Discretionary Authority is when the external advisor provides investment advice or oversight, but does not have the authority to execute trades. Depending on the public agency's specific needs, the external advisor's responsibilities can also lie somewhere between. The cost analysis above assumed that the public agency would outsource its investment funds on a discretionary basis. The external advisor would be responsible for the on-going management of the portfolio and the public agency would focus its attention on investment objectives and oversight. A public agency could also choose to hire an investment manager on a non- discretionary basis. This would allow the public agency to retain the day-to-day management of the portfolio while enhancing the experience and resources available to it by contracting with an external advisor. The range of services provided under a non-discretionary engagement can vary considerably depending on the specific needs of the public agency. Certain public agencies use an external advisor to provide portfolio oversight and general investment advice while other agencies rely on the external manager for daily portfolio recommendations. While there are specific reasons and benefits for using a non-discretionary management approach, it is generally less cost effective than either outsourcing the management or retaining it entirely in-house. Due to the work involved, the investment advisory fees are often not much lower than full discretionary investment management while the public agency still incurs most of its in-house costs. Types of Funds The division of responsibilities between the public agency and its external advisor could also vary based on the type of investment funds. Rather than outsource the entire investment function, the public agency could choose to allocate its funds between the in-house and external management based on the complexity of investment funds and the potential benefit to be derived. For example, it is not uncommon for public agencies using an external investment advisor to retain the management of very short-term funds in-house. Often with these funds, the balances are lower, the investments options are more limited, and the yield differentials are smaller than City of Dublin - Investment Program Review D-9 Investment Advisors to the Public Sector 12 un 4f~' with intermediate- to longer-term portions of the portfolio. Typically, the more important investment issue with very short-term funds is understanding the day-to-day cash flows requirements and transferring funds to and from the public agency. For these short-term funds, the potential benefit is smaller (due to the amount of dollars involved and the time they are to be invested) and it may be more efficient to retain management of these funds in-house rather than trying to coordinate the flow of funds with an external advisor. The investment conditions typically change as the investment horizon shifts to intermediate- and longer-term investments. With these types of investments, the range of investment options increases and the yield and risk characteristics of different investments can vary widely. The complexity of investment decisions and the potential risks and benefits to be derived are generally higher. With these funds, there can be more opportunities for an external advisor to add value. In addition, with these types of funds, cash flow requirements typically do not change on a day-to-day basis, making it easier to coordinate the timing of investments with the advisor. Conclusion When the complexity of the public agency's portfolio is sufficient to require a reasonably high level of portfolio management skills and resources to avoid risk and obtain the maximum benefit from its portfolio, the public agency can often benefit from outsourcing all or a portion of its investment portfolio to an independent investment advisor. From a cost-benefit perspective, it would be difficult, at a reasonable cost, for a public agency to duplicate and maintain in-house the expertise and resource available through outsourcing investment management to an independent investment advisor. If a public agency was to outsource all of or a portion of its investment portfolio, they should pay careful attention to the relevant experience, resources, and reputation of the firms considered. There should also be a good match between the public agency's investment objectives and the philosophy and approach of the investment advisor. Ultimately, a good investment advisory firm will function as an extension of the public agency's investment activities and take care of the investment management activities, so the public agency's staff can focus their attention towards investment objectives and oversight and thereby allocate more time on other responsibilities. While recognizing the value an independent investment advisor can bring to a public agency, the GFOA recommends in its public policy statement, Federal Regulation of Investment Advisers, that "local governments exercise caution in their selection of investment advisers and implement an ongoing risk control management program. The Association urges governmental entities considering or retaining independent investment advisers to carefully review the credentials, procedures, and controls of firms offering investment advisory services. Recommended precautionary measures include delivery versus payment, third-party custody arrangements, prohibitions against self-dealing, audits, timely reconciliations, and other appropriate internal control measures." City of Dublin - Investment Program Review D-I0 Investment Advisors to the Public Sector 1~<t ~ References . California Government Code . Federal Regulation of Investment Advisers, Government Finance Officers Association (GFOA), 1992 · An Elected Official's Guide to Investing, M. Corinne Larson, GFOA, 1995. · An Introduction to Investment Advisers for State and Local Governments, M. Corinne Larson, GFOA 1996. · Investing Public Funds, Second Edition, Girard Miller with M. Corinne Larson and W. Paul Zorn, GFOA, 1998. · Selection of Investment Advisers for Non-Pension Fund Assets, GFOA, 1999 City of Dublin - Investment Program Review D-ll 7~~f STATEMENT OF INVESTMENT POLICY FOR THE CITY OF DUBLIN I. INTRODUCTION The purpose of this document is to identify various policies and procedures that enhance opportunities for a prudent and systematic investment policy. This document also serves to organize and formalize investment related activities. II. SCOPE It is intended that this policy cover all funds and investment activities under the direct authority of the City of Dublin, as set forth in the State Government Code, sections 53600 et seq.. Cash held by the City shall be pooled in order to more effectively manage City cash resources. All pooled funds are accounted for in the City's Comprehensive Annual Financial Report and include: Funds General Fund Special Revenue Funds Capital Project Funds Internal Service Funds Enterprise Funds Agency Funds Excluded funds are those held v/ith a fiscal agent. They may have their ov;n specific "pennitted I investments" as sho\vn in their bond covenants. III. OBJECTIVES General: The overall obligation of the City Treasurer is to maintain sufficient cash to pay existing debts. It shall be the policy of the City to invest the maximum amount of idle cash ayailablc to the City in order to generate interest earnings, which supplement other City revenue sources. The investment program shall be subject to the following parameters, which are presented in their order of importance: The overall program shall be designed and managed with a degree of professionalism worthy of the public trust. The primary objectives, in order of priority, of the City's investment activities shall be: (1) Safety: Safety of principal is the foremost obiective of the investment program. The City's investments shall be undertaken in a manner that seeks to safeguard the principal of the funds under its control by maintaining an appropriate risk level. The first priority for the investment program shall be the safety of the principal amount invested. Speculation or risky investment media will be avoided, even though high interest rates might be offered. Protection and preservation of municipal investments on behalf of the citizens of the community are of primary importance. The follO'.ving list proyides examples of investments v;hich demonstrate safety. 1 G:\Investments\PFM Investment Review\Al!:enda Report\Attach2 Redline rev 07investment policv.docG:\lnycstments\PFM Investment Rev~\Agenda-ReJl&Ft-\dmft--=rev=l).7ilWeStmen-t-poliey.,doe ATTACHMENT 2 (Red-lined Changes To Current Investment Policy - 8/21/2007 1?