sample slide · 2008 credit crisis liquidity 0.82% 1 year 1.54% 2 year 2.65% 3 year 2.83% 4 year...

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© PFM 1© PFM 1© PFM 1

The Investment Game

PFM Asset

Management LLC

50 South Sixth Street

Suite 2250

Minneapolis, MN 55402

612-338-3535

www.pfm.com

Brian Johnson, Director

Danny Nelson, Senior Managing Consultant

Presented by PFM Asset Management LLC

February 7, 2020

2020 MASBO Winter Conference

© PFM 2

Rates, Yields, and the Curve


A line that plots interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity dates

Rates at the short end of the curve (under 1 year) are directly correlated to the Fed Funds rate established by the

Federal Open Market Committee (“FOMC”); the longer end of the curve typically reflects investor expectations

There are three types of curves: normal/positive, inverted, and flat

Yield Yield

Term to Maturity

Upwardly Sloped

(Normal)Inverted

Term to Maturity

What Is a Yield Curve?

Yield

Term to Maturity

Flat

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A Normal Yield Curve

Forms during market conditions where

investors generally believe that there will be no significant changes to the economy

Longer-term instruments offer higher yields than shorter-term instruments

Period

5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25

Maturity

Yie

ld

0 1 2 3 4

Term Structure of Interest Rates

Normal Yield Curve


A Flat Yield Curve

Indicates that the market is sending

mixed signals to investors

There may be some signs that short-

term interest rates will rise and others that long-term interest rates will fall

Period

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25

Maturity

Yie

ld

Term Structure of Interest RatesFlat Yield Curve


An Inverted Yield Curve

Forms during market conditions where investor

expectations are completely inverse to those

demonstrated by a normal yield curve

Investors assume long-term rates will decline, likely driven by expectations of a slow-down in

economic growth

Historically, certain types of yield curve inversions have signaled a pending

economic slowdown

Period

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22

Maturity

Yie

ld

Term Structure of Interest Rates

Inverted Yield Curve

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10%

15%

20%

25%

30%

35%

40%

Dec-18 Mar-19 Jun-19 Sep-19 Dec-19

Recession Probability

After Steadily Rising for Most of 2019, Recession Probability Has Declined

Source: Wall Street Journal Economic Forecasting Survey, as of 12/31/19.

Improving economic data and a general decline in

uncertainty has led to recession fears fading.


Treasury Yields Have Settled into a New, Lower Range

Source: Bloomberg, as of 1/10/20.

1.53%1.64%

1.84%

2.30%

1.25%

1.50%

1.75%

2.00%

2.25%

2.50%

2.75%

3.00%

3.25%

3M

1Y

2Y

3Y

4Y

5Y

10Y

30Y

Yie

ld

Maturity

January 10, 2020

December 31, 2019

December 31, 2018

U.S. Treasury Yield Curve


Short-Term Yields Dropped Significantly in 2019

Source: Bloomberg, PFM Trading Desk, as of December 31, 2019. Not a specific recommendation. 3-mo CP yield spread based on A1/P1 rated CP index.

1.25%

1.50%

1.75%

2.00%

2.25%

2.50%

2.75%

3.00%

Dec '17 Mar '18 Jun '18 Sep '18 Dec '18 Mar '19 Jun '19 Sep '19 Dec '19

3-month CP 3-month Treasury

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0.50%

1.00%

1.50%

2.00%

2.50%

Dec '16 Dec '17 Dec '18 Dec '19 Dec '20

The Market Expects Little Change in Short-Term Rates

Target rate (mid-point)

Market Projection

Federal Reserve Target Overnight Rate

20173

20184

20193

Source: Federal Reserve and Bloomberg. Market projection based on fed funds futures as of 1/9/20.

Implied probability of a rate cut

by year-end is currently 60%

© PFM 11© PFM 11© PFM 11

10-Year U.S. Treasury Yield

12/31/20193/30/20206/28/20209/26/202012/25/20203/25/20216/23/20219/21/202112/20/20213/20/20220.50%

1.00%

1.50%

2.00%

2.50%

3.00%

3.50%

4.00%

2017 2018 2019 2020 2021

Forward Curve

Forward Curve Implies Steady Rates; Economist Projections Vary Widely

Forecasts sourced from Bloomberg. Only those economists that provided forecasts for all time periods were included.

