2014-08-27 Item 08C - Annual Investment Report and Annual Adoption of Investment Policy AGENDA REPORT
City Council
MEETING DATE: August 27, 2014
PREPARED BY: Jay Lembach; Finance DEPT. DIRECTOR: Tim Nash
Manager
DEPARTMENT: Finance Department CITY MANAGER: Gus Vina
SUBJECT:
Annual Investment Report and Annual Adoption of Investment Policy
RECOMMENDED ACTIONS:
(1) Accept and file the Annual Investment Report for the fiscal year ended June 30, 2014.
(2) Adopt the Investment Policy to be effective for the fiscal year 2014-15
STRATEGIC PLAN:
Organizational Effectiveness & Efficiency: Goal 1. Maintain the City's financial health
FISCAL CONSIDERATIONS:
There is no fiscal impact related to this Agenda Item.
BACKGROUND:
The City's adopted Investment Policy (Section XVI) requires the City's Investment Officer to
report investment positions and results of the Pooled Investment Fund and the Investment of
Bond Proceeds to the City Council annually at a Public Meeting. Section XVII requires that the
Investment Policy be reviewed and adopted at least annually, regardless of whether there are
any proposed changes to the Policy.
REVIEW OF INVESTMENT REPORT(S):
The Annual Investment Report for the Pooled Investment Fund (Attachment 1) is produced via
the City's SymPro investment-tracking software. It includes a number of separate reports,
which together, are intended to address all significant aspects of the City's Investment Program.
The City had approximately $100 million under management at June 30, 2014. Of this amount,
approximately $91.8 million was invested in various investment vehicles, which are detailed in
Section VIII of the Policy. There were no amounts invested, either at June 30, 2014 or during
the fiscal year that exceeded the internal guidelines for maximum allocations described in that
same Section. The balance of $8.7 million was on deposit with Union Bank, in anticipation of
several large payments which are made in early July of each year.
08/27/2014 Item #8C Page 1
The Pooled Investment Fund earned $428,862 for the fiscal year, a return of 0.5% based on an
average investable balance of$84.5 million. As of June 30, and generally during the fiscal year,
the Pool's weighted-average maturity (WAM) was about 500-600 days, meaning that its average
life was about 1.5 years. The City's adopted Performance Benchmark (described in Section XV
of the Policy) is the 1 year US Treasury bill, thus, our average life is slightly above the
benchmark. To make for a fairer comparison, the approximate average yield of a 1.5 year T-
note was approximately 0.35%. Thus, Encinitas' return on investment exceeded the benchmark
by 0.15%, or 15 basis points. While the actual rates of return and monies earned are modest by
historical standards, this year's performance exceeded the (revised) benchmark by almost 50%.
The Annual Investment Report for the Investment of Bond Proceeds (Attachment 2) is straight-
forward and is subject to only very minor changes in activity from year-to-year. It should be
noted that the City's 2013 Lease Revenue Bonds do not list, and are not required to maintain a
debt service reserve fund. Rates on available investment vehicles (which are extremely limited
by the Bond Indentures) are yielding near zero at this point.
INVESTMENT POLICY:
The City's first written Investment Policy was developed and implemented in 1994. The Policy
was extensively modified and upgraded in 2002, and earned the City the distinction of an award
from the Association of Public Treasurers — US and Canada: the Certificate of Excellence —
Investment Policy. The award of this certificate requires a rigorous review of the Investment
Policy to assure that all current best practices have been incorporated in the development and
implementation of the Policy. Those criteria have not changed since 2002.
There are no proposed changes to the Policy at this time. The proposed amended Policy is
attached hereto as Attachment 3.
ATTACHMENTS:
ATTACHMENT 1 Annual Investment Report
ATTACHMENT 2 Investment Report on Bond Proceeds
ATTACHMENT 3 Investment Policy
ATTACHMENT 4 Investment Update
08/27/2014 Item #8C Page 2
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ATTACHMENT 1
Annual Investment Report
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08/27/2014 Item #8C Page 3
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ATTACHMENT 2
Investment of Bond Proceeds
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08/27/2014 Item #8C Page 24
CITY OF ENCINITAS
INVESTMENT OF BOND PROCEEDS
For the Fiscal Year ended June 30,2014
Maturity Market FY 2013-14
GOVERNMENTALFUNDS TRUSTEE CASH&INVESTMENTS Yield Date Value Income Budget
ENCINITAS PUBLIC FINANCING AUTHORITY
1997 CERTIFICATES OF PARTICIPATION(CIVIC CENTER)
Bond Fund Blackrock Money Market Fund 1 day $ 1 3
Reserve Fund Guaranteed Investment Contract 5.97% 1 12/1/2016 619,500 1 $ 36,881 40,000
$ 619,501 $ 36,884 $ 40,000
2006 LEASE REVENUE BONDS(PUBLIC LIBRARY)
Bond Fund Blackrock Money Market Fund 0.02% $ 63 53
Interest Account Federated Prime Cash Money Market Fund 0.02% 0 1