~ 11 · Treasury and Federal agency paper and repurchase agreements are the highest quality inyestment available In terms of safety and liquidity. The City shall not directly enter into repurchase agreements, although this investment tool may be used by authorized pooled investments which are managed by others (i.e. LAIF, CA1VIP, Mutual Funds, etc). · Certificates of deposit (negotiable and nonnegotiable) and savmgs accounts must be insured by FDIC, SAIF, NCUI, or collateralized at 110% of market value with U.S. Treasury and Agency Securities. · Bankers acceptances must be secured by the irrevocable primary obligation of the accepting domestic bank. · The Local ./A~gency Investmeilt Fund (LAIF) shall be considered as a proper investment for safety inasmuch as the State Treasurer of California IS the State Elected Officer responsible for that investment portfolio. · The California Asset Management Program (CAMP) shall be considered as a proper investment for safety inasmuch as it IS a professionally managed money market portfolio rated AAAm by Standard and Poors and created for California Public Agencies. · Commercial paper of "prime" quality from a domestic corporation having total assets In excess of five hundred million dollars and ratings of/\. 1 by Standard andPoors,P 1 by Moody's and F 1 by Fitch rating or higher shall be considered as a safe investment. · Only money market and mutual fund accounts that have 100% of their assets invested in Treasury Federal agency paper shall be considered safe. This list has been presented for descriptive purposes only and actual investments shall be III accordance with authorized Sections of the Government Code. The following summary of maXImum percentage limits and maturities allowed by State Law IS established for the City's investment portfolio: Bankers acceptances Maximum % of Portfolio ~ ~ 4{}% (30% in anyone commercial banl{) ~ ~ (10% in any ODe Maximum Maturity iC.,~ C< '7T ~. , '-~-- . A. ...."." 1 5 Years 5 Years 180 days T _ Tn_. ~~ ~ .r t''' U.S. Treasury/Agency Securities 1"'..,.. (:' , LAIF / CAMP Comm6rcialpaper NIA 270 da)'s I'" ^ T ___1 ^ '-"./~ n ...l. ~ 2-Q.% 2-Q.% 5 Years NIA NIA Money Market Funds U.S. Treasury Mutual Funds 2 G:\Investments\PFM Investment Review\Aeenda Report\Attach2 Redline rev 07investment policv.docC:\Investments\PFM Investment Rcview\Agendll..RelWr-t\dFaft::.l'cv::O-+iltvestflleHt-polieyrtloe ATTACHMENT 2 (Red-lined Changes To Current Investment Policy - 8/21/2007) llP6b&f1 II (1~~~: a:~~e mutual fund) (2) Liquidity: The City's investment portfolio will remain sufficiently liquid to enable the City to meet its reasonably anticipated cash flow requirements. An adequate percentage of the portfolio should be maintained in liquid short tern1 investments that can be converted to cash if necessary to meet disbursement requirements. Since all cash requirements must be anticipated, investments in securities with active secondary or resale markets is highly recommended. Emphasis should be on marketable securities with lo'l/ sensitivity to market risk. Maturities of investments for which there is limited opp01iunity for resale (i.e. certificates of deposit held by banks and savings and loans) shall be staggered to maximize liquidity. Many of the im'estment examples identified in paragraph #1 above demonstrate the type of investments \vhich demonstrate liquidity. (3) Yield: Yield should become a consideration only after the basic requirements of safety and liquidity have been met. The City seeks to attain market average rate of return on its investments throughout economic cycles, consistent with constraints imposed by its safety obiectives and cash flow considerations. The City intends to hold its investments to maturity in order to maximize its return on its investments and minimize its exposure to potential losses resulting from temporary declines in the market yalues of its investments. Although there may be opportunities to resell securities, this type of regular trading is not considered ,consistent '.vith the City's geat&: (4) Diversification: The investment portfolio will be diversified to avoid incurring unreasonable and avoidable risks regarding specific security types or individual financial institutions. This shall also conform with applicable sections of the Government Code. (5) Prudence: The agency adheres to the guidance provided by California Civil Code Section 2261 related to the "prudent person mle." The exercise of investment decisions in accordance v/ith this policy shall be made with judgment and care and shall consider the probable safety of the invested capital as '.veIl as the probable income to be derived. (6) Public Tru:;t: All participants in the investment process shall act as custodians of the public trust. Investment officials shall recognize that the investment portfolio is subject to public revis\\' and evaluation. The overall program shall be designed and managed 'l,'ith a degree of professionalism thr.t is worthy of the public trust. Thus employees and officials involved in the im'estment process shall refrain from personal business activity that conflicts w'ith proper execution of the investment program, or impuirs their ability to make impartial investment decisions. f~dditionally the City Treasurer and the Deputy Treasurer shall file applicable financial disclosures as required by the Fair Political Practices Commission (FPPC). In a dbersified portfolio it must be recognized that occasional measured losses are inevitable, and must be considered ',':ithin the context of the 0'.1erall portfolio's investment return, pro'/ided that adequate diversification has been implemented. 3 G:\Investments\PFM Investment Review\Al.!enda Report\Attach2 Redline rev 07investment policv.docC:\Im'estment!!\PFl\1 Investment Review\AgendIl-.RelffiFt,dr*ft::ffV=g.1illvest.ment-poliey,~ ATTACHMENT 2 (Red-lined Changes To Current Investment Policy - 8/21/2007 11~ -'it IN. DESICNATION OF CITY TREASURER TO CARRY OUT INVESTMENT DUTIES DELEGATION OF AUTHORITY As authorized in Government Code Section 53607, the City Council delegates the authority to invest funds of the City to the City Treasurer and/or any duly appointed Deputy City Treasurer.:. The Treasurer and any duly appointed Deputy City Treasurer shall make all investment decisions and transactions in strict accordance with State law and this investment policy. is/are hereby authorized to invest, reinvest, sell, or exchange monies v;ithin the City Treasury. The Administrative Services Director shall be designated as the City Treasurer and the City Manager and/or Finance Manager shall be designated as the Deputy City Treasurer. This delegation shall be for a one-year period until the delegation of authority is revoked or expires. The City Council may renew the authority each year as part of an annual review of this policy. Quarterly reports of said transactions, if any, shall be provided to the City CounciL The City recognizes that in a diversified portfolio, occasional measured losses may be inevitable and must be considered within the context ofthe overall portfolio's return and the cash flow requirements of the City. Authorized individuals acting in accordance with written procedures and the investment policy and exercising due diligence shall be relieved of personal responsibility for an individual security's credit risk or market price changes, provided deviations from expectations are reported in a timely fashion and appropriate action is taken to control adverse developments. V. PRUDENCE Pursuant to California Government Code Section 53600.3, all persons authorized to make investment decisions on behalf of the City are trustees and therefore fiduciaries subiect to the prudent investor standard: "When investing, reinvesting, purchasing, acquiring, exchanging, selling, or managing public funds, a trustee shall act with care, skill, prudence, and diligence under the circumstances then prevailing, including, but not limited to, the general economic conditions and the anticipated needs of the agency, that a prudent lJerson acting in a like capacity and familiarity with those matters would use in the conduct of funds of a like character and with like aims, to safeguard the principal and maintain the liquidity needs of the agency." VI. ETHICS AND CONFLICTS OF INTEREST All participants in the investment process shall acts as custodians of the public trust. Investment officials shall recognize that the investment portfolio is subiect to public review and evaluation. The overall program shall be designed and managed with a degree of professionalism that is worthy of the public trust. Thus employees and officials involved in the investment process shall refrain from personal business activity that conflicts with proper execution of the investment program, or impairs their ability to make impartial investment decisions. Additionally, the City Treasurer and the Deputy Treasurer shall file applicable financial disclosures as required by the Fair Political Practices Commission (FPPC). 