Economist Projections

© PFM 12© PFM 12© PFM 12

Yield Total Return

Understanding Total Return – Yield vs. Total Return

Percentage rate that expresses an annualized rate

of return at a point in time

Percentage rate that expresses a rate of return

over a specific period (periods less than one year

are un-annualized)

Assumes no change in cash flow, no change in

market value, and reinvestment at the same rate

Takes into account all changes in portfolio,

including interest earnings, market value changes,

reinvestment rates, and all cash flows

Forward- looking number Historical number

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Market values move inversely to interest rates

Total Return = Income + Change in Market Value

Interest

Rates

MarketValue

Interest

Rates

Market

Value

© PFM 14© PFM 14© PFM 14

Interest Rate Risk … Introduction to Duration

Prices and interest rates are related

Market values and rate movements are inversely related (normally)

Longer maturity = greater risk

Duration = Inverse of Yield Movement times Years to Maturity

Interest

Rates

Portfolio

Value

Portfolio

Value

Interest

Rates

© PFM 15© PFM 15© PFM 15

Longer-Term Securities are More Sensitive*(*if bonds had feelings)

Portfolio

Duration

Simultaneous Change in Interest Rates

-2% -1%No

Change+1% +2%

1.00 200,000 100,000 - (100,000) (200,000)

2.00 400,000 200,000 - (200,000) (400,000)

4.00 800,000 400,000 - (400,000) (800,000)

$10 million Portfolio

Changes in Market Value By Duration and Yield

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Duration is measure of how sensitive the price of a bond or other debt instrument is to changes

in interest rates

– A higher duration means a bond’s price is more sensitive to interest rate changes (and vice versa)

– For example, the price of a bond with a duration of 5 years will increase or decrease by 5% when

interest rates move by 1%, whereas a bond with a duration of just 1 year will increase by just 1% when interest rates move by 1%

What About Duration (Time to Maturity)?

An outlook for higher rates typically leads managers to shorten portfolio duration, while an outlook for stable or lower rates will typically lead

managers to extend duration

The greater the time to maturity. . . .

The greater the swings in market value

© PFM 17© PFM 17© PFM 17

Investment Game

Investment performance will be calculated

on a total return basis over a 1-year horizon

Each investment team will be allocated $100

million to invest

The $100 million can be allocated to

investments with maturities ranging from

overnight liquidity investments to five-year

maturity U.S. Treasuries

A minimum of $5 million must be invested in

liquidity investments (you need some money

to pay bills!)

Rules

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© PFM 19© PFM 19

Frozen in Time 25%

Forward Curve(ball) 20%

Step Up 20%

Twist and Shout 20%

2008 Credit Crisis 10%

Happy Days 5%

Scenario Probability

© PFM 20© PFM 20© PFM 20

Team ____________________Investment Allocation

Investment Rules:

– The total allocation must equal $100 million

– A minimum of $5 million must be allocated to the Liquidity bucket

Investment

Maturity

Investment Allocation

($ in Millions)

U.S. Treasuries

Liquidity

1 Year

2 Year

3 Year

4 Year

5 Year

Total

© PFM 21© PFM 21© PFM 21

Current Market Yields (as of 1/15/2020)

0.00%

0.50%

1.00%

1.50%

2.00%

Liquidity 1 Year 2 Year 3 Year 4 Year 5 Year

Maturity

Yields

Current Treasury Market

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SCENARIO: FROZEN IN TIME

Assumes that interest rates do not

change over the next year

Scen

ario

s

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© PFM 23© PFM 23© PFM 23

Froz

en in

Tim

e

Treasury Total Return

MaturityFrozen in

Time

Liquidity 1.56%

1 Year 1.54%

2 Year 1.57%

3 Year 1.57%

4 Year 1.63%

5 Year 1.67%

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0.00%

0.50%

1.00%

1.50%

2.00%


Maturity

U.S. Treasury Yields


Frozen in Time

SCENARIO: FORWARD CURVE (BALL)

Assumes the U.S. Treasury forward

curve (as of 1/15/2020)

Scen

ari

os

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MaturityForward

Curve(ball)