Reserve Fund Federated Prime Cash Money Market Fund 0.02% 568,725 172.12
$ 568,788 $ 226 $ 0
2010 LEASE REVENUE BONDS(COMM PARK ACQUISITION)
Bond Fund Blackrock Money Market Fund 0.00% $ 1 2
Reserve Fund Blackrock Money Market Fund 0.01% 1,411,867 209
$ 1,411,868 $ 211 $ 0
2013 LEASE REVENUE BONDS(COMM PARK DEVELOPMENT)
Bond Fund Blackrock Money Market Fund 0.00% $ 0 1
Project Fund Blackrock Money Market Fund 0.014 - 371 -
$ 0 $ 372 $ 0
ENCINITAS PUBLIC FINANCING AUTHORITY TOTALS A $ 2,600,157 $ 37,694 $ 40,000
CITY OF ENCINITAS/ASSOCIATION OF BAY AREA GOVERNMENTS(ABAG)
2002 LEASE REVENUE BONDS(ABAG FUNDING)
Bond Fund Wells Fargo Money Market Fund 0.01% $ 383 4
Principal Fund Wells Fargo Money Market Fund 0.01% 255,000
Interest Fund Wells Fargo Money Market Fund 0.01% 24,768
Reserve Fund Wells Fargo Money Market Fund 0.01% 216,008 148 -
OTHER CITY BOND ISSUES (B) $ 496,159 $ 6 $ 0
TOTALS FOR GOVERNMENTAL FUNDS (A)+(B) $ 3,096,316 $ 37,700 $ 40,000
Maturity Market FY 2013-14
ENTERPRISE FUNDS TRUSTEE CASH&INVESTMENTS Yield Date Value Income Budget
SAN DIEGUITO WATER DISTRICT
2004 WATER REVENUE BONDS
Bond Fund Blackrock Money Market Fund 0.00% $ 1 3
Reserve Fund Blackrock Money Market Fund 0.01% 238
Reserve Fund Federated Prime Cash Money Market Fund 0.02% 1,039,738 315
TOTALI $ 1,039,977 $ 318 $ 0
TOTALS FOR ENTERPRISE FUNDS (C) $ 1,039,977 $ 318 $ 0
TOTAL TRUSTEE CASH &INVESTMENTS (A) + (B) + (C) S 4,136,293 1 1$ 38,018 ao,000
NOTE:the City's leases for capital equipment do not require any trustee deposits,and thus,are not listed on this summary
Attachment 2
08/27/2014 Item #8C Page 25
ATTACHMENT 3
Investment
Policy
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9
CITY OF ENCINITAS
ADMINISTRATIVE MANUAL
Policy Title: Investment Policy Section: Finance
Responsible Department: Finance Number. Admin Policy F019
Approved By. City Council Date Approved: 1994
Last Amended: October 23, 2013
Amendment Date: August 27, 2014
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1. Philosophy
The Investment Policy of the Encinitas City Council for the City of Encinitas represents the financial
guidelines for the City's Investment Program. It is the policy of the City of Encinitas to invest excess
public funds in a prudent manner that safeguards the public trust, minimizes the risk of loss of capital,
and provides assurance that all financial obligations will be met in the regular course of business. The
City Council shall provide direction to the Investment Officer as to the goals and specific objectives of
the Investment Program.
ll. Scope
This Investment Policy applies to all financial assets under the oversight of the City of Encinitas,
except bond proceeds held by outside trustees and funds held by other governmental agencies. The
City of Encinitas includes the City and all component units: the Encinitas Housing Authority(EHA), the
Encinitas Public Financing Authority (EPFA), and the San Dieguito Water District (SDWD). These
funds are accounted for in the City of Encinitas'Comprehensive Annual Financial Report and include:
GENERALFUND
SPECIAL REVENUE FUNDS
CAPITAL PROJECT FUNDS
ENTERPRISE FUNDS
INTERNAL SERVICE FUNDS
This policy also applies to funds that the City manages for other governmental agencies. Currently,
the City manages funds for the Encinitas Ranch Golf Authority (ERGA), a legally separate joint
powers authority which is not a component unit of the City.
The investment of Bond Proceeds held with trustees is directed by the City, but is governed by the
restrictions on Permitted Investments in the applicable Bond Indenture agreements.
A portion of City funds is held by other governmental agencies. These funds are invested under the
guidelines of the investment policies of those agencies.
The City retirement plan is with CALPERS, and the City has no authority or oversight over the
investments in any of those plans. Further, the City administers several deferred compensation
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08/27/2014 Item #8C Page 27
plans. Assets held in those plans are held in trust for the participants, and are not assets of the City.
The City does not have any authority over the investments held in these trusts.
Ill. Prudence
Investments shall be made with reasonable financial judgment and care, under circumstances then
prevailing, which persons of prudence, discretion and intelligence exercise in the management of their
own affairs, not for speculation, but for investment, considering the probable safety of their capital as
well as the probable income to be derived.
The standard of prudence to be used by investment officials shall be the `prudent person" and/or
`prudent investor'standard California Gov't Code 53600.3 states that, "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 of the Agency. The
standard shall be applied in the context of managing an overall portfolio. Investment officials acting in
accordance with established procedures and exercising due prudence shall be relieved of personal
responsibility for an individual security's credit risk or market price changes.