4 G:\Investments\PFM Investment Review\Al!enda ReDort\Attach2 Redline rev 07investment Dolicv.docC:\lnvestments\PFl\1 Investment Re'l'iew\Agendll..Rep&l't\d-ra.ft=l'eY-.:-O-1ilWestrnent-polk.y,doe ATTACHMENT 2 (Red-lined Changes To Current Investment Policy - 8/21/2007) 1~6bq{ VII. INTERNAL CONTROLS The Treasurer is responsible for establishing and maintaining an internal control structure designed to ensure that the assets of the entity are protected from loss, theft or misuse. The internal control structure shall be designed to provide reasonable assurance that these obiectives are met. The concept of reasonable assurance recognizes that (1) the cost of a control should not exceed the benefits likely to be derived: and (2) the valuation of costs and benefits requires estimates and iudgments by management. Periodically as deemed appropriate by City Management and/or the City Council an independent analysis by an external auditor shall be conducted to review internal controls, account activity and compliance with policies and procedures. VIII. AUTHORIZED FINANCIAL DEALERS AND INSTITUTIONS To the extent practical the Treasurer shall endeavor to complete investment transactions using a competitive bid process whenever possible. It shall be the City's policy to purchase securities only from authorized institutions and firms. No deposit of public funds shall be made except in a qualified public depository as established by state laws. The Treasurer shall maintain procedures for the establishing a list of authorized broker/dealers and financial institutions which are approved for investment purposes. These may include primary or regional dealers that qualify under Securities & Exchange Commission Rule 15C3-1 (uniform net capital rule). The City requires each firm that will be used for the purchase or sale of securities to be evaluated by the Treasurer prior to any investments. The firms shall submit current financial statements, and annual audited financial statements each year thereafter, which are to ~e evaluated by the Treasurer. At a minimum, the firm must be financially sound and have been in business a minimum of three years. In addition, the firms must provide: proof of National Association of Security Dealers membership, proof of state registration or exemption, and certificate of having read the City's investment policy. IXV. AUTHORIZED AND SUITABLE INVESTMENT~ INSTRUMENTS The authorized investments to be made by the City Treasurer shall be in accordance \vith Sections 53601 and 53635 of the California Government Code as they may be amended. Reporting of all transactions shall occur as noted in Section VIII below. The City Treasurer / Deputy City Treasurer shall not directly invest any monies in Repurchase Agreements or Reverse Repurchase Agreements unless this policy is amended by the City Council. In accordance w'ith Government Code Section 53601.6 (including as it may be further amended) no investment shall 5 G:\Investments\PFM Investment Review\Ae:enda Report\Attach2 Redline rev 07investment policv.docCI\lnYe5tmeHt~\PFM Investment Review~Rel~a.ft=t'CV::07ilWestn_t-.pol~e ATTACHMENT 2 (Red-lined Changes To Current Investment Policy - 8/21/2007 19~ "'. be made directly in any of the following instruments: inverse floaters, range notes, or interest only strips derived from a pool of mortgages (i.e. CoIluteralized Mortgage Obligations)_ The City's investments are governed by Government Code, Sections 53600 et seq. Within the investments permitted by the Government Code, the City seeks to further restrict eligible investment to the investments listed below. In the event an apparent discrepancy is found between this Policy and the Government Code, the more restrictive parameters will take precedence. Percentage holding limits listed in this section apply at the time the security is purchased. Any investment currently held at the time the Policy is adopted which does not meet the new Policy guidelines can be held until maturity, and shall be exempt from the current Policy. At the time of the investment's maturity or liquidation such funds shall be reinvested only as provided in the most current Policy_ An appropriate risk level shall be maintained by primarily purchasing securities that are of high quality, liquid, and marketable. The portfolio shall be diversified by security type and institution to avoid incurring unreasonable and avoidable risks regarding specific security types or individual financial institutions. 1. United States Treasury Issues. United States Treasury notes, bonds, bills, or certificates of indebtedness, or those for which the faith and credit of the United States are pledged for the payment of principal and interest. There is no limitation as to the percentage of the portfolio that may be invested in this category. 2. Federal A2:ency Obli2:ations.. Federal agency or United States government-sponsored enterprise obligations, participations, or other instruments, including those issued by or fully guaranteed as to principal and interest by federal agencies or United States government- sponsored enterprises. There is no limitation as to the percentage of the portfolio that may be invested in this category. However, the Treasurer should strive to limit the portfolio's exposure to anyone federal agency issuer to 40 percent of the overall portfolio and limit the portfolio's exposure to callable federal agency securities to 25 percent of the overall portfolio. 4. Bankers Acceptances. Bankers' acceptances, otherwise known as bills of exchange or time drafts, that are drawn on and accepted by a commercial bank. Bankers' acceptances must be secured by the irrevocable primary obligation of the accepting domestic bank. Purchasers are limited to issuers whose short-term debt is rated "A-I" or higher, or the equivalent, by a Nationally Recognized Statistical-Rating Organization (NRSRO). Bankers' acceptances cannot exceed a maturity of 180 days. A maximum of 40 percent of the portfolio may be invested in this category. The amount invested in bankers' acceptances with anyone financial institution in combination with any other debt from that financial institution shall not exceed 20 percent of the portfolio. 5. Commercial Paper. Commercial paper of "prime" quality of the highest ranking or of the highest letter and number rating as provided for by a NRSRO. The entity that issues the 6 G:\Investments\PFM Investment Review\Al!enda Report\Attach2 Redline rev 07investment policv.docC:\Investments\PFM In-/e5tmeni Review\AgeJHia-Rellffl't\d-rnft:::..J"~IWestment-flolic)',dllC ATTACHMENT 2 (Red-lined Changes To Current Investment Policy - 8/21/2007) <6:J6b~~ commercial paper shall. meet all of the following conditions in either paragraph (A) or paragraph (B): (A) The entity meets the following criteria: (i) Is organized and operating in the United States as a general corporation. (ii) Has total assets in excess of five hundred million dollars ($500,000,000). (iii) Has debt other than commercial paper, if any, that is rated "A" or higher by a nationally recognized statistical-rating organization. (B) The entity meets the following criteria: (i) Is organized within the United States as a special purpose corporation, trust, or limited liability company. (ii) Has program wide credit enhancements including, but not limited to, over collateralization, letters of credit, or surety bond. (iii) Has commercial paper that is rated "A-I" or higher, or the equivalent. by a nationally recognized statistical-rating organization. Eligible commercial paper shall have a maximum maturity of 270 days or less and not represent more than 10 percent of the outstanding paper of an issuing corporation. A maximum of 25 percent of the portfolio may be invested in this category. The amount invested in commercial paper of anyone issuer in combination with any other debt from that issuer shall not exceed 20 percent of the portfolio. 6. Ne20tiable Certificates of Deposit. Negotiable certificates of deposit (NCDs) issued by a nationally or state-chartered bank, a savings association or a federal association, a state or federal credit union, or by a state-licensed branch of a foreign bank. Purchases are limited to institutions which have long-term debt rated "AA" or better and/or have short-term debt rated at least "A-I" or higher, or the equivalent by a NRSRO. A maximum of 30 percent of the portfolio may be invested in this category. The amount invested in NCDs with anyone financial institution in combination with any other debt from that financial institution shall not exceed 20 percent of the portfolio. 7. Time Certificates of Deposit. Time Certificates of Deposit (TCDs) placed with commercial banks and savings and loans. The purchase of TCDs from out-of-state banks or savings and loans is prohibited. The amount on deposit shall not exceed the shareholder's equity in the financial institution. . To be eligible for purchase, the financial institution must have received a minimum overall satisfactory rating for meeting the credit needs of California Communities in its most recent evaluation, as provided Government Code Section 53635.2. TCDs are required to be collateralized as specified under Government Code Section 53630 et. seq. The Treasurer, at his discretion, may waive the collateralization requirements for any portion that is covered by federal insurance. The City shall have a signed agreement with the depository per Government Code Section 53649. TCDs may not exceed one (1) year in maturity. A maximum of 10 percent of the portfolio may be invested in this category. 9. Money Market Funds. Shares of beneficial interest issued by diversified management companies that are money market funds registered with the Securities and Exchange Commission under the Investment Company Act of 1940 (15 U.S.C. Sec. 80a-l and following). The company shall have met either of the following criteria: (A) Attained the highest ranking or the highest letter and numerical rating provided by not less than two 7 G:\Investments\PFM Investment Review\Al!enda ReDort\Attach2 Redline rev 07investment Dolicv.docG:\lnvestments\PFM Investment Rev~\Agenda.