Feature Articles and Resources

• Investment Strategies for the Current Economy
  
• Developing a Successful Investment Program
  
• Washington Update
  
• Share Your Expertise
  

• Panel of Economists: Economic Outlook
  
• Interest Rate Outlook
  
• Snapshot of Economy and Interest Rates

• Performance Benchmarks
  • 10-Bill Index
  • Money Market Fund Index
  • LGIP Index
  • Key Rates: Cash Markets
  • Relative Value Yield Chart

Investment Strategies for the Current Economy

By Byron Gehlhardt

Current Environment

Moderation reigns supreme as inflation has shown signs of ebbing and the economy has strengthened over the first half of 2007, even though the economy is still performing below its potential. Federal Reserve Chairman Ben Bernanke's recent testimony before Congress predicted that core inflation (inflation excluding volatile sectors such as energy and food) would move lower over the remainder of the year. The Fed has sought to rein monthly core inflation increases into a targeted 1 percent to 2 percent range and wants the focus to remain on this issue.

Economic growth is seen as strong; however, concerns remain about subprime mortgage market woes spreading into other segments of mortgage lending, such as the “Alt-A” segment. The credit troubles in the subprime market received significant press coverage as they crippled several hedge funds and scared investors in other fixed-income markets. Both consumers and businesses have begun to feel the initial tightening of credit driven by the subprime issue. Mortgage rates have inched upwards and banks have become more careful with lenders. Consumers are feeling the squeeze as adjustable rate mortgage loans are resetting upwards and replacement loans are priced even higher.

Investment Strategies

The Fed continues to maintain its policy stance that, “incoming data have supported the view that the current stance of policy is likely to foster economic growth and a gradual ebbing of core inflation.” While the mortgage finance and home price issues remain concerns, robust global growth will buoy the US economy in the near term.

The following are some approaches for this economic climate.

• The market adjusted its expectations of future fed funds rates, pushing expectations of an easing into early 2008. A gentle steepening occurred in the money market curve and has created an opportunity for investors to extend into three- to six-month paper and receive additional compensation. A short-to-neutral duration bias has a greater potential for outperformance since there appear to be more risks leading to an economic slowdown than an inflation increase. This duration stance better prepares the treasury manager for a more stable fed funds environment.

• A barbell strategy focusing on securities within a three-month maturity range remains an attractive strategy. On the other hand, floating rate securities are not attractive investments since they have not become cheaper during the repricing of the money market curve. Specifically, assets with a maturity of less than 3 months generally trade at a LIBOR spread, which have been more attractive than floating rate assets that reset off reference rates indexed to LIBOR. In addition, limited exposures to callable structures in the six- to 12-month maturity range can provide some insurance against the remote chance of a hike in rates.

Byron Gehlhardt is a portfolio manager for MBIA Asset Management Group. The opinions expressed in this article are solely those of the author, are based on sources of information believed to be reliable, and are subject to change without notice.

Developing a Successful Investment Program

By Ryan K. Nelson, CFA

From the corner office to the public office, business leaders everywhere are seeing a greater emphasis on ethics and compliance issues. Public finance officials have felt the impact of this trend, reporting that both their decisions and investments are facing greater levels of scrutiny. As the scrutiny on these investment mounts, so does the pressure to find sources of revenue to combat budget deficits and cost overruns. The result is a difficult balancing act for public officials, who must maximize interest earnings on their investments while staying within the ethical and structural bounds of public fund investing. Certainly, it is no easy task, but there are some proactive steps you can take to help avoid becoming part of tomorrow’s headlines.

Establishing a SMART Investment Process. Fortunately, public fund investors are given guidance in the form of an investment policy. This document provides a detailed framework of eligible investments and outlines your entity’s investment objectives and constraints. While this is a valuable starting point, it certainly doesn’t provide all the answers. This document will not tell you exactly which investment to choose nor will it tell you how much to purchase. Similarly, it will not tell you when to invest, how long to invest, or with whom to invest.

For these reasons, you need to establish criteria for your evaluation process to help answer these questions. By considering a few key criteria, you can dramatically improve your investment process and avoid some common pitfalls. To make these easier to remember, here is a simple acronym to help determine if you are making a SMART investment decision:

• Suitability – Does this investment have a suitable risk/return profile for my entity?
  
  
• Maturity – When does the investment mature?
  
  
• Appropriate – How will the individual investment impact my investment portfolio as a whole?
  
  
• Rate – What level of yield does the investment offer?
  
  
• Time Horizon – Does the investment make sense within the context of my cash flow needs?

Identifying a Qualified Investment Provider. When evaluating the various investment options, you also should be performing due diligence on the investment professionals offering these services to your entity. In the investment world, there are market specialists and market generalists. Some of these investment professionals perform in-depth investment analysis and offer investment advice, while others are sales professionals promoting their products. Before deciding to work with a particular investment professional, carefully research their background.

For a Broker/Dealer:

• Obtain an NASD background report on the individual
  
  
• Verify their employment history
  
  
• Determine any discipline or complaints of misconduct
  
  
• Seek additional information at www.nasdbrokercheck.com.