IV. Investment Objectives
A. Safety of Principal- the first objective of this policy is to ensure the safety of principal. The
portfolio shall be planned and managed to minimize the risk of actual loss of principal. Principal is
defined as the original purchase price of the security, excluding any purchase of accrued interest, up
to the par (face) value of the security. Any purchase amount above par value (premium) is
considered to be a purchase of accrued interest, and is excluded from the calculation of principal
amount. The Investment Officer shall consider both credit risk and concentration risk(the concept of
diversification) when assessing safety, and shall follow the guidelines outlined later in this policy to
achieve that objective.
B. Liquidity - The second obiective is the maintenance of sufficient liquidity to meet all
operating and capital spending requirements that can be reasonably anticipated. Liquidity is further
broken down between primary and secondary liquidity. Primary liquidity is defined as funds which
are available to the City to pay demands within 48 hours without loss of interest. Secondary liquidity
is defined as funds invested in authorized investments that mature within a one-year time period,
minimizing market risk.
C. Return on investments- The third objective is yield, specifically, attaining a market rate of
return over time, consistent with Council direction as to acceptable levels of risk. Refer to Section
XV below for further discussion of performance measurement.
V. Delegation of Authority
Authority and responsibility to manage the City of Encinitas' Investment Program rests first with the
City Council. Primary management responsibility rests with the City Treasurer. The City of
Encinitas Municipal Code designates that the Finance Director shall serve as City Treasurer. The
Finance Director/City Treasurer has the option to designate another individual within the organization
to assume some, or all, of the duties described in this Policy. The Finance Director has assigned
some of those duties to the City Finance Manager 111. For purposes day-to-day management of the
Investment Program, the Finance Manager 111 shall be designated as the Investment Officer, and the
duties referred to herein will generally cite the Investment Officer as performing those tasks.
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Investment Procedures
The Investment Officer is responsible for establishing written investment procedures for the
management and operation of the Investment Program, consistent with this Policy. Those
procedures shall include reference to such items as: custody/safekeeping, repurchase agreements
(if applicable), wire transfer agreements, banking service agreements, and explicit delegation of
authority to personnel involved in the processing of banking or investment transactions. No person
may engage in any investment transaction except as provided under the terms of this Policy and
the established procedures.
Vl. Ethics, & Conflict of Interest
The investment responsibility carries with it the responsibility of ensuring that investments placed are
done so without improper influence or the appearance of improper influence. All officers and
employees (officials) involved in the investment function shall adhere to the State's Code of
Economic Interest and to the following:
Officials shall refrain from personal business activity that could conflict with proper and impartial
execution of the Investment Program, or that could impair their ability to make impartial investment
decisions. Further, officials shall not personally or through a close relative maintain any accounts,
interest, or private dealings with any firm with which the City places investments, with the exception
of regular savings, checking and money market accounts, or other similar transactions that are
offered on a non-negotiable basis to the general public. Any such relationships shall be disclosed
annually to the City Clerk in conjunction with annual disclosure statements of economic interest.
VII. Authorized Financial Dealers and Institutions
i
The Investment Officer shall maintain a list of qualified financial institutions authorized to provide
financial or investment services to the City.
The City shall contract with one institution to provide general banking services, which shall be
reviewed at least every five years. City Council shall approve the selected institution and the
contract for banking services.
The City shall contract with one institution to provide investment custody services, which shall
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be reviewed at least every five (5)years. City Council shall approve the selected institution and
the contract for custody services.
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The Investment Officer shall maintain a list of qualified security broker-dealers authorized to provide
financial or investment services to the City. To be eligible for consideration to become an authorized
provider, each Broker/Firm shall meet the following MINIMUM requirements:
(1) have a net capital position in excess of$10 million,
(2) have been in business for at least five years,
(3) are currently licensed as a broker-dealer or investment adviser in California, and
(4) Must carry adequate insurance coverage including liability, errors and omissions, and
workers compensation (if applicable.)
Firms providing only representation of money market funds are exempt for requirement#1, but must
still comply with all other requirements, including those listed below.
The City Council shall approve the initial authorization of any broker-dealer. Authorized firms shall
be notified by the Investment Officer via an engagement letter, which outlines each parties'
responsibilities (primarily the continuing compliance requirements discussed directly below). There
is no contract for professional services or term to the engagement. The Investment Officer shall
periodically evaluate the performance of all qualified broker-dealers, and determine if any changes
need to be made.
All broker-dealers authorized to do business with the City of Encinitas must also comply with the
following requirements:
(1) Firms must submit audited financial statements annually, within six months of their fiscal
year-end,
(2) Firms must provide proof of their NASD certification, and must disclose to the City
immediately any regulatory actions or complaints against the broker assigned to the City
account,
(3) Firms must provide proof of their registrationAicense to do business in the State of
California, and shall immediately disclose to the City any change in that status.
(4) Firms must certify in writing that they have received, read, and agree to comply with the City
of Encinitas'most recently adopted Investment Policy.
Vlll. Authorized & Suitable Investment Instruments
As a unit of local government in the State of California, the City of Encinitas is restricting itself to
the investments authorized by Government Cod, Sections 53600 through 53635 (the Gov't
"Code') except as otherwise provided herein by specific additional Council actions.