-ReJmFt\d-Faft:::Fcv::O-f.im'estme!lt-fKllie~ ATTACHMENT 2 (Red-lined Changes To Current Investment Policy - 8/21/2007 ~I~e;t NRSROs. (B) Retained an investment adviser registered or exempt from registration with the Securities and Exchange Commission with not less than five years' experience managing money market mutual funds with assets under management in excess of five hundred million dollars ($500,000,000). A maximum of 20 percent of the portfolio may be invested in this category. For due diligence, the Treasurer shall maintain on file a copy of the current Prospectus for any mutual fund in which the City has funds invested. 10. State of California Local A2:ency Investment Fund (LAIF). A maximum of 75 percent of the portfolio may be invested in this category. For due diligence, the Treasurer shall maintain on file a copy ofLAIF's current Answer Book. 11. California Asset Mana2:ement Pro2:ram (CAMP). Shares of beneficial interest issued by a ioint powers authority organized pursuant to Government Code Section 6509.7 that invests in the securities and obligations authorized in subdivisions (a) to (n), inclusive of to Government Code Section 53601. For due diligence, the Treasurer shall maintain on file a coPY of CAMP's current Information Statement. x. AUTHORIZED INVESTMENTS FOR BOND PROCEEDS Bond proceeds shall be invested in securities permitted by the applicable bond documents. If the bond documents are silent as to the permitted investments, bond proceeds will be invested in securities permitted by this Policy. Notwithstanding the provisions of Policy, the percentage or dollar portfolio limitations listed in elsewhere in this Policy do not apply to bond proceeds. In addition to the securities listed in Section IX above, bond proceeds may be invested in structured investment products if approved by the Treasurer. XI. PROHIBITED INVESTMENT PRACTICES AND INSTRUMENTS The City shall not make investments for the purpose of trading or speculation as the dominate criterion such as anticipation of appreciation of capital value through changes in market rates. Securities are purchased with the intent to hold to maturity. Any investment in a security not specifically listed as an Authorized and Suitable Investment above, but otherwise permitted by the Government Code, is prohibited without the prior approval ofthe City Council. Section 53601.6 of the Government Code specifically disallows investments in invoice floaters, range notes, or interest-only strips that are derived from a pool of mortgages. WXII. TERM OF INVESTMENTS Maturities of investments '",ill be selected based on liquidity requirements to minimize interest rate risk and maximize earnings. Current and expected yields will be analyzed and the portfolio v,ill be invested accordingly. As specified in Government Code Section 53601, the City Council must expressly authorize the investment of funds that maturo in excess of five years. Placement of such im'estments car..not 8 G:\Investments\PFM Investment Review\Al!:enda Report\Attach2 Redline rev 07investment policv.docC:\Innstments\PFM InnstmeRt Re'l'iew\Agenda-RCfHH't\dt'aft:=fl'V::..-O-7tlwestmellt-floliey,4fue ATTACHMENT 2 (Red-lined Changes To Current Investment Policy - 8/21/2007) ~ttb~ occur until three months has lapsed from the date of authorization. The selection of maturities by the Treasurer shall also take into consideration any other policies adopted by the City Council such as an adopted policy on the Use and Management of General Fund Reserves. Funds of the City will be invested in accordance with sound treasury management principles. It is the obiective of this Policy to provide a system which will accurately monitor and forecast revenues and expenditures so that the City can invest funds to the fullest extent possible. The maximum maturity of individual investments shall not exceed the limits set forth in under Authorized and Suitable Investments. No investment shall exceed a maturity of five years from the date of purchase unless the City Council has granted express authority to make that investment either specifically or as a part of an investment program approved by the City Council no less than three months prior to the investment. VII. INTERNAL CONTROLS City Treasurer and City Staff shall develop and implement such administrative procedures and intemal controls which are considered prudent, gi';en the size of the organization and the complexity of investments. The controls are designed to prevent losses of public funds arising from fraud, error or imprudent actions by employees and officers ofthe City. . Existing procedures require all wire transfers involving investments to be fully docume-nted and approved by the City Treasurer and Deputy City Treasurer. Monthly reconciliations to bank statements and the related general ledger accounts is conducted to ensure proper handling of all investment transactions. An independent analysis by an external auditor shall be conducted periodically to revievi internal controls, account activity and compliance with policies and proced'..lres. XIII. SAFEKEEPING AND CUSTODY Investment securities are to be purchased when possible in book-entry form in the City's name. All security transactions entered into by the City shall be conducted on a delivery-versus- payment (DVP) basis. All cash and securities in the City's portfolio shall be held in safekeeping in the City's name by a third party bank trust department. acting as agent for the City under the terms of a custody agreement executed by the bank and the City. All investment transactions will require a safekeeping receipt or acknowledgment generated from the trade. A monthly report will be received by the City from the safekeeping institution listing all securities held in safekeeping with current market data and other information. The only exception to the foregoing shall be depository accounts and securities purchases made with: (i) local government investment pools~ (ii) time certificates of deposit, and, (iii) money mutual funds, since the purchased securities are not deliverable. Term and non-negotiable instruments, such as certificates of deposit, can be held by the Treasurer, or in safekeeping as the Treasurer deems appropriate. XIV. PERFORMANCE BENCHMARK The Treasurer shall monitor and evaluate the portfolio's performance. A coml'arison of the portfolio's performance against a performance benchmark may be included in the Treasurer's quarterly report. The Treasurer shall select an appropriate, readily available index to use as a performance benchmark. 9 G:\Investments\PFM Investment Review\Al!enda Report\Attach2 Redline rev 07investment policv.docG:\InvtJstments\PFM Inyestment Review\Agenda Ref*H'1\dr-aft:::l'ev::::0-7i1westment-policy.doe ATTACHMENT 2 (Red-lined Changes To Current Investment Policy - 8/21/2007 '6:> Db 4ft vmxV. REpORT INFORMATION The Treasurer shall submit a monthly report of investment transactions to the City Council. In addition, +he- The Treasurer shall report to the City Council on a quarterly basis within 30 days following the end of the quarter covered by the report. specific information related to the City investments. The report shall be inclusive of a monthly listing of investment transactions At a minimum the quarterly report shall include the following: a) Type of Investment b) Issuer c) Date of Maturity d) Par and dollar amount invested e) Current Market Value as of the date of the report f) Source of the market value information g) A list of investment transactions. hg) A statement of compliance with the investment policy ill:) A statement as to the ability of the City to meet its expenditure requirements for the next six months In accordance with the Governmental Accounting Standards Board (GASB) Statement No. 31, "Accounting and Financial Reporting for Certain Inyestments", as of June 30th of euch Fiscal Year the CitY'Nill report all investments with maturity dates in excess of one year at market value in the Comprehensive Annual Financial Report. Any change in the value of the investments will be recognized on an annual basis, as a component of interest income. This reporting change shall begin to take effect for the y€ar ending June 30, 1998. IX. SEl.ECTION OF INSTITUTIONS In selecting the financial institutions for the deposit or investment of City of Dublin funds, the City Treasurer shall consider the credit 'Northiness of institutions '.vhich are utilized. .l^,Jl broker/dealers should be primary dealers regularly reporting to the NeVI York Federal Reserve BaHlt Efforts shall be made to monitor the credit characteristics and financial history throughout the period in which agency f\;mds are deposited or invested. In the case of securities purchased by or on behalf of the agency, a third party safekeeping account, who is in no VlUy related to the company \vho sold the securities, shall be maintained in the name of the City of Dublin. X. RISK TOI...I~RANCE As noted, diversification shall be utilized to control risk. No individual investment transaction shall be undertaken \vhich jeopardizes the total capital position of the overall portfolio. All transuctions \'.fill be executed on a delivery versus payment basis. When practical, a competitive