Liquidity 1.56%

1 Year 1.54%

2 Year 1.54%

3 Year 1.54%

4 Year 1.52%

5 Year 1.52%

Forw

ard

Cur

ve

25

0.00%

0.50%

1.00%

1.50%

2.00%


Maturity



Forward Curve(ball)

SCENARIO: TWIST AND SHOUT

Assumes that the Federal Reserve will

aggressively increase short-term interest

rates while intermediate and long-term

rates fall

Scen

ario

s

26

© PFM 27© PFM 27© PFM 27


MaturityTwist and

Shout

Liquidity 2.06%

1 Year 1.54%

2 Year 0.95%

3 Year 1.14%

4 Year 1.94%

5 Year 3.54%

Twis

t an

d Sh

out

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0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%


Maturity



Twist and Shout

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SCENARIO: STEP UP

Assumes that interest rates increase

across the curve

Scen

ario

s

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© PFM 29© PFM 29© PFM 29


Maturity Step Up

Liquidity 2.12%

1 Year 1.54%

2 Year 0.34%

3 Year -0.92%

4 Year -2.17%

5 Year -3.48%

Step

Up

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1.00%

1.50%

2.00%

2.50%

3.00%

3.50%


Maturity



Step Up

SCENARIO: 2008 CREDIT CRISIS

Assumes that interest rates fall to levels

seen during the 2008 credit crisis

Scen

ari

os

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© PFM 31© PFM 31© PFM 31


Maturity2008 Credit

Crisis

Liquidity 0.82%

1 Year 1.54%

2 Year 2.65%

3 Year 2.83%

4 Year 2.85%

5 Year 2.98%

2008

Cre

dit

Cri

sis

31

0.00%

0.50%

1.00%

1.50%

2.00%


Maturity



2008 Credit Crisis

SCENARIO: HAPPY DAYS (1994 Massacre)

Assumes a rapidly growing U.S.

economy, rising inflation expectations,

& increases in the Fed Funds rate

Scen

ario

s

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© PFM 33© PFM 33© PFM 33


Maturity Happy Days

Liquidity 3.32%

1 Year 1.54%

2 Year -2.08%

3 Year -5.99%

4 Year -10.11%

5 Year -14.27%

Ha

ppy

Da

ys

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0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%


Maturity



Happy Days

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© PFM 34© PFM 34© PFM 34

Summary – Total Returns

Frozen in TimeForward

Curve(ball)Step Up

Twist and

Shout

2008 Credit

CrisisHappy Days

Maturity Tsy Tsy Tsy Tsy Tsy Tsy

Liquidity 1.56% 1.56% 2.12% 2.06% 0.82% 3.32%

1 Year 1.54% 1.54% 1.54% 1.54% 1.54% 1.54%

2 Year 1.57% 1.54% 0.34% 0.95% 2.65% -2.08%

3 Year 1.57% 1.54% -0.92% 1.14% 2.83% -5.99%

4 Year 1.63% 1.52% -2.17% 1.94% 2.85% -10.11%

5 Year 1.67% 1.52% -3.48% 3.54% 2.98% -14.27%

© PFM 35

WinnerSelection

© PFM 36© PFM 36© PFM 36

Disclaimers

Any investment advice in this document is provided solely by PFM Asset Management LLC. PFM Asset Management

LLC (“PFM”) is an investment advisor registered under the Investment Advisers Act of 1940. PFM Advisors is a division

of PFM Asset Management LLC. Public Financial Management Inc. is not providing and is not responsible for any

investment advice herein.

This material is based on information obtained from sources generally believed to be reliable and available to the public,

however PFM Asset Management LLC cannot guarantee its accuracy, completeness or suitability. This material is for

general information purposes only and is not intended to provide specific advice or a specific recommendation. All

statements as to what will or may happen under certain circumstances are based on assumptions, some but not all of

which are noted in the presentation. Assumptions may or may not be proven correct as actual events occur, and results

may depend on events outside of your or our control. Changes in assumptions may have a material effect on results.

Past performance does not necessarily reflect and is not a guarantee of future results. The information contained in this

presentation is not an offer to purchase or sell any securities.

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sample slide · 2008 credit crisis liquidity 0.82% 1 year 1.54% 2 year 2.65% 3 year 2.83% 4 year...

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