You should also ask about any special education, training, and experience that the investment professional has that would qualify him/her to invest public monies. Specifically, with investment advisors, determine whether the investment professional has obtained the Chartered Financial Analyst (CFA) designation. CFA charterholders are required to have mastered a rigorous curriculum in investment management and are required to adhere to a strict code of ethics and professional code of conduct.

Competitive Bidding. Once the investment decision has been made, best practice is to use competitive bidding to execute the purchase or sale. Doing so allows you to demonstrate that your entity has taken a proactive approach to ensure that it is receiving the best price or yield on a security. In addition, this process protects the entity against any claims of favoritism.

Even if you are a smaller entity that primarily invests in certificates of deposit you should be obtaining competitive bids from more than one banking institution. You then have the necessary information to make a qualified investment decision. If you are an entity who uses only one or two sources for your investment needs, you should at least check the quotes you receive against comparable quotes published in some type of financial publication or online resource to verify that you have received the best execution.

Investment Reporting. Investment reporting comes in many flavors and varieties, so it is important to take some time to understand how to interpret each report. A broker will provide a monthly statement that shows what is being held at the brokerage firm, which typically includes each holding’s market value. The broker also may provide additional reports such as an Excel spreadsheet if requested.

If you deal with an investment advisor, reporting can vary widely, from simple Excel spreadsheets to more comprehensive reporting and investment detail. Many times, investment advisers have sophisticated software that allows them to run customized reports to suit your entity’s unique needs. When using an investment adviser, you will likely receive a statement from the custodian as well since the investment adviser will not typically be the safe keeper of your investments.

Another critical aspect of investment reporting is making sure your investment provider can provide you with accurate and timely reporting. As protection for the public finance officer as well as the entity, it is necessary to report on the investment holdings in a timely and effective manner.

You should refer to your entity’s investment policy on specific investment reporting requirements, but generally, your investment reports should include the following information:

• Name of the Investment
• Quantity of the Investment
• Cost of Investment
• Market Value
• Maturity Date
• Yield on the Investment

Ryan K. Nelson, CFA, is a director with RBC Public Fund Services. RBC Public Fund Services provides investment management services to public fund clients throughout the United States and is a division of Voyageur Asset Management.

Washington Update

Congress has kept to a busy schedule during the first session of the 101st Congress, aiming to complete all appropriation bills by the end of the fiscal year on September 30. During this session, Congress held hearings on a myriad of issues including various tax proposals, investor protection issues, landmark energy legislation, and education reform. This article will highlight several developments in Washington that are of particular interest to Treasury Management readers.

Tax Offset Program. This spring, the House Subcommittee on Oversight Management, Organization, and Procurement of the Committee on Oversight and Government Reform held a hearing and approved legislation that would create a pilot program allowing for a taxpayer's federal tax refund to be reduced by the amount the taxpayer owes for a past-due legally enforceable local government tax obligation. H.R. 1865, co-sponsored by Congressmen Jim Moran (D-Virginia) and Tom Davis (R-Virginia), would create a pilot program during 2009 and 2010 allowing local governments in three to five states (to be selected from Illinois, Iowa, Louisiana, New York, Ohio, and Virginia) to work through their state government and alert the federal Treasury department of the local past-due tax obligation and have that amount deducted from a taxpayer's federal tax refund and remitted through the state to the local government.

Similar legislation was introduced in past Congresses, but this was the first time a hearing was held on the matter. Testifying on behalf of local governments was Patricia Weth of Arlington County, Virginia, and Mayor Mick Cornett of Oklahoma City, Oklahoma. Both speakers spoke strongly in support of the legislation and emphasized the importance of intergovernmental partnerships. Mayor Cornett asked that the pilot program be expanded to include at least eight states – two from each region of the country – North, South, East, and West.

GFOA members are encouraged to write to their member of Congress and ask them to support H.R. 1865. Additional information and a grassroots form letter are available on the GFOA's Web site.

The legislation is awaiting action by the full committee and was also referred to the House Committee on Ways and Committee. Similar legislation has not been proposed in the Senate.

Withholding of Government Payments to Vendors/Contractors. Last year, Congress passed legislation that requires state and local governments that spend more than $100 million on goods and services to withhold 3 percent of payments to vendors and contractors. The legislation, which would take effect in 2011, also requires governments to report to the IRS all payments that they make to vendors and contractors. The legislation containing these requirements was titled “The Tax Increase Prevention and Reconciliation Act of 2006 (TIPRA).”

State and local governments maintain that the provision is an unfunded mandate and would create enormous financial and administrative burdens. The GFOA along with other national organizations such as the National Association of Counties, the National Association of State Auditors, Comptrollers and Treasurers, the National League of Cities (NLC), and the U.S. Conference of Mayors (USCM) have asked Congress to repeal the provision prior to its implementation.

Bipartisan legislation has been introduced in the House and Senate to repeal this requirement, H.R. 1023 and S. 777, sponsored by Representatives Kendrick Meek (D-Florida) and Wally Herger (R-California) and Senator Larry Craig (R-Idaho), respectively. The GFOA and others are working to add cosponsors to the legislation and are calling on Congress to hold hearings.