bid process will be used to place all investment purchases. XVI. REVIEW OF INVESTMENT POLICY 10 G:\Investments\PFM Investment Review\Al!enda Report\Attach2 Redline rev 07investment policv.docC:\Inycstments\PFM Investment Revie-w\AgeJIda-RCJ*lrt\df'llJt=~1.jnvestment--poliey.doe ATTACHMENT 2 (Red-lined Changes To Current lnvestment Policy - 8/21/2007) g~6b Cf1 This policy shall be subject to review by the City Council on an annual basis, by the second Council meeting in September. Any recommended modifications or amendments shall be presented by Staff to the City Council for their consideration and adoption. G:\Investrnents'.in'lostrnent policy. doc 11 G:\Investments\PFM Investment Review\A!!enda Report\Attach2 Redline rev 07investment policv.docC:\Invcstments\PFM Inve~tmcnt Review\A~da-ReptH"Adl'llft=-_v=01ilw.estnleut-p&liey.dee ATTACHMENT 2 (Red-lined Changes To Current Investment Policy - 8/21/2007 ~SlQi$ RESOLUTION NO. xx - 07 A RESOLUTION OF THE CITY COUNCIL OF THE CITY OF DUBLIN ********* ADOPTING A REVISED POLICY FOR CITY INVESTMENTS WHEREAS, the current Investment Policy was adopted September 20,2005; and WHEREAS, on December 5, 2006 the City Council authorized the engagement ofPFM Asset Management LLC (PFM) to conduct a special study; and WHEREAS, the focus of the study was a comprehensive review of the City Investment policy and practices; and WHEREAS, the annual review of the investment policy was delayed to allow for completion of the investment review by PFM; and WHEREAS, PFM has recommended modifications to the City investment policy to reflect current laws as well as the format recommended as a best practice; and WHEREAS, the City Council has reviewed the revised Investment Policy at a public meeting on August 21,2007; and WHEREAS, the Revised City of Dublin Investment Policy is attached to this resolution as Exhibit A. NOW, THEREFORE, BE IT RESOLVED that the City Council of the City of Dublin does Adopt the revised Investment Policy as attached hereto. PASSED, APPROVED AND ADOPTED this 21 st day of August, 2007, by the following vote: AYES: NOES: ABSENT: ABSTAIN: Mayor ATTEST: City Clerk Attachment 3 i'lI~ 4}1 ~ STATEMENT OF INVESTMENT POLICY FOR THE CITY OF DUBLIN 1. INTRODUCTION The purpose of this document is to identify various policies and procedures that enhance opportunities for a prudent and systematic investment policy. This document also serves to organize and formalize investment related activities. II. SCOPE It is intended that this policy cover all funds and investment activities under the direct authority of the City of Dublin, as set forth in the State Government Code, sections 53600 et seq.. Cash held by the City shall be pooled in order to more effectively manage City cash resources. All pooled funds are accounted for in the City's Comprehensive Annual Financial Report and include: Funds General Fund Special Revenue Funds Capital Project Funds Internal Service Funds Enterprise Funds Agency Funds III. OBJECTIVES The overall program shall be designed and managed with a degree of professionalism worthy of the public trust. The primary objectives, in order of priority, of the City's investment activities shall be: (1) Safety: Safety of principal is the foremost objective of the investment program. The City's investments shall be undertaken in a manner that seeks to safeguard the principal of the funds under its control by maintaining an appropriate risk level. (2) Liquidity: The City's investment portfolio will remain sufficiently liquid to enable the City to meet its reasonably anticipated cash flow requirements. (3) Yield: Yield should become a consideration only after the basic requirements of safety and liquidity have been met. The City seeks to attain market average rate of return on its investments throughout economic cycles, consistent with constraints imposed by its safety objectives and cash flow considerations. (4) Diversification: The investment portfolio will be diversified to avoid incurring unreasonable and avoidable risks regarding specific security types or individual financial institutions. This shall also conform with applicable sections of the Government Code. 1 G:\Investments\PFM Investment Review\Agenda Report\ExAreso _ InvPolicy _ 2007.doc EXHIBIT A f16b .,.~ IV. DELEGATION OF AUTHORITY As authorized in Government Code Section 53607, the City Council delegates the authority to invest funds of the City to the City Treasurer and/or any duly appointed Deputy City Treasurer. The Treasurer and any duly appointed Deputy City Treasurer shall make all investment decisions and transactions in strict accordance with State law and this investment policy. The Administrative Services Director shall be designated as the City Treasurer and the City Manager and/or Finance Manager shall be designated as the Deputy City Treasurer. This delegation shall be for a one-year period until the delegation of authority is revoked or expires. The City Council may renew the authority each year as part of an annual review of this policy. The City recognizes that in a diversified portfolio, occasional measured losses may be inevitable and must be considered within the context ofthe overall portfolio's return and the cash flow requirements of the City. Authorized individuals acting in accordance with written procedures and the investment policy and exercising due diligence shall be relieved of personal responsibility for an individual security's credit risk or market price changes, provided deviations from expectations are reported in a timely fashion and appropriate action is taken to control adverse developments. V. PRUDENCE Pursuant to California Government Code Section 53600.3, all persons authorized to make investment decisions on behalf of the City are trustees and therefore fiduciaries subject to the prudent investor standard: "When investing, reinvesting, purchasing, acquiring, exchanging, selling, or managing public funds, a trustee shall act with care, skill, prudence, and diligence under the circumstances then prevailing, including, but not limited to, the general economic conditions and the anticipated needs of the agency, that a prudent person acting in a like capacity and familiarity with those matters would use in the conduct of funds of a like character and with like aims, to safeguard the principal and maintain the liquidity needs ofthe agency." VI. ETHICS AND CONFLICTS OF INTEREST All participants in the investment process shall acts as custodians of the public trust. Investment officials shall recognize that the investment portfolio is subject to public review and evaluation. The overall program shall be designed and managed with a degree of professionalism that is worthy of the public trust. Thus employees and officials involved in the investment process shall refrain from personal business activity that conflicts with proper execution of the investment program, or impairs their ability to make impartial investment decisions. Additionally, the City Treasurer and the Deputy Treasurer shall file applicable financial disclosures as required by the Fair Political Practices Commission (FPPC). VII. INTERNAL CONTROLS The Treasurer is responsible for establishing and maintaining an internal control structure designed to ensure that the assets of the entity are protected from loss, theft or misuse. The internal control structure shall be designed to provide reasonable assurance that these objectives are met. The concept of reasonable assurance recognizes that (1) the cost of a control should not 2 G:\Investments\PFM Investment Review\Agenda Report\ExAreso _ InvPolicy _2007 .doc Exhibit A ~~6b 1~ exceed the benefits likely to be derived; and (2) the valuation of costs and benefits requires estimates and judgments by management. Periodically as deemed appropriate by City Management and/or the City Council an independent analysis by an external auditor shall be conducted to review internal controls, account activity and compliance with policies and procedures. VIII. AUTHORIZED FINANCIAL DEALERS AND INSTITUTIONS To the extent practical the Treasurer shall endeavor to complete investment transactions using a competitive bid process whenever possible. It shall be the City's policy to purchase securities only from authorized institutions and firms. No deposit of public funds shall be made except in a qualified public depository as established by state laws. The Treasurer shall maintain procedures for the establishing a list of authorized broker/dealers and financial institutions which are approved for investment purposes. These may include primary or regional dealers that qualify under Securities & Exchange Commission Rule 15C3-1 (uniform net capital rule). The City requires each firm that will be used for the purchase or sale of securities to be evaluated by the Treasurer prior to any investments. The firms shall submit current financial statements, and annual audited financial statements each year thereafter, which are to be evaluated by the Treasurer. At a minimum, the firm must be financially sound and have been in business a minimum of three years. In addition, the firms must provide: proof of National Association of Security Dealers membership, proof of state registration or exemption, and certificate of having read the City's investment policy. IX. AUTHORIZED AND SUITABLE INVESTMENTS The City's investments are governed by Government Code, Sections 53600 et seq. Within the investments permitted by the Government Code, the City seeks to further restrict eligible investment to the investments listed below. In the event an apparent discrepancy is found between this Policy and the Government Code, the more restrictive parameters will take precedence. Percentage holding limits listed in this section apply at the time the security is purchased. Any investment currently held at the time the Policy is adopted which does not meet the new Policy guidelines can be held until maturity, and shall be exempt from the current Policy. At the time of the investment's maturity or liquidation such funds shall be reinvested only as provided in the most current Policy. An appropriate risk level shall be maintained by primarily purchasing securities that are of high quality, liquid, and marketable. The portfolio shall be diversified by security type and institution to avoid incurring unreasonable and avoidable risks regarding specific security types or individual financial institutions. 