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ACCEPT THE QUARTERLY INVESTMENT REPORT FOR QUARTER ENDED MARCH 31, 2022
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RECOMMENDATION
It is recommended that the City Council accept by motion the Quarterly Investment Report for the quarter ended March 31, 2022.
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Summary
Pursuant to California Government Code section 53646 and the City’s Investment Policy (Policy No. 17.01.030), the City Treasurer (Chief Financial Officer) is required to provide a quarterly report and certification to the City Council, City Manager, and City Auditor. The Quarterly Investment Report shall include a complete description of the portfolio, the type of investments, the issuers, maturity dates, par value, and dollar amounts invested in all securities, investments, or programs that are under the management of contracted parties, including lending programs. The certification must provide assurances that investments were made consistent with the City’s Investment Policy and that the City will meet its expenditure obligations for the next six months.
The Quarterly Investment Report and Certification for the quarter ending March 31, 2022, are provided as required (Attachments A and B). This report is presented as required and will bring the City current on its reporting requirements. The report has also been posted to the City’s website: <http://www.stocktongov.com/government/departments/adminServices/finInv.html>
The City’s consolidated investment portfolio (market value) was approximately $808 million as of March 31, 2022; this includes the City’s liquidity position, short-term investments and the reserve portfolio (as shown on page 14, Attachment A). The total market value-based earnings for the most recent quarter were ($18,156,387), or -2.25 percent. The market value-based earnings are comprised of interest earned of $1,800,608, a market value decrease of $20,017,871, and the City’s liquid portfolio earnings of $60,876, for the quarter ended March 31, 2022.
DISCUSSION
Background
To comply with state law and city policy, the City is required to present quarterly investment reports detailing the City’s investment portfolio to the City Council, City Manager, and City Auditor. The City also posts monthly transaction reports to the City’s website. The authority of the Council to invest, reinvest funds, sell or exchange securities is delegated to the City’s Chief Financial Officer, who also serves as City Treasurer (Resolution #2021-06-22-1602). Pursuant to the Investment Policy, the City Treasurer may and does delegate some fiduciary responsibility to an outside investment management firm. An investment manager’s fiduciary responsibility is a legal requirement related to registration with the Securities and Exchange Commission under the Investment Advisor Act of 1940.
Due to the specialized services and expertise required to assist the City in the varied investment options available, the City contracted with an experienced investment manager, PFM Asset Management LLC (PFM).
Present Situation
The attached report (Attachment A) details the activities of the quarter ended March 31, 2022, and includes detailed information on the holdings of the City’s portfolio on that date. It consists of a certification (Attachment B) that the assets comply with the requirements of State law and City policy and that there is sufficient liquidity to cover the subsequent six months of budgeted activities.
The attached quarterly investment report has been published online along with monthly reports: <http://www.stocktongov.com/government/departments/adminServices/finInv.html>
Portfolio Balances and Performance
The City divides its investment portfolio into Reserve and Liquid portions with a consolidated market value of approximately $808 million as of March 31, 2022. The Reserve portion represents the long-term assets managed by PFM Asset management and the Liquid part represents funds invested in several accounts (State of California Local Agency Investment Fund, California Asset Management Program, Dreyfus Treasury Money Market) to maintain adequate liquidity and optimize returns. The total returns on the consolidated portfolio for the first quarter of the fiscal year were ($18,156,387) or -2.25%, which includes the change in market value for the reserve portfolio, interest income, (Attachment A, page 26), and the liquid portfolio’s earnings of $60,876. The market value changes in the City’s portfolio are not realized losses. The reduced market value is attributable to the rising interest rate environment, and we will likely continue to see the impacts of that in the portfolio. However, to minimize realized losses from the interest rate changes, City staff works closely with our investment advisors to ensure that securities in our portfolio, are held until maturity, only trading them when doing so involves minimal realized losses, and better positions the portfolio to lock-in future realized gains. The quarterly return valuation includes funds from all activities, restricted and unrestricted, and includes changes in fair market value (unrealized gains/losses). The return is not netted with the expenses of the pool.
The performance of the reserve portion of the portfolio managed by PFM through March 31, 2022, is benchmarked against the Bank of America Merrill Lynch index of 1-5-year government and U.S. issued corporate securities rated A- or better. The benchmark generally reflects the portfolio’s strategy and composition. City staff works closely with PFM to monitor the status of the City’s investment portfolio and its returns. Over the last quarter, the reserve portion of the City’s portfolio outperformed the performance of the benchmark by 0.14%. For the year, the City’s portfolio return was -3.59%, but with the differing composition (described above), outperformed the benchmark by 0.11% (Attachment A, page 26).
During the quarter, as investors revised their expectations for inflation and Federal Open Market Committee interest rate hikes, yields across the curve surged, volatility increased, and credit spreads widened. The Fed’s tightening cycle began with an initial rate hike of 25 basis points (0.25%) in mid-March, while Russia’s invasion of Ukraine increased geopolitical uncertainty. Outperformance relative to the benchmark was due to the portfolio’s shorter average maturity (more defensive duration position). Additionally, the portfolio’s diversification benefited the portfolio’s performance relative to the benchmark. While rising interest rates and widening spreads impacted the market values of the portfolio’s current investments, it also created opportunities to add new securities to the portfolio at substantially higher yields. The portfolio has also added, for the first time, positions in the 5-10 year maturity range, locking in yields above 2.00% over a longer time period. The allocation to this maturity range may continue to grow as yields rise.
The City’s investment portfolio complies with California Government Code 53601. It is invested solely in fixed-income securities (no stock holdings) that, while earning certain rates of interest, gain in market value when interest rates fall and lose market value when interest rates rise. The portfolio’s earnings on a market value basis were negative, as unrealized market value losses due to rising rates were greater than realized earnings. The reserve portfolio yield at cost is 1.15% (Attachment A, page 20) while realizing $1,541,877 of earnings during the quarter (Attachment A, page 27) on an amortized cost basis (this excludes unrealized gains/losses).
While the economic recovery continues on a positive track, several risk factors loom, including high inflation, Fed policy uncertainty, the Russian-Ukraine war, and the ever-present risk of a Covid resurgence. On the economic front, consumer balance sheets remain strong, but sentiment is surprisingly weak. The labor market is very strong, but unfilled jobs are holding back the expansion and supply chain recovery. Inflation remains problematic, but outside of some commodity prices (e.g. energy, wheat, aluminum), should begin to moderate over the balance of 2022. At quarter-end, expectations had risen for one or two 50 basis point (0.50%) Fed rate increases, and a total of 200 to 250 basis point (2%-2.5%) of increases for the year.
While rising interest rates will continue to dampen market values and total return performance, continued reinvestment into the higher yielding environment will increase the City’s interest earnings going forward.
FINANCIAL SUMMARY
There is no financial impact related to the presentation of these reports.
Attachment A - Quarterly Investment Report for the Quarter Ended 3-31