Feature Articles and Resources

• How to Be Your Own Investment Adviser: Part 1
  
• Useful Resources to Get Started with Public Fund Investing
  
• Investment Strategies for the Current Economy
  
• Five Essential Items for an Electronic Payments RFP
  

• 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

A 10-Step Plan to Becoming Your Own Investment Adviser: Part One - Preparing to Invest

By Kent R. Austin, CPFO

This article is the first half of a 10-step plan for keeping the investment function “in-house.” The first half presents five steps that a government should take to prepare itself for investing. A second article will present five steps for making investment purchases.

(There are both advantages and disadvantages to hiring an investment adviser or keeping the investment function “in house.” For more on this topic see the GFOA publication An Introduction to Investment Advisers and the March 2007 issue of Treasury Management .)

Before managing your entity’s investments, you should take the following five steps.

• Authorized investments. Identify which investment instruments are permitted and which are prohibited. Be aware that state law may allow items that your own policy does not. (A useful resource for developing an investment policy is the GFOA Sample Investment Policy.) The following is an example of one city’s authorized investments.

  Permitted	Not Permitted
  U.S. Treasury obligations U.S. agency obligations State and other public obligations rated A or above SEC-regulated no-load money market mutual funds	Collateralized mortgage obligations Commercial paper Bankers' acceptances

• Portfolio diversification or asset allocation. Determine if your investment policy sets limits on the proportion of entity holdings in any one type of instrument. These limits are designed to reduce risk by preventing a portfolio from becoming overweighted in any one category. The GFOA’s recommended practice on diversification is a helpful resource. Here is an example of one government's diversification requirements:

  Description	Maximum Percent of Portfolio
  U.S. Treasury obligations	100%
  U.S. agency obligations	60%
  Local government investment pools	50%
  Repurchase agreements	30%
  Certificates of deposit	30%
  Money market mutual funds	15%

• Maximum maturity and weighted average maturity. Investment policies usually prescribe the maximum maturity for any one instrument, and often they establish a maximum weighted average maturity for the entire portfolio. These elements are designed to reduce interest rate risk – the risk that your portfolio will lose value if rates go up – and prevent too much of the portfolio from being tied up in illiquid investments. The GFOA’s recommended practice on managing market risk is a helpful resource on this topic.

• Competitive bidding. Many investment policies require competitive bidding for securities purchases. This requirement is designed to make sure the government receives the best price possible and the broker-dealer does not impose excessive markups. (For more on this topic see the GFOA's recommended practice on securities dealers.) An exception may exist for new issue securities that are sold at the same price by multiple dealers. Online services like Bloomberg or Tradeweb allow investors to view broker-dealer securities inventories directly and select the most attractive instruments.

Step 2: Develop a Cash Flow Worksheet. With the online tools available today, it is possible to know of almost every penny going into and out of an entity’s bank account before it occurs. Two treasury services products are indispensable for this task – online banking software and controlled disbursement. The finance officer should be able to identify online all electronic transactions crediting the account – credit card sales, sales tax receipts, lockbox deposits – as well as manual deposits taken to the bank each day from sources like utility bill payments, traffic fines, and building permits. Similarly, if controlled disbursement accounts have been established, the entity will be able to obtain a “same day balance report” that lists all vendor checks and ACH debits to be posted that day. The GFOA’s recommended practice on cash forecasting is a helpful resource on developing a cash flow worksheet. Another resource is the April 2007 issue of Treasury Management.

Step 3: Evaluate your Entity’s Existing Portfolio. Identify the types of investments your entity currently holds, the dollar value of each category, and the maturity dates for fixed-term investments. Look back over the past three years to identify the portfolio’s high and low points, then graph the data to help determine how much of the total invested balance should remain liquid and how much could be placed in fixed-term instruments. Under normal yield curve conditions, when interest rates increase with time, the portion of the total balance that is not needed for liquidity can be invested longer term to produce more income. In the chart below, the portfolio balance does not fall below $45 million. By backing off this amount $5 million, one could invest $40 million fixed term.

Portfolio Balance

Step 4: Establish Safekeeping and Internal Controls. A third-party safekeeper serves as custodian of your entity’s investment holdings. The custodian is the key element in each delivery-versus-payment transaction, so that your bank releases funds for purchase of a security only after the safekeeper acknowledges receipt of the security from the broker-dealer. Monthly reports of portfolio holdings provide a means of reconciling your ledger account balances, and transaction documentation can often be downloaded from the safekeeper’s Web site.

Internal controls like segregation of duties and co-authorization for wire transfers are essential for prudent investment management. One officer could be in charge of making the investment purchases and placing the orders, while another reviews and acknowledges the transaction and ensures that it aligns with the entity’s investment policy and state law. For more on this topic see the GFOA’s electronic publication “Investment Procedures and Internal Controls Guidelines.”

Monthly Safekeeping Report (excerpt)

Step 5: Select Broker-Dealers. Given the hundreds of broker-dealer firms across the country, selecting who to do business with can seem daunting. Having between five and nine firms is probably right for most entities. Fewer than five limits the information and perspective available, while more than nine is too many salespersons to deal with.

Consider a mix of primary and secondary dealers. Primary dealers are large national firms who may trade directly with the Federal Reserve, must meet minimum capital requirements, and are obligated to make bids and offers when the Fed conducts open market operations. They possess tremendous buying power, expertise, and research capabilities.