1. United States Treasury Issues. United States Treasury notes, bonds, bills, or certificates of indebtedness, or those for which the faith and credit of the United States are pledged for the payment of principal and interest. There is no limitation as to the percentage of the portfolio that may be invested in this category. 3 G:\Investments\PFM Investment Review\Agenda Report\ExAreso _ InvPolicy _2007 .doc EXHIBIT A ~'tDb tt!~$ 2. Federal Aeencv Oblieations. Federal agency or United States government-sponsored enterprise obligations, participations, or other instruments, including those issued by or fully guaranteed as to principal and interest by federal agenpies or United States government- sponsored enterprises. There is no limitation as to the percentage of the portfolio that may be invested in this category. However, the Treasurer should strive to limit the portfolio's exposure to anyone federal agency issuer to 40 percent of the overall portfolio and limit the portfolio's exposure to callable federal agency securities to 25 percent of the overall portfolio. 3. Bankers Acceptances. Bankers' acceptances, otherwise known as bills of exchange or time drafts, that are drawn on and accepted by a commercial bank. Bankers' acceptances must be secured by the irrevocable primary obligation of the accepting domestic bank. Purchasers are limited to issuers whose short-term debt is rated "A-I" or higher, or the equivalent, by a Nationally Recognized Statistical-Rating Organization (NRSRO). Bankers' acceptances cannot exceed a maturity of 180 days. A maximum of 40 percent of the portfolio may be invested in this category. The amount invested in bankers' acceptances with anyone financial institution in combination with any other debt from that financial institution shall not exceed 20 percent of the portfolio. 4. Commercial Paper. Commercial paper of "prime" quality of the highest ranking or of the highest letter and number rating as provided for by a NRSRO. The entity that issues the commercial paper shall meet all of the following conditions in either paragraph (A) or paragraph (B): (A) The entity meets the following criteria: (i) Is organized and operating in the United States as a general corporation. (ii) Has total assets in excess of five hundred million dollars ($500,000,000). (iii) Has debt other than commercial paper, if any, that is rated "A" or higher by a nationally recognized statistical-rating organization. (B) The entity meets the following criteria: (i) Is organized within the United States as a special purpose corporation, trust, or limited liability company. (ii) Has program wide credit enhancements including, but not limited to, over collateralization, letters of credit, or surety bond. (iii) Has commercial paper that is rated "A-I" or higher, or the equivalent, by a nationally recognized statistical-rating organization. Eligible commercial paper shall have a maximum maturity of 270 days or less and not represent more than 10 percent of the outstanding paper of an issuing corporation. A maximum of 25 percent of the portfolio may be invested in this category. The amount invested in commercial paper of anyone issuer in combination with any other debt from that issuer shall not exceed 20 percent of the portfolio. 5. Neeotiable Certificates of Deposit. Negotiable certificates of deposit (NCDs) issued by a nationally or state-chartered bank, a savings association or a federal association, a state or federal credit union, or by a state-licensed branch of a foreign bank. Purchases are limited to institutions which have long-term debt rated "AA" or better and/or have short-term debt rated at least "A-I" or higher, or the equivalent by a NRSRO. A maximum of 30 percent of the portfolio may be invested in this category. The amount invested in NCDs with anyone 4 G:\Investments\PFM Investment Review\Agenda Report\ExAreso _ InvPolicy _ 2007.doc Exhibit A qf)~ ~tl( financial institution in combination with any other debt from that financial institution shall not exceed 20 percent of the portfolio. 6. Time Certificates of Deposit. Time Certificates of Deposit (TCDs) placed with commercial banks and savings and loans. The purchase of TCDs from out-of-state banks or savings and loans is prohibited. The amount on deposit shall not exceed the shareholder's equity in the financial institution. To be eligible for purchase, the financial institution must have received a minimum overall satisfactory rating for meeting the credit needs of California Communities in its most recent evaluation, as provided Government Code Section 53635.2. TCDs are required to be collateralized as specified under Government Code Section 53630 et. seq. The Treasurer, at his discretion, may waive the collateralization requirements for any portion that is covered by federal insurance. The City shall have a signed agreement with the depository per Government Code Section 53649. TCDs may not exceed one (1) year in maturity. A maximum of 10 percent of the portfolio may be invested in this category. 7. Money Market Funds. Shares of beneficial interest issued by diversified management companies that are money market funds registered with the Securities and Exchange Commission under the Investment Company Act of 1940 (15 U.S.C. Sec. 80a-l and following). The company shall have met either of the following criteria: (A) Attained the highest ranking or the highest letter and numerical rating provided by not less than two NRSROs. (B) Retained an investment adviser registered or exempt from registration with the Securities and Exchange Commission with not less than five years' experience managing money market mutual funds with assets under management in excess of five hundred million dollars ($500,000,000). A maximum of 20 percent of the portfolio may be invested. in this category. For due diligence, the Treasurer shall maintain on file a copy of the current Prospectus for any mutual fund in which the City has funds invested. 8. State of California Local A2enCy Investment Fund (LAIF). A maximum of 75 percent of the portfolio may be invested in this category. For due diligence, the Treasurer shall maintain on file a copy ofLAIF's current Answer Book. 9. California Asset Mana2ement Pro2ram (CAMP). Shares of beneficial interest issued by a joint powers authority organized pursuant to Government Code Section 6509.7 that invests in the securities and obligations authorized in subdivisions (a) to (n), inclusive of to Government Code Section 53601. For due diligence, the Treasurer shall maintain on file a copy of CAMP's current Information Statement. x. AUTHORIZED INVESTMENTS FOR BOND PROCEEDS Bond proceeds shall be invested in securities permitted by the applicable bond documents. If the bond documents are silent as to the permitted investments, bond proceeds will be invested in securities permitted by this Policy. Notwithstanding the provisions of Policy, the percentage or dollar portfolio limitations listed in elsewhere in this Policy do not apply to bond proceeds. In addition to the securities listed in Section IX above, bond proceeds may be invested in structured investment products if approved by the Treasurer. 