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SPECIFIC INVESTMENT TYPES AND AMOUNTS - The Investment Officer is authorized to invest
in only the following types of investments listed below in Section Vlll., unless specifically
authorized in advance by the Finance Director/City Treasurer.
INVESTMENT ALLOCATIONS- The Maximum allocations listed below refer to the percentage of
the total portfolio that may be invested in each instrument under the provisions of the Gov't Code.
The Target allocations refer to guidelines the Investment Officer generally follows, in order to
effect proper diversification of the portfolio and limit concentration risk. The Investment Officer is
permitted to exceed these target allocations for temporary periods. Any asset allocation that
exceeds the target for a period of more than three months shall be reported to the Finance
Director/City Treasurer.
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For purposes of calculating the percentage allocations, the assumption will be applied that the
size of the portfolio for any fiscal year shall be determined by the total par value of the portfolio at
the beginning of the first day of the fiscal year. Any investment types that exceed the maximum
allowable under the Gov't Code shall be reported to the City Council in the quarterly investment
report.
INVESTMENT ALLOCATIONS
MAXIMUM TARGET
STATE LAW INV POLICY
(1) Repurchase agreements NO LIMIT 20%
This type of investment is only authorized in relation to the City's general banking
arrangements, in which excess cash balances are "swept"into an interest earning
account overnight. Maximum maturity is one day. All balances are required to be
properly collateralized at 102% of par value in accordance with State requirements.
(2) CA Local Agency Inv Fund(LAIF) $80 million 30%
The $80 million listed under "MAXIMUM STATE LAW" refers to the LAIF limit on
maximum deposits per local agency, not to the CA gov't code restrictions. The City
of Encinitas maintains two accounts with the LAIF, one in the name of the City and
the other in the name of the San Dieguito Water District. Each account has a
deposit limit of$40 million. Since San Dieguito Water District is a component unit of
the City, the City may legally utilize the SDWD account in the operation of the City
Pool. Thus, SDWD owns its ratable share of all City Pooled investments, but does
not have a direct ownership interest in the LAIF account in its name.
(3) Other Gov't Managed Pools NO LIMIT NO LIMIT
Per Issuer 10%per Pool
Investments in individual pools shall be limited to 10% of the total portfolio.
Currently approved pools are the San Diego County Investment Pool and the
California Asset Management Program (CAMP). The City Council must approve
the addition of any other governmental pools.
(4) Mutual Funds(Total) 20% 20%
Per Issuer 10% 10%
(A) Money Market Mutual Funds N/A 20% j
Per Issuer N/A 10%
Money Market Mutual Funds have a stable NA (net asset value) of $1.00 as
defined under United States Securities and Exchange Commission (SEC) rule 2a-7
Qualifying funds must meet one of the following criteria: (1) Attained the highest
ranking or the highest letter and numerical rating provided by not less than two
nationally recognized statistical rating organizations, OR(2) Retained an Investment
Advisor registered or exempt from registration with the SEC with not less than five
years' experience managing money market mutual funds with assets under
management in excess of$500 million.
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INVESTMENT ALLOCATIONS (continued)
MAXIMUM TARGET
STATE LAW INV POLICY
(B) Bond Mutual Funds N/A 10%
Per Issuer N/A $5 million
Bond Mutual Funds are similar to Money Market Mutual Funds, and are subject to
the same limitations as Money Market Mutual Funds. In other words, the total
allocation to Mutual Funds (investment types 4 & 5) is limited to 20% of the total
portfolio. Bond Mutual Funds typically have a weighted average maturity of greater
than 70 days, and are subject to more volatility and market risk. They have a net
asset value (price) that can change based on market conditions. Because of the
higher risk profile, the City is limiting investment in Bond Mutual Funds to no more
than 10%of the total portfolio, and to$5 million per issuer.
Currently, SEC regulations are being drafted that will likely change the accounting
and measurement focus for certain money market funds. Specifically, certain funds
will no longer be permitted to maintain a "stable NAV" of $1.00. They will be
required to `mark-to-market" all investments every working day. This could, and
likely will periodically, change the overall value of the fund. This would create either
a gain or loss on the fund, depending on the effect of interest rate and credit risk
changes. For the next period, the City of Encinitas will not be investing in any
money market funds which are required to, or actually adopt, what is referred to as
a "floating NA V.
(5) Certificates of Deposit(CD's) NO LIMIT 10%
Per Issuer NO LIMIT $1 million
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All CD's must be either insured by the FDIC or properly collateralized, pursuant to j
Section X below. Maturity shall not exceed one year. No more than $1 million per
issuer. To be eligible to receive deposits from the City of Encinitas, each qualified
financial institution must have received an overall rating of not less than
"satisfactory"in its most recent evaluation by regulators of its record of meeting the
credit needs of its community. y'y
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(6) Negotiable Certificates of Deposit 30% 10%
Per Issuer $1 million
All Negotiable CD's must be issued by a provider rated either: (1)Aaa by Moody's,
(2) AAA by Standard & Poors, or (3) Aa1 by Moody's and AA+ by Standard &
Poors. Investments with institutions rated at least Aa3 and AA- will be allowed, but
shall be properly collateralized pursuant to Section X below. Investments of
$250,000 or less that are fully insured by the FDIC are exempt from the above
credit rating requirements. Maturity shall not exceed five years. No more than $1
million per issuer
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INVESTMENT ALLOCATIONS (continued)
MAXIMUM TARGET
STATE LAW INV POLICY
(7) Bankers Acceptances 40% 10%
Per Issuer 30% $1 million
Bankers Acceptances (BA's) represent a time draft drawn on and accepted by a
Bank for payment of the shipment or storage of merchandise. They are generally
considered a very safe investment since both the credit of the issuer and the Bank
is pledged for repayment. They must not exceed 180 days maturity. BA's must
have an underlying credit rating ofA1/P1, and are limited to$1 million per issuer.
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(8) U.S. Treasury Bills, Notes and Bonds NO LIMIT 50%
(9) U.S. Government-Sponsored Agencies NO LIMIT 60%
Per Issuer 15%
City shall invest primarily in securities issued by Federal Home Loan Bank (FHLB),
Federal National Mortgage Association (FNMA), Federal Home Loan Mortgage
Corporation (FHLMC), and Federal Farm Credit Bureau (FFCB). City may invest in
Student Loan Marketing Association (SLMA), Private Equity Funding Corporation
(PEFCO) and Tennessee Valley Authority (TVA); however, the overall limit of 60% I
still applies. City may also invest in the Government National Mortgage Association,
but only via authorized Mutual Funds cited in Category 5 above, and subject to
those limitations.
(10) Commercial Paper 25% 25%
Per Issuer (see below) $5 million
Commercial Paper (CP) is a short-term 1.0.U. issued by large corporations of high
credit standing which is unsecured. Investments are limited to only `prime quality"
CP issued with the highest letter and number rating provided by one of the three
nationally recognized rating agencies. City limits itself only to CP rated A-1 or better
by Standard & Poors and P-1 by Moodys. Issuing corporations must be (1)
organized and operating within the United States, (2) have total assets in excess of
$500 million, and (3) have a A" or higher rating for the issuers other debt
obligations. Organized and operating within the United States includes global
companies that sponsor United States commercial paper programs. City may not
purchase more than 10% of outstanding commercial paper of any single corporate
issuer. The maximum allowable maturity is 270 days or less.
(11) Commercial Medium-Term Notes 30% 15%
Per Issuer $1 million
Medium-Term Notes are defined as all corporate and depository institution debt
securities with a maximum remaining maturity of five years or less, issued by
corporations organized and operating in the United States or by depository
institutions licensed by the United States. State Code requires a credit rating of A"
or better by one nationally recognized rating agency. The City is further limiting
itself to notes that are rated Aa3 or better(Moody's) and AA-or better(S&P).
08/27/2014 Item #8C Page 33
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INVESTMENT ALLOCATIONS (continued)
MAXIMUM TARGET
STATE LAW INV POLICY
(12) Guaranteed Investment Contracts 10%
Per Issuer $5 million
Guaranteed Investment Contracts (GIC's) are corporate obligations similar to
medium-term notes, but are issued directly to the Agency by the issuer in the form
of an investment contract. They are generally longer term in nature. They are
generally utilized for the investment of bond proceeds, but may be utilized for the
investment of Pooled funds. Uncollateralized GIC's are permitted only with issuers
rated Aaa (Moody's) and/or AAA (Standard & Poors) Collateralized GIC's are
permitted with issuers rated Aa2 or better(Moody's) and AA or better(Standard &
Poors). No more than$5 million per issuer.
(13) Demand Deposits(non-interest bearing) 0-2%
Per Issuer 0-2%
Non-interest bearing demand deposits with a financial institution approved to do
business with the City shall be an allowable investment for the City Pool. These
types of accounts are necessary to carry on the regular day-to-day financial
operations of the City, and are reported as "cash" on the monthly investment
reports. When available, the Investment Officer shall execute a "sweep
arrangement" with the designated financial institution, to provide for excess
overnight balances to earn interest.
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(14) Demand Deposits(interest bearing) 20%
Per Issuer $20 million
Interest-bearing demand deposits with a financial institution approved to do
business with the City shall be an allowable investment for the City Pool. These
types of accounts generally serve as an alternative to bank certificates of deposit,
and have a stated minimum balance requirement. These types of accounts require
a separate agreement with the financial institution, and must be fully collateralized
as Public Deposits under California law. In addition, some part of the deposit
(currently$250,000) may be insured by the Federal Deposit Insurance Corporation
(FDIC) in lieu of collateralization. Deposits (excluding accrued interest) above $20
million must be approved in advance by the City Manager, and shall be reported at
the next scheduled report date to the City Council.
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08/27/2014 Item #8C Page 34
SUMMARY TABLE of INVESTMENT ALLOCATIONS
STATE LAW INV POLICY
(1), REPURCHASE AGREEMENTS NO LIMIT 20%
(2) CALIFORNIA LAIF NO LIMIT 30%
(3) OTHER GOVT POOLS NO LIMIT 30%
Per Issuer 10%
(4) MUTUAL FUNDS 20% 20%
Per Issuer 10% 10%
(5) CD's NO LIMIT 10%
Per Issuer $1 Million
(6) NEGOTIABLE CD's 30% 10%
Per Issuer $1 Million
(7) BANKERS ACCEPTANCES NO LIMIT 10%
Per Issuer 30% $1 Million
(8) U.S. TREASURYS NO LIMIT 50%
(9) U.S. FEDERAL AGENCIES NO LIMIT 60%
Per Issuer 15%
(10) COMMERCIAL PAPER 25% 25%
Per Issuer $5 Million
(11) COMMERCIAL MTN NOTES 30% 15%
Per Issuer $1 Million
(12) GIC's NO LIMIT 10%
Per Issuer $5 Million
(13) Demand Deposits (non-interest bearing) NO LIMIT 0-2%
Per Issuer 0-2%
(14) Demand Deposits(interest bearing) NO LIMIT 20%
Per Issuer $20 Million
The State of California Government Code restricts local agencies from investing in securities with
final maturity dates greater than five (5) years, except as specifically authorized by the City Council. j
This Policy authorizes two specific exceptions to the above restriction.
(1) The City may invest in up to$5 million (par value) of securities (at date of purchase)
rated AAA or equivalent with maturities of greater than five (5) years, but not
exceeding seven (7)years.
(2) The City's General Contingency Reserve is not a part of normal operating reserves,
and the related funds are not expected to be utilized in the foreseeable future, thus,
the likelihood of liquidation is very small. The objective(s) of investment in this area
are to maximize earnings with safety, while recognizing that liquidity is less of an
issue than with operating or capital funds. Consistent with these objectives, the
Investment Officer is authorized to invest contingency funds in securities rated AAA
or equivalent with maturities greater than seven (7) years that have a ready market
should the need arise to liquidate the investment.
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The City Council has directed the Investment Officer.not to invest in securities of companies involved
in the production of tobacco or alcohol related products. The City recognizes that, due to the
extreme complexity of today's corporate structures, it is possible that investments may be placed in
good faith in corporations that have an interest in tobacco or alcohol related products that is not
widely known or properly disclosed by those corporations. The Investment Officer shall make his/her
best efforts, including notice to broker/dealers, to assure that any corporate investments are placed
with companies who are not in the tobacco or alcohol business. This policy applies at the time of
purchase only.
Certain investments are specifically prohibited by the State Code. Local Agencies may not invest in
the following: Inverse floating-rate notes, range notes, or mortgage-derived interest-only strips. The
Code also states that A local Agency shall not invest in any security that could result in zero interest
accrual if held to maturity." The City's interpretation of this Code section is that it does not prohibit
investment in U.S. Treasury or Federal Agency securities which carry a variable rate of interest;
because the chance that such notes could result in zero interest accrual to maturity is remote.
IX. Due Diligence Requirements for Investment Pools, Mutual Funds, and CD's
Investments of these types are authorized in Section Vlll. above. Before investing any funds in
pools or mutual funds, the Investment Officer shall perform a thorough investigation of the fund(s) to
determine the suitability of the investment for the City of Encinitas Pooled Investment Fund. This
investigation shall include, at a minimum:review of the Funds investment policy and/or prospectus, a
review of the performance history of the Fund, review of ratings (where applicable), review of the
latest published portfolio composition, review of fees and charges, and references from other
agencies who invest in the Fund.
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The Investment Officer shall monitor placement of Certificates of Deposit with financial institutions on
a regular basis. Compliance with collateral requirements shall be monitored(if applicable).
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X. Collateralization of Public Deposits
Collateralization will be required on two types of investments: certificates of deposit (which are not
fully insured by FDIC) and repurchase agreements. The Finance Director/City Treasurer has agreed
to waive collateral requirements on the first$250,000 of CD's from each institution, which are insured
by FDIC. In order to anticipate market changes and provide a level of security for all invested funds, i
the required collateralization levels will be:
(1) Overnight repurchases 102%of market value
(2) Certificates of Deposit 100%of market value
(3) Demand Deposits in accordance with CA law regarding Public Deposits
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Collateral must be held by an independent third party with whom the entity has a current custodial
agreement. Collateral for overnight repurchases (sweep agreements) may be held by the Trust
Department of the institution providing such sweep services. Sweep contracts shall provide for a
perfected security interest for the City in collateralized securities. j
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Collateral shall be provided by the issuing institution in accordance and compliance with the
California Gov't Code Sections 53630 et al. Issuing institution is responsible for compliance with all
collateral requirements, and must provide the City periodic evidence of that compliance, in a form
acceptable to the City.
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Xl. Safekeeping and Custody
All security transactions entered into by the City shall be conducted on a delivery-versus-payment
(DVP) basis. Securities shall be held by an independent third-party custodian approved by the City
Council. All broker-dealers shall send a transaction confirmation to the Investment Officer, and all
security transactions confirmations shall be treated as a "Vital Record"by City personnel and kept
safe per the requirements of City policy on Vital Records. Broker-dealers shall also send a monthly
activity statement to the City showing all transactions entered into in the period. No City securities or
cash will be held by any broker-dealer. The custodian sends a monthly statement to the Investment
Officer covering all investment activity handled by that institution.