Secondary or regional dealers may still be national in scope but not as prominent as primary dealers. Yet they may be just as competitive and may give your account more attention. One way to develop a short list of firms is to talk with colleagues in other entities to learn who they use. Then make contact with these firms to get a sense of their interest in working with you. Have them complete a broker-dealer questionnaire, such as the one available from GFOA, and provide an acknowledgement that they have read and understood your investment policy. The GFOA’s broker-dealer questionnaire is in the GFOA publication, “An Introduction to Broker-Dealer Relations.” Two additional GFOA resources are the recommended practice on securities dealers and the September 2007 issue of Treasury Management.

Kent R. Austin is the director of finance for the City of University Park, Texas, and a member of the GFOA Committee on Cash Management.

Investment Strategies for the Current Economy

By Byron Gehlhardt

In late September, the Federal Open Market Committee (FOMC) cut the federal funds rate by 50 basis points instead of the expected 25. The decision had the desired effect in helping to ease the liquidity crunch that had nearly paralyzed Wall Street in August. The market is hopeful that the Fed will cut rates by at least another 25 basis points by the end of the year to further facilitate lending and shore up liquidity.

While the liquidity crisis has abated, it has left damage in its wake. A number of major Wall Street institutions have revealed significant losses from subprime-related investments. The larger-than-expected rate cut and improving inflation releases clearly indicate that the Fed is now more concerned about slow economic growth than it is about inflation. In its press release after the September 18 meeting, the Fed noted that “readings on core inflation have improved” and it is “monitoring inflation developments carefully.”

Investment Strategies

There has been a clear change in the investment environment since the last quarter. The market’s focus has shifted from inflation watching to combating credit concerns, fighting a flagging housing sector, and preparing for the possibility of another liquidity crunch. The Federal Reserve’s decision to ease rates by 50 basis points has helped bring order back to the market and has also forced a change in how investment managers approach the market.

At this point, it is sensible to maintain a higher concentration than average in short-term positions (overnight to 1 week). Highly-rated commercial paper from money center banks, agency discount notes, repurchase agreements, and highly-rated money market funds are good investments to diversify this exposure. For the near-term, safety and liquidity carry heightened importance until the market fully re-prices the risk and liquidity of certain structured investments.

After ensuring that liquidity needs are met, cautiously extending maturities can pay off. The favorable interest rate curve in the money market arena makes this opportunity possible for longer-term core monies. High-quality bank CDs and direct commercial paper present some opportunities in the six- to 12-month time frame. It should be noted, however, that with an uncertain economic picture, future Fed rate eases are expected.

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.

Five Essential Items for an Electronic Payments RFP

Editor's note: Norman Cummings, the director of administration for the County of Waukesha, Wisconsin, offers the following tips based on the county's recent experience issuing an RFP for electronic payments.

1. Accept both electronic checks and credit/debit payments. Electronic checks typically have lower processing costs.

2. Require that funds be deposited either at the government's bank or at an alternative bank satisfactory to the vendor only if the account is in government's name. This assures fast, safe receipt of funds and minimizes the risk of loss of funds. It also eliminates vendor investment income on collected funds in favor of a clearly calculated fee payment for vendor service.

3. Require that the government's Web site serve as the starting point for electronic payment transactions. In addition, assure that the payment process includes validation of customers' pertinent account information. This provides the customer with a sense of security and limits potential confusion. It assures customers that they are contacting the appropriate government entity and are making payments to the correct accounts.
4. Require encryption of all payment account information and include a process for purging this information as soon as payments are confirmed. This provides the necessary security of customer account data during transactions. If hackers breach systems, there will be no relevant data.
5. Require ability to control convenience fees charged to customers. Your government is in the best position to determine costs and savings (return on investment) in using electronic payments. In addition, you might consider subsidizing some of the cost of convenience fees in initial years to attract customers until the transaction volume offsets costs.

Norman Cummings is the director of administration for the County of Waukesha , Wisconsin, and is a member of the GFOA Cash Management Committee.

Economic Outlook

This month, Treasury Management asked its panel of economists if the Federal Reserve is at the beginning of a new easing cycle. We also asked whether the problems in the housing market are likely to be “contained” or have a widespread impact on the economy. Finally, we asked the panelists to provide their forecasts of the economy.

Eugenio J. Alemán of Wells Fargo Bank says that it is still too early to say if the Fed is at the beginning of a new easing cycle. Alemán believes that the impact of the housing market on the economy will be contained, but cannot rule out some wider effects due to the drying up of the commercial paper market. However, he adds that if the economy continues on its current path, inflationary concerns will return as the Fed's main policy risk, which would make this easing cycle a very short-lived one.

Lacy Hunt of Hoisington Investment Management predicts that the U.S. will be in a prolonged growth recession. A growth recession is when the economy grows at less than its potential growth rate, and thus is unable to provide all entrants into the labor force with a job. Hunt notes that labor market performance has deteriorated this year and the University of Michigan 's consumer sentiment index fell to a 14-month low in early October. Hunt expects that restrictive monetary conditions and greater slack in the labor markets will serve to put additional downward pressure on the inflation rate. Over the next six months, core inflation should ease toward 1.5 percent. In addition, the entire Treasury yield curve should shift downward.