5 G:\Investments\PFM Investment Review\Agenda Report\ExAreso _ InvPolicy _2007 .doc EXHIBIT A ~/"'b ~8 XI. PROHIBITED INVESTMENT PRACTICES AND INSTRUMENTS The City shall not make investments for the purpose of trading or speculation as the dominate criterion such as anticipation of appreciation of capital value through changes in market rates. Securities are purchased with the intent to hold to maturity. Any investment in a security not specifically listed as an Authorized and Suitable Investment above, but otherwise permitted by the Government Code, is prohibited without the prior approval of the City Council. Section 53601.6 ofthe Government Code specifically disallows investments in invoice floaters, range notes, or interest-only strips that are derived from a pool of mortgages. XII. TERM OF INVESTMENTS Funds of the City will be invested in accordance with sound treasury management principles. It is the objective of this Policy to provide a system which will accurately monitor and forecast revenues and expenditures so that the City can invest funds to the fullest extent possible. The maximum maturity of individual investments shall not exceed the limits set forth in under Authorized and Suitable Investments. No investment shall exceed a maturity of five years from the date of purchase unless the City Council has granted express authority to make that investment either specifically or as a part of an investment program approved by the City Council no less than three months prior to the investment. XIII. SAFEKEEPING AND CUSTODY Investment securities are to be purchased when possible in book-entry form in the City's name. All security transactions entered into by the City shall be conducted on a delivery-versus- payment (DVP) basis. All cash and securities in the City's portfolio shall be held in safekeeping in the City's name by a third party bank trust department, acting as agent for the City under the terms of a custody agreement executed by the bank and the City. All investment transactions will require a safekeeping receipt or acknowledgment generated from the trade. A monthly report will be received by the City from the safekeeping institution listing all securities held in safekeeping with current market data and other information. The only exception to the foregoing shall be depository accounts and securities purchases made with: (i) local government investment pools; (ii) time certificates of deposit, and, (iii) money mutual funds, since the purchased securities are not deliverable. Term and non-negotiable instruments, such as certificates of deposit, can be held by the Treasurer, or in safekeeping as the Treasurer deems appropriate. XlV. PERFORMANCE BENCHMARK The Treasurer shall monitor and evaluate the portfolio's performance. A comparison of the portfolio's performance against a performance benchmark may be included in the Treasurer's quarterly report. The Treasurer shall select an appropriate, readily available index to use as a performance benchmark. 6 G:\Investments\PFM Investment Review\Agenda Report\ExAreso _InvPolicy _2007.doc Exhibit A xv. REpORT INFORMATION ~2 'b ~.~ The Treasurer shall report to the City Council on a quarterly basis within 30 days following the end of the quarter covered by the report. The report shall be inclusive of a monthly listing of investment transactions At a minimum the quarterly report shall include the following: a) Type of Investment b) Issuer c) Date of Maturity d) Par and dollar amount invested e) Current Market Value as of the date of the report f) Source of the market value information g) A list of investment transactions. h) A statement of compliance with the investment policy i) A statement as to the ability of the City to meet its expenditure requirements for the next six months XVI. REVIEW OF INVESTMENT POLICY This policy shall be subject to review by the City Council on an annual basis, by the second Council meeting in September. Any recommended modifications or amendments shall be presented by Staff to the City Council for their consideration and adoption. 7 G:\Investments\PFM Investment Review\Agenda Report\ExAreso _ InvPolicy _2007 .doc EXHIBIT A CITY OF DUBLIN INVESTMENT POLICY - APPENDIX GLOSSARY OF CASH MANAGEMENT TERMS (For Background and Informational Purposes Only) q~ifJ,t( ACCRUED INTEREST: Interest earned but not yet received. AGENCIES: Federal agency securities and/or Government-sponsored enterprises. Examples of well known agencies that issue bonds are Federal Home Loan Mortgage Corporation (FHLMC or "Freddie Mac"), Federal National Mortgage Association (FNMA or "Fannie Mae"), and the Federal Home Loan Bank. AMORTIZATION: An accounting practice of gradually decreasing (increasing) an asset's book value by spreading its depreciation (accretion) over a period of time. ASKED: The price at which securities are offered. BANKERS' ACCEPTANCE (BA): A draft or bill or exchange accepted by a bank or trust company. The accepting institution guarantees payment of the bill, as well as the issuer. BASIS POINT: One basis point is one hundredth of one percent (.01). BENCHMARK: A comparative base for measuring the performance or risk tolerance ofthe investment portfolio. A benchmark should represent a close correlation to the level of risk and the average duration of the portfolio's investments. BID PRICE: The price offered by a buyer of securities. (When you are selling securities, you ask for a bid.) See Offer. BOND: A financial obligation for which the issuer promises to pay the bondholder a specified stream of future cash flows, including periodic interest payments and a principal repayment. BOOK ENTRY: The system maintained by the Federal Reserve, by which most money market securities are delivered to an investor's custodial bank. The Federal Reserve maintains a computerized record of the ownership of these securities and records any changes in ownership corresponding to payments made over the Federal Reserve wire (delivery versus payment.) BOOK VALUE: The value at which a debt security is shown on the holder's balance sheet. Book value is acquisition cost less amortization of premium or accretion of discount. BROKER: A broker brings buyers and sellers together for a commission. CALLABLE BOND: A bond issue in which all or part of its outstanding principal amount may be redeemed before maturity by the issuer under specified conditions. CALL PRICE: The price at which an issuer may redeem a bond prior to maturity. The price is usually at a slight premium to the bond's original issue price to compensate the holder for loss of income and ownership. 8 G:\Investments\PFM Investment Review\Agenda Report\ExAreso_ InvPolicy _2007 .doc Exhibit A CITY OF DUBLIN INVESTMENT POLICY - APPENDIX GLOSSARY OF CASH MANAGEMENT TERMS (For Background and Informational Purposes Only) t:1+Db1~ CALL RISK: The risk to a bondholder that a bond may be redeemed prior to maturity. CERTIFICATE OF DEPOSIT (CD): A deposit insured up to $100,000 by the FDIC at a set rate for a specified period of time. COLLATERAL: Securities, evidence of deposit or other property which a borrower pledges to secure repayment of a loan. Also refers to securities pledged by a bank to secure deposits of public monies. COMMERCIAL PAPER: An unsecured promissory note of industrial corporations, utilities and bank holding companies having assets in excess of $500 million and an "A" or higher rating for the issuer's debentures. Interest is discounted from par and calculated using the actual number of days on a 360- day year. The notes are in bearer form, mature from one to 270 days and generally start at $100,000. There is a secondary market for commercial paper and an investor may sell them prior to maturity. Unused lines of credit back commercial paper from major banks. COMPREHENSIVE ANNUAL FINANCIAL REPORT (CAFR): The official annual financial report for the City. It includes combined statements and basic financial statements for each individual fund and account group prepared in conformity with Generally Accepted Accounting Principles (GAAP). Supplemental information is also included including a detailed multi year comparative statistics. COUPON: (a) The annual rate of interest that a bond's issuer promises to pay the bondholder on the bond's face value. (b) A certificate attached to a bond evidencing interest due on a payment date. CURRENT YIELD: The interest paid on an investment expressed as a percentage ofthe current price of the security. CUSTODY: A banking service that provides safekeeping for the individual securities in a customer's investment portfolio under a written agreement which also calls for the bank to collect .and payout income, and to buy, sell, receive and deliver securities when ordered to do so by the account holder. DEALER: A dealer, as opposed to a broker, acts as a principal in all transactions, buying and selling for his own account. DEBENTURE: A bond secured only by the general credit of the issuer. DELIVERY VERSUS PAYMENT (DVP): Delivery versus payment is delivery of securities with an exchange of money for the securities. DERIVATIVES: (1) Financial instruments whose return profile is linked to, or derived from, the movement of one or more underlying index or security, and may include a leveraging factor, or (2) financial contracts based upon notional amounts whose value is derived from an underlying index or security (interest rates, foreign exchange rates, equities or commodities). Page 9 of 13 CITY OF DUBLIN INVESTMENT POLICY - APPENDIX GLOSSARY OF CASH MANAGEMENT TERMS (For Background and Informational Purposes Only) '1661> c;f' DISCOUNT: The difference between the cost price of a security and its value at maturity when quoted at lower than face value. DISCOUNT SECURITIES: Non-interest bearing money market instruments that are issued a discount and redeemed at maturity for full face value, e.g., U.S. Treasury Bills. DIVERSIFICATION: Dividing investment funds among a variety of securities offering independent returns. DURATION: A measure of the timing of the cash flows, such as the interest payments and the principal repayment, to be received from a given fixed-income security. This calculation is based on three variables: term to maturity, coupon