cash flow analysis in portfolio management january 13, 2011 presented by: carlos oblites, senior...

Cash Flow Analysis in Portfolio Management

January 13, 2011

Presented by:Carlos Oblites, Senior Managing Consultant

PFM Asset Management LLC

PFM

Investment Advisors to the Public Sector

$0

$5 million

$10 million

$15 million

$20 million

$25 million

Liquid 0-1 Years 1-2 Years 2-5 Years

$20

$10

$0

$5

Current Investments

$15

$9

$6$5

Cash Flow Needs

Do Current Investments Meet Cash Flow Needs?

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$0

$5 million

$10 million

$15 million

$20 million

$25 million


$20

$10

$0

$5

Current Investments

$15

$9

$6$5

Cash Flow Needs

Do Current Investments Optimize Earnings?

3

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Investment Advisors to the Public Sector4

How Much Liquidity is Enough?

• Cost of insufficient liquidity

– Delayed payments

– Additional interest costs

– Transaction costs

– Bad press

• Cost of excess liquidity

– Lost investment income

– Bad press

• Understanding cash flow is critical!

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Cash Flows

• Most Crucial Questions

– How much to keep liquid?

= “Will I have it available when I need it?”

– How much to lock up in longer maturity securities?

= “Will I earn a good return it?”

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What to Do?

“I think we’re all in agreement that it’s time to abandon the “waiting for a miracle strategy.”

Earnings

6

Returns

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Approach

• Determine Cash Flow Needs

– Consider all funds

– Determine amount of cash needed for expenditures

– Consider the timing of receipts and expenses

• Categorize your funds

– Funds that needs to be kept liquid

– Funds available to invest longer

= “core balance”

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Cash Flow Information Sources

• Bank statements

• General ledger balances

• Budgets

• Capital project spending

• Investments

8

All Accounts--Historical Cash Balance

January February March April May June

2006 146,653 62,132 128,696 271,752 253,689 91,298

2007 159,316 231,776 233,711 256,840 354,342 172,293

2008 143,452 312,719 398,301 334,999 335,778 206,748

2009 311,183 322,314 411,459 372,365 479,918 279,289

2010 302,354 382,075 627,762 352,203 523,190 378,193

July August September October November December

2006 142,743 238,846 155,024 157,220 41,327 131,154

2007 270,991 155,720 259,047 301,516 97,385 171,371

2008 269,545 254,939 252,113 262,490 150,764 187,172

2009 234,185 384,253 333,707 357,302 243,477 233,042

2010 270,991 155,720 259,747 301,516 97,385 171,371

PFM


Sample Cash Flow Report

(in $1,000’s) July August September OctoberRevenues

Tax receipts 10,000 4,000 300 0 Investment income 350 50 100 150 Other income 1,000 400 10 15 Total Revenues 11,350 4,450 410 165

Expenses

Accounts Payable 500 0 0 3,000 Insurance Premiums 0 1,000 400 3,000 General Admin. 75 65 65 75 Total Expenses 575 1,065 465 6,075

Monthly Net Cash 10,775 3,385 (55) (5,910)Beg Balance 2,000 12,775 16,160 16,105End Bal 12,775 16,160 16,105 10,195

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Macro Forecasting Process

Analysis of Historical Monthly Cash Flows

5,000,000

10,000,000

15,000,000

20,000,000

25,000,000

30,000,000

35,000,000

40,000,000

Jan-

99

Apr

-99

Jul-9

9

Oct

-99

Jan-

00

Apr

-00

Jul-0

0

Oct

-00

Jan-

01

Apr

-01

Jul-0

1

Oct

-01

Jan-

02

Apr

-02

Jul-0

2

Oct

-02

Jan-

03

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Computation of Growth

• Fund balances sometimes show growth trends

Historic Monthly Balance Average Portfolio Growth

Analysis of Historical Monthly Cash Flows

5,000,000

10,000,000

15,000,000

20,000,000

25,000,000

30,000,000

35,000,000

40,000,000Ja

n-99

Apr

-99

Jul-9

9

Oct

-99

Jan-

00

Apr

-00

Jul-0

0

Oct

-00

Jan-

01

Apr

-01

Jul-0

1

Oct

-01

Jan-

02

Apr

-02

Jul-0

2

Oct

-02

Jan-

03

Average Monthly Increase: $205,118Historic Annual Growth Rate: 9.9%

11

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Balance Projections

• Historic data can be used to predict future investable balances

Actual Monthly Balances Projected Monthly Balances

Projected Portfolio Growth

5,000,000

10,000,000

15,000,000

20,000,000

25,000,000

30,000,000

35,000,000

40,000,000

45,000,000

Jan-

99

May

-99

Sep

-99

Jan-

00

May

-00

Sep

-00

Jan-

01

May

-01

Sep

-01

Jan-

02

May

-02

Sep

-02

Jan-

03

May

-03

Sep

-03

Jan-

04

May

-04

Sep

-04

Jan-

05

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Core Portfolio

• Most governments have a “core” or stable portion of the portfolio

Analysis of Portfolio

5,000,000

10,000,000

15,000,000

20,000,000

25,000,000

30,000,000

35,000,000

40,000,000

45,000,000

Jan-

99

May

-99

Sep

-99

Jan-

00

May

-00

Sep

-00

Jan-

01

May

-01

Sep

-01

Jan-

02

May

-02

Sep

-02

Jan-

03

May

-03

Sep

-03

Jan-

04

May

-04

Sep

-04

Jan-

05

Historical Liquid FundsHistorical Core Funds

Projected Liquid FundsProjected Core Funds

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How to Invest it?