In addition to our effort to repeal the legislation, the GFOA and other groups in the public and private sectors are working to avoid the acceleration of the implementation dates for the reporting and the withholding requirements. In his proposed FY08 budget, President Bush called for the reporting requirement to begin in 2008.

To assist with these efforts, GFOA members are encouraged to complete a survey that will enhance our ability to educate Congress on the devastating impact this law will have on state and local governments. The survey for local and state governments may be found online.

Credit Card Fees. While the Senate Banking and the House Financial Services Committees have held hearings on credit card practices, vendor convenience fees have not been a point of discussion. The hearings and subsequent legislation has focused on credit card company practices impacting consumers. The GFOA continues to monitor the issue for any opportunities for a dialogue with the credit card companies, Congress, and the Treasury Department.

Collection on Remote Sales Taxes. On May 22, Senator Michael Enzi (R-Wyoming) introduced the Sales Tax Fairness and Simplification Act , S. 34. The legislation would permit states that have adopted the Streamlined Sales and Use Tax Agreement (SSUTA) to require sellers, including remote sellers, to collect and remit sales and use taxes on all transactions. Currently, more than 20 states have implemented the SSUTA on a voluntary basis. Sellers in those states may elect to collect sales and use taxes in return for simplified sales and use tax law administration.

The GFOA and other local government associations, including NLC and USCM are supportive of federal legislation that allows for collection of taxes on remote sales; however, there is a troubling provision in the legislation that calls for undefined simplification of telecommunications taxes to take place before remote sales tax collection may occur. Such a provision could cause a significant loss of revenue for local governments if they are forced to compromise their taxing and franchising practices. The GFOA will continue to monitor the legislation as it moves through Congress.

SEC Activities. For the first time in over a decade, the chairman and all commissioners of the Securities and Exchange Commission (SEC) testified together before the House Financial Services Committee in June. The four-hour hearing entitled A Review of Investor Protection and Market Oversight, allowed the chairman and commissioners to brief the committee on current projects before the SEC and answer a number of questions from committee members. Most of the hearing focused on possible changes to the Sarbanes-Oxley Act, as well as emerging concerns with hedge fund oversight, and ensuring that U.S. capital markets remain strong in an increasingly globalized economy. Chairman Cox praised the work of the SEC's enforcement division, which includes fighting fraud, improving mutual fund and 401(k) disclosure practices, and enhancing the SEC's Web site to provide easy-to-use data on private companies.

For the remaining months of 2007, Congress will complete its appropriations work, address tax issues (including a small fix rather than wholesale reform of the alternative minimum tax), and focus on national security issues. The GFOA's Federal Liaison Center will continue to monitor movement on the issues mentioned above and other areas that impact state and local governments.

Susan Gaffney is the director of the GFOA's Federal Liaison Center in Washington, D.C.

Share Your Expertise

The GFOA is accepting applications to serve on its seven standing committees:

• Committee on Accounting, Auditing and Financial Reporting;
• Committee on Cash Management;
• Committee on Economic Development and Capital Planning;
• Committee on Governmental Budgeting and Fiscal Policy;
• Committee on Governmental Debt Management;
• Committee on Retirement and Benefits Administration; and
• Committee on Canadian Issues.

Serving on a standing committee is an excellent opportunity for GFOA members to contribute their experience and knowledge to the entire membership. Associate members may apply to serve as advisors on each of the committees.

Committee members meet twice a year—at the Winter Meeting in Washington D.C. (Canadian Committee meets in Canada) and also in conjunction with the GFOA's annual meeting. Committee members also work via conference calls throughout the year on various issues and recommended practices related to their discipline.

Additional information and an application may be found at on the GFOA's Web site . Applications are due by August 17.

Economic Outlook

This month, Treasury Management asked its panel of economists what caused the recent rise in long-term interest rates. We also asked the panelists to provide their forecasts of the economy.

Eugenio J. Alemán of Wells Fargo Bank says that the financial markets have started to realize that the Federal Reserve is not joking when it says they are more concerned with inflation than with economic growth. He notes that, with the weakest quarter of this latest cycle behind us, it is very unlikely that the Fed will lower rates any time soon.

Lacy Hunt of Hoisington Investment Management states that the rise in long-term interest rates was an adverse psychological reaction to an improvement in second-quarter GDP. However, he notes that the underlying conditions of the economy have worsened. For example, the growth in real personal consumption expenditures has slowed due to a softening labor market, lower income growth, falling home prices, and tighter lending standards. In recent years, extraction of equity from homes has generated a huge amount of cash available for spending. That source of consumer cash has largely dried up. Hunt predicts recessionary conditions late this year or early next year. As a result, the already low U.S. inflation rate will decrease.

According to Carl Tannenbaum of LaSalle Bank/ABN-Amro, the rise in long-term interest rates was due to improved economic prospects, which make it very unlikely that the Fed will cut the Fed Funds rate. Inflation remains a risk in the current economy. Tannenbaum predicts steady, 2.5 percent GDP growth for the second half of this year.