Transcript Document
Investing Through the Interest Rate Cycle & Custodians Doug Milliken Arapahoe County Treasurer March 25, 2010 Interest rate cycle 2 Different strategies for interest rates • Four scenarios: – Increasing rates – Near the top – Decreasing rates – Near the bottom 3 Increasing interest rates • Prices will decrease with rate increase • Keep investments short • If increases come quickly, you are better off in money market fund • Don’t be fully invested: you’ll want to buy the higher yielding bonds once rates rise 4 Rates near the top • • • • • • You won’t know for sure when you are at the top Use strategies with a portion of portfolio Lock in long term rates Consider allowable investments, terms Non-callable bullets Prices increase as rates fall 5 Compare MM to long term yields • When rates near the top of cycle, long term rates will be lower than money market • Strategy is to buy lower yielding long term bonds than money market, expecting that MM will decline soon, while long term rates stay high 6 Example of scenario Long term rates lower than MM 7 Decreasing interest rates • Portfolio value remains at or above purchase price, useful in case of emergencies requiring early sale • Value of portfolio rises • Under concept of total return, increased value is equal to interest earnings • Usually, you won’t know when rates hit bottom 8 Rates near the bottom • Maximum increase to market value • Bonds at increased value earning very low yield • Consider selling to take capital gains if allowed and putting proceeds in money market 9 Yield curves 10 Usual shape of yield curve • Shown on lower portion of previous chart • Yield increases with term • No significant changes expected to interest rates 11 Inverted yield curve • • • • Shown on upper portion of previous graph Yield declines with term Market in flux Market has sold off short and medium term bonds, and yield has risen • Often predictive of recession 12 Concept of total return • Realized and unrealized capital gains equal to interest earnings • Compare market value at beginning and end of period 13 How are you reviewing your performance? • Just interest earned, or also market gain? • How does your government view performance? • How do various components of return show up on CAFR? • What do state statutes and investment policy allow? 14 Call-ability • Issuers gain what you lose • Mathematically, callable issues are worth less than non-callable • Callable issues create asset to issuer • Sometimes, you want bonds called • Mostly, you want the choice of selling or keeping 15 Current opportunity in agencies • • • • • • • • Callable step-up Issue date 11/18/09 First coupon 5/18/10 Final maturity 11/18/14 Beginning coupon 2% Steps up to 4% on 11/18/11 if not called Callable at 11/18/11 at par Selling at premium to yield 1.5% 16 Reason I bought it • FNMA thinks rates will jump up in next year and 7 months. I consider this unlikely, based on current state of economy • FNMA has right to call at par if rates don’t rise • I get 1.5% for 1 year 7 months, higher than bullet • I’m happy if it’s called • Success of strategy depends on correct prediction of interest rate movements 17 Another example – FHLMC 18 Current investment idea • I purchase CDs in banks based in my county slightly below market interest rate • I request that the banks makes loans <$500,000 to small and medium sized businesses in county. • Banks make all credit decisions • In Colorado, banks must collateralize with US government securities valued at 102% of deposit, so no risk 19 Banks report quarterly on each loan: - loan terms - type of business - location Yield is higher than agency or money market Public good in keeping businesses alive, allowing expansion and job creation 20 Benefit to issues with larger issue size • Trade with lower spread • Readily salable • Analogous to Global Corporate Issues 21 Custodians • Insist on Delivery versus Payment • Money leaves your account only when security put in your ownership • Security leaves ownership only when money enters your account • Securities lending can be profitable, but some investors have lost when agents fail • Sample Banking/Custodian RFP on GIOA website 22 Feel free to contact me… Doug Milliken Arapahoe County Treasurer 5334 S. Prince St. Littleton, CO 80166 [email protected] 303-681-5505 23