rate, and yield to maturity. The duration of a security is a useful indicator of its price volatility for given changes in interest rates. FEDERAL CREDIT AGENCIES: Agencies of the Federal government set up to supply credit to various classes of institutions and individuals, e.g., S&L's, small business firms, students, farmers, farm cooperatives, and exporters. FEDERAL DEPOSIT INSURANCE CORPORATION (FDIC): A federal agency that insures bank deposits, currently up to $100,000 per deposit. FEDERAL FUNDS RATE: The rate of interest at which Fed funds are traded. This rate is currently pegged by the Federal Reserve through open-market operations. FEDERAL HOME LOAN BANKS (FHLB): Government sponsored wholesale banks (currently 12 regional banks) which lend funds and provide correspondent banking services to member commercial banks, thrift institutions, credit unions and insurance companies. FEDERAL NATIONAL MORTGAGE ASSOCIATION (FNMA or Fannie Mae): FNMA, like GNMA was chartered under the Federal National Mortgage Association Act in 1938. FNMA is a federal corporation working under the auspices ofthe Department of Housing and Urban Development (HUD). The corporation is called, is a private stockholder-owned corporation. The corporation's purchases include a variety of adjustable mortgages and second loans, in addition to fixed-rate mortgages. FEDERAL OPEN MARKET COMMITTEE (FOMC): Consists of seven members of the Federal Reserve Board and five of the twelve Federal Reserve Bank Presidents. The President of the New York Federal Reserve Bank is a permanent member, while the other Presidents serve on a rotating basis. The Committee periodically meets to set Federal Reserve guidelines regarding purchases and sales of Government Securities in the open market as a means of influencing the volume of bank credit and money. 10 G:\Investments\PFM Investment Review\Agenda Report\ExAreso _ InvPolicy _ 2007.doc Exhibit A qTY OF DUBLIN INVESTMENT POLICY - APPENDIX GLOSSARY OF CASH MANAGEMENT TERMS (For Background and Informational Purposes Only) t:; ~ Db 1( FEDERAL RESERVE SYSTEM: The central bank of the United States created by Congress and consisting of a seven member Board of Governors in Washington, D.C., 12 regional banks and about 5,700 commercial banks that are members of the system. FED WIRE: A wire transmission service established by the Federal Reserve Bank to facilitate the transfer of funds through debits and credits of funds between participants within the Fed system. FEDERAL HOME LOAN MORTGAGE CORPORATION (FHLMC or Freddie Mac): A United States government sponsored corporation. GOVERNMENT NATIONAL MORTGAGE ASSOCIATION (GNMA or Ginnie Mae): Securities influencing the volume of bank credit guaranteed by GNMA and issued by mortgage bankers, commercial banks, savings and loan associations, and other institutions. Security holder is protected by full faith and credit of the U.S. Government. Ginnie Mae securities are backed by the FHA, VA or FmHA mortgages. The term "pass-throughs" is often used to describe Ginnie Maes. INTEREST RATE: The annual yield earned on an investment, expressed as a percentage. LIQUIDITY: Refers to the ability to easily and rapidly convert a security into cash. LOCAL AGENCY INVESTMENT FUND (LAlF): The local Agency Investment Fund (LAIF) is a special fund in the California State Treasury created and governed pursuant to Government Code Sections 16429.1 et seq. There are limits on the maximum dollars deposited by a city as well as the number of transactions allowed each month. MARKET VALUE: The price at which a security is trading and could presumably be purchased or sold on a specific date. MATURITY: The date upon which the principal or stated value of an investment becomes due and payable. MONEY MARKET MUTUAL FUND:Mutual funds that invest solely in money market instruments (short-term debt instruments, such as Treasury bills, commercial paper, bankers' acceptances, and federal funds). NATIONAL ASSOCIATION OF SECURITIES DEALERS (NASD): A self-regulatory organization (SRO) of brokers and dealers in the over-the-counter securities business. Its regulatory mandate includes authority over firms that distribute mutual fund shares as well as other securities. NATIONALLY RECOGNIZED STATISTICAL RATING ORGANIZATIONS (NSROs); Credit rating agencies whose ratings are permitted to be used for regulatory purposes such as those imposed by the Securities and Exchange Commission. Page 11 of 13 CITY OF DUBLIN INVESTMENT POLICY - APPENDIX GLOSSARY OF CASH MANAGEMENT TERMS (For Background and Informational Purposes Only) ~1 O1oq!~ NEGOTIABLE CERTIFICATE OF DEPOSIT: A large denomination certificate of deposit which can be sold in the open market prior to maturity. NEW ISSUE: Term used when a security is originally "brought" to market. OFFER: The price asked by a seller of securities. (When you are buying securities, you ask for an offer.) See Asked and Bid. OPEN MARKET OPERATIONS: Purchases and sales of government and certain other securities in the open market by the New York Federal Reserve Bank as directed by the FOMe in order to influence the volume of money and credit in the economy. Purchases inject reserves into the bank system and stimulate growth of money and credit; sales have the opposite effect. Open market operations are the Federal Reserve's most important and most flexible monetary policy tool. PORTFOLIO: Collection of securities held by an investor. PREMIUM: The amount by which the price paid for a security exceeds the security's par value. PRIMARY DEALER: A group of government securities dealers who submit daily reports of market activity and positions and monthly financial statements to the Federal Reserve Bank of New York and are subject to its informal oversight. Primary dealers include Securities and Exchange Commission (SEC)-registered securities broker-dealers, banks, and a few umegulated firms. PRINCIPAL: The face value or par value of a debt instrument, or the amount of capital invested in a given security. PURCHASE DATE: The date in which a security is purchased for settlement on that or a later date. RATE OF RETURN: The yield obtainable on a security based on its purchase price or its current market price. This may be the amortized yield to maturity on a bond or the current income return. REPURCHASE AGREEMENT (RP OR REPO): A holder of securities sells these securities to an investor with an agreement to repurchase them at a fixed price on a fixed date. The security "buyer" in effect lends the "seller" money for the period ofthe agreement, and the terms of the agreement are structured to compensate him for this. RULE 2a-7 OF THE INVESTMENT COMPANY ACT: Applies to all money market mutual funds and mandates such funds to maintain certain standards, including a 13- month maturity limit and a 90- day average maturity on investments, to help maintain a constant net asset value of one dollar ($1.00). SAFEKEEPING: See CUSTODY. 12 G:\Investments\PFM Investment Review\Agenda Report\ExAreso _ InvPolicy _2007 .doc Exhibit A CITY OF DUBLIN INVESTMENT POLICY - APPENDIX GLOSSARY OF CASH MANAGEMENT TERMS (For Background and Informational Purposes Only) q~ 'b ~&' SECONDARY MARKET: A market made for the purchase and sale of outstanding issues following the initial distribution. SECURITIES & EXCHANGE COMMISSION: Agency created by Congress to protect investors in securities transactions by administering securities legislation, SETTLEMENT DATE: The date on which a trade is cleared by delivery of securities against funds. TIME CERTIFICATE OF DEPOSIT: A non-negotiable certificate of deposit which cannot be sold prior to maturity. TREASURY BILLS: A non-interest bearing discount security issued by the U.S. Treasury to finance the national debt. Most bills are issued to mature in three months, six months, or one year and are sold on a discount basis. TREASURY BONDS: Long-term coupon-bearing U.S. Treasury securities issued as direct obligations of the U.S. Government and having initial maturities of more than 10 years. TREASURY NOTES: Medium-term coupon-bearing U.S. Treasury securities issued as direct obligations ofthe U.S. Government and having initial maturities of 1 to 10 years. U.S. GOVERNMENT AGENCIES: Instruments issued by various US Government Agencies most of which are secured only by the credit worthiness of the particular agency. WEIGHTED AVERAGE MATURITY (W AM): The average maturity of all the securities that comprise a portfolio that is typically expressed in days or years. YIELD: The rate of annual income return on an investment, expressed as a percentage. It is obtained by dividing the current dollar income by the current market price of the security. YIELD TO MATURITY: The rate of income return on an investment, minus any premium or plus any discount, with the adjustment spread over the period from the date of purchase to the date of maturity of the bond, expressed as a percentage. YIELD CURVE: The yield on bonds, notes or bills of the same type and credit risk at a specific date for maturities up to thirty years. ZERO-COUPON SECURITY: Security that is issued at a discount and makes no periodic interest payments. The rate of return consists of a gradual accretion of the principal of the security and is payable at par upon maturity. Page 13 of 13