• Determined by:

1. Cash flow needs

2. California Government Code

3. Investment policy

4. Investment objectives

5. Current market conditions

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Key Investment Objectives

Protect principal Provide necessary

liquidity to cover both ongoing and

unexpected cash needs

Maximize earnings recognizing need for safety and liquidity, and subject to

restrictions specified by Government Code and the local governing body

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And If These Are Bond Proceeds?

1. Determine if issue will meet spend-down exceptions per arbitrage rebate regulations

2. Identify investment options (legal, bond covenants, policy)

3. Formulate investment strategy based on rebate status

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Selecting Maturities for Project Funds

• Things to consider:

– What is the project schedule?

– What are future rate expectations?

• Does it make sense to buy longer investments if interest rates are rising?

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Selecting Maturities for General Funds

• Things to consider

– Are there any investment restrictions?

– What is your target average maturity?

– What is your benchmark to measure performance?

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• Before you buy, you must make sure that the investments comply with your public agency’s preferences.

– Social issues

– Prior history with particular investment

Additional Considerations

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Specific Goals

• Assure steady income stream = Enhance portfolio yield

• Grow the portfolio value = Enhance portfolio total return

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Risk and Return of Different Duration Targets

© 2011 PFM Asset Management LLC 21

Risk/Return of Various Benchmarks10 Years Ended 12/31/2010

Merrill Lynch Index DurationOverallReturn

CumulativeValue of

$50,000,000

Quarters WithNegativeReturns

LAIF 0.50 Years 2.85% $66,225,462 0 out of 40

1 Year Treasury Index 0.99 Years 3.16% $68,230,632 3 out of 40

1-3 Year Treasury Index 1.85 Years 3.92% $73,448,512 5 out of 40



PFM


Target: Average Maturity or Duration

0.75

1.25

1.50

1.75

2.00

Time

yea

rs

High Average Maturity Band

Low Average Maturity Band

Target

22

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Implementation

• Based upon expected cash flows and investment policy, four decisions must be made:

– Sector selection

– Credit quality

– Average maturity or duration

– Maturity position (yield curve strategy)

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• Once you know your target duration, choose a portfolio structure that will capitalize on market conditions.

– Match cash flows exactly—great for most liquid portions of portfolio

– Laddered

– Bullet

– Barbell

Maturity Positioning

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$0

$5 million

$10 million

$15 million

$20 million


$15

$9

$6$6

Current InvestmentsCash Flow Needs

$6 $6

$15

$9

Portfolio Structure: “Match Cash Flows Exactly”

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Portfolio Structure: “Laddered”

$0

$5 million

$10 million

$15 million

$20 million

0-1 Yr 1-2 Yrs 2-3 Yrs 3-4 Yrs 4-5 Yrs

$12 mm $12 mm $12 mm

$0 $0

Laddered

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Portfolio Structure: “Bullet”

$0

$5 million

$10 million

$15 million

$20 million

$25 million

$30 million

$35 million

$40 million

0-1 Yr 1-2 Yrs 2-3 Yrs 3-4 Yrs 4-5 Yrs

Bullet$36 mm

$0 $0 $0$0

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Portfolio Structure: “Barbell”

$0

$5 million

$10 million

$15 million

$20 million

$25 million

$30 million

$35 million

$40 million

0-1 Yr 1-2 Years 2-3 Years 3-4 Years 4-5 Years

$18 mm

$0

$18 mm

$0 $0

Barbell

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U.S. Treasury Yield Curve

3m 2y 5y 10y 30y

Time to Maturity

Yield

Yield Curves: “Positively Sloped”

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Time to Maturity

Yield


3m 2y 5y 10y 30y

Yield Curves: “Inverted”

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3m 2y 5y 10y 30y

Time to Maturity

Yield

Yield Curves: “Flat”

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Actual U.S. Treasury Yield Curves

32

11/3/2010 1/4/2011 Change

3 month 0.12% 0.13% + 0.01%

6 month 0.15% 0.18% + 0.03%

1 year 0.20% 0.26% + 0.06%

2 year 0.33% 0.62% + 0.29%

3 year 0.47% 1.02% + 0.55%

5 year 1.11% 2.01% + 0.90%

10 year 2.57% 3.33% + 0.76%

30 year 4.04% 4.41% + 0.37%

U.S. Treasury Yield CurveNovember 3, 2010 vs. January 4, 2011

Source: Bloomberg

Fed holding short rates near zero

What structure does this environment call for?

PFM


Yield Curve Getting Steep Once More

291 bps

271 bps

Source: Bloomberg

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Source: Bloomberg

Treasury Yields Rebound From Record Lows

1.17%

0.33%

0.62%

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• Determine how much is liquid, how much is core

• Reduce unnecessary liquidity—but mind the current environment

• Keep communication lines open with all parties involved:

– Project Manager

– Investment Manager

– Budget Manager

• After ensuring safety and correct liquidity level, invest it!

Optimize!

Key Concepts

35

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• Questions?

Cash Flow and Investing

36

Insufficient Liquidity

Risky InvestmentsVolatile Markets

Bad Returns

cash flow analysis in portfolio management january 13, 2011 presented by: carlos oblites, senior...

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