Xll. Diversification
The City will diversify its investments by security type and institution, to avoid incurring unreasonable
risks inherent in over-investing in specific instruments or individual financial institutions. This Policy
sets limits on maximum allocations by investment type and by issuer. Refer to Section Vlll. above
for a listing of authorized investments and the maximum allocation by type of investment. Section
Vlll. also details specific limitations per issuer. For purposes of this Policy, those limits each apply to
the overall portfolio.
Xlll. Maximum Maturities
To the extent possible, the City of Encinitas will attempt to match its investments with anticipated
cash flow requirements, after taking into consideration interest rate (market) risk and the potential
benefits of extending investment maturities. The City conforms to the California Gov't Code
requirements limiting investments in notes to five (5)years, subject to the exceptions cited in Section
VIII. This relates principally to funds classified as reserves, which may be invested in specified
instruments with maturities greater than five (5) years. In addition, the City maintains primary and
secondary liquidity pools, as described in Section IV. (2) above. Primary liquidity shall be maintained
of$10 million minimum, with secondary liquidity maintained at an additional $10 million. Primary I
liquidity above the$10 million minimum shall count towards the secondary liquidity requirement.
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XIV. Internal Control
The Investment Officer shall establish a system of internal controls over all cash management and
investment transactions, designed to provide reasonable assurance that assets are safeguarded and
that all transactions are properly and timely recorded.
The City's independent auditor shall annually review the system of internal controls and report any
deficiencies and/or suggestions for improvements to the Investment Officer and Finance
Director/City Treasurer, Any confirmed significant deficiencies shall be reported to the City Manager
and City Council in writing, along with the City's response to the audit findings.
XV. Performance Standards:
The City's investment strategy is active, and as such, the organization has determined that periodic
quantitative measurement of investment portfolio performance is an important component of the
overall monitoring of the investment program. As stated in Section IV(C) above, the performance
objective of the Program is attaining a market rate of return over time consistent with the overall risk
tolerance of the organization.
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The Investment Officer is charged with determining an appropriate benchmark by which to measure
periodic performance. The chosen benchmark shall be designed to match as closely as practicable
the City's tolerance for investment risk. Utilization of the benchmark and analysis of actual
performance vs. the benchmark represent an important risk management tool, and analysis of
significant variations shall be reported to the City Council in a timely manner. At the same time, it is
recognized that the benchmark represents a guideline only, and that performance may vary,
especially over relatively short time periods. A timeframe of 2-3 years is considered to be the
minimum time period necessary for judging overall performance, due to changing market conditions,
cash flow requirements and the fact that no chosen performance benchmark will exactly mirror the
City's portfolio.
Attaining a market rate of return over time shall be measured and reported to the City Council, at
least quarterly, via the utilization of the following benchmark to measure performance.
The one (1) year constant maturity Treasury index
Any change to the above performance benchmark shall be reported to the City Council during the
Investment Officer's quarterly investment report.
The Investment Officer shall report performance on a quarterly basis based on the book yield
(standard income) approach. Book yield calculates the earnings on an investment based on actual
interest earned during any reporting period, including the accretion of purchase discounts and/or the
amortization of purchase premiums. The Investment Officer shall also report the estimated market
value of investments held (as provided by a third-party data provider) with each periodic report. The
City no longer reports investment income on a total return basis each fiscal year (the alternative
method presented in Gov't Actg. Standards Board (GASB) Statement No. 31) as the results over
time are roughly comparable.
XVI. Investment Accounting and Reporting
The Investment Officer shall prepare (or have prepared) monthly investment reports sufficient to
properly track and record all investment transactions and activity. The Investment Officer shall report
investment positions and results of the Pooled Investment Fund to the City Council at least quarterly,
in a form acceptable to the City Council(currently in a summary fashion.) These reports shall either
be presented as an Agenda Report or as a memo report to the City Council members, at the
discretion of the City Manager. The Investment Officer shall report positions and results of the
Pooled Investment Fund and the Investment of Bond Proceeds annually to the City Council at a
Public Meeting. Detailed annual reports of the Pooled Investment Fund shall be made available on
the City's WebSite for Public Review.
"IL Investment Policy Adoption:
The Investment Policy shall be reviewed and adopted by the City Council at a Public Meeting at least
annually, regardless of whether there are any proposed changes to the Policy. The Policy shall be
posted for public review on the City's WebSite (www.encinitasCA.pov) under City
Departments/Finance.
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Any typographical errors of other minor errors or inconsistencies shall be investigated and interpreted by the
Investment Officer, who shall then seek the concurrence of the Finance Director before making any changes
to policies or procedures. Any unresolved matters, which are judged to be insignificant in the overall context
of the Policy, shall be presented to the City Manager for a final determination.
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ATTACHMENT 4
Investment Update f
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Investment Update
Fiscal Year 2013-14
This investment update and commentary is intended to be for information purposes only. Any
opinions stated herein are not intended to constitute investment advice.
The investing environment for local governmental agencies has not changed significantly in the
last 12 months. Available interest rates for the types of investments suitable for local
governments have remained relatively stable. For example, utilizing the Agency's Performance
Benchmark (the one-year US Treasury bill); that rate is 0.10% today compared to 0.15% one
year ago. Rates on investments with maturities of over one year and up to five years have
increased modestly in the same time period. Thus, some agencies that have a benchmark of
more than one year have been able to improve performance year-over-year. However,
benchmarking to a longer maturity also increases the risk of market value losses, should
interest rates rise as they have in the past year.
Short-term interest rates have been below one-percent (1.00%) for over five years, and now are
near zero. This is primarily because of various actions taken by the US Federal Reserve (the
"Fed") to lower interest rates, with the intention of stimulating economic activity in the United
States. Specifically, the most common measure of US economic activity (Gross Domestic
Product, or GDP) went negative in 2008, in what many are now calling the Great Recession.
Two consecutive quarters of negative GDP is the common definition of a recession.
The reason that interest rates have been so low for so long is fairly simple. Despite the
unprecedented actions of the Fed over the last five years, economic activity has remained quite
low by historical standards. For instance, GDP has averaged 2% growth over the last three
years, compared to about 5-6% in previous economic recoveries. Quite frankly, the Fed's
actions are not having the desired effects. Thus, the Fed has yet to even signal a change in
policy, which could take the country back into recession.
This continuing low interest rate policy has had dramatic effects on the earnings of local
governmental agencies. These agencies are limited by Law to invest in only the safest
investment vehicles, which happen to be the types of investments most affected by low rate
policies. Most agencies have seen their interest earnings decline by over 90% in the past five
years.
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The biggest debate in the investment community has and continues to be: when will the Fed
start increasing interest rates? By how much? And how quickly? About the only thing we know
for sure is: the Fed will try to raise rates slowly, in small increments. However, market forces
also come into play. The Fed cannot SET interest rates, only the Markets can do that. If the
markets react strongly to the first indications of a rate hike (a likely scenario) then short-term
interest rates could "spike up", out of proportion to the actual Fed announcement or actions.
Agencies holding fixed-rate securities with longer maturity dates (say, 3 to 5 years) would see a
sharp decline in the market value of those securities. This is what is commonly referred to as
"market" or "interest-rate" risk. While the agency may not ultimately incur a loss on any
particular security, it may well be necessary to hold. the security for its entire term in order to
have the total principal returned. Many agencies are uncomfortable taking that type of risk.
08/27/2014 Item #8C Page 40
While it is important to evaluate what has happened in the financial markets, it is much more
important to consider what is likely to happen in the future. That is where forecasting comes
into the picture. Investment managers do their best to discern future trends, using the best
available information. The objective is to utilize the forecast results to develop an investment
strategy, which would typically cover the next year. Once developed, the strategy is
implemented and then continuously monitored, to ensure that future market events and
conditions are consistent with that strategy. If conditions change, the manager would then
evaluate whether any changes are needed to the current strategy.
The forecast as of today is to expect short-term interest rates (one year or less) to rise modestly
over the next year, but not necessarily in a straight line. Rates in the one to five year range are
likely to increase as well.
Any forecast contains many assumptions. The most important assumption for the next six
months to one year involves geo-political risk. If tensions rise between East and West or
significant events such as an invasion of Ukraine were to occur, the effect on financial markets
would very likely be swift and significant. Rather than rising rates, we would actually see lower
interest rates. This is because investors worldwide would be seeking safety for their money,
and US Treasury bills are the safest investment in the World. A sharp increase in demand for
Treasury bills means higher prices, and thus, lower yields. It is possible that the one-year
Treasury bill could actually have a negative yield (meaning that investors would PAY the US
Government to keep their money for some period of time.) It has happened in the past, and
could occur again.
Given the amount of uncertainty in the current environment, a prudent investment strategy is to
hold only the safest investments, maintain a relatively low average maturity (one year or less),
and wait to see what trends develop over the next year. This may result in slightly less interest I
income to the agency, but it lessens the risk of market value losses and the resultant volatility in
overall holdings.
One other factor in municipal investing is the changes to money market funds that are being
promulgated by the US Securities and Exchange Commission (SEC). Briefly, most money
market funds currently have what is known as a Stable Net Asset Value (NAV). This means
that the price of the fund is pegged at $1.00. The $1.00 NAV applies when you purchase
shares in a fund. It also applies when you withdraw money (sell your shares.) The NAV does
not change, even if the underlying value of the securities in the fund drops below $1.00. The
change mandated by the SEC will require funds to adopt and apply a Floating NAV. It would
also severely restrict the amounts allowed to be invested in Commercial Paper, thus restricting
the yield of the Fund. As a result, if an Agency deposits monies in a money market fund, and
the NAV drops below $1.00, the Agency would incur a loss when they elect to withdraw funds
(again, sell shares.) Even though the resulting loss would likely be very small, it is still a big
change from what investors are accustomed to in these markets.
These changes are just now being implemented. It will take some time to evaluate the effects
of these new rules. However, it will likely mean that investors will seek alternative investments
to avoid those risks of loss. This trend, in and of itself, could cause the money market funds to
experience significant outflows of monies, which would put further pressure on their NAV's.
This is an issue that investment managers will be following closely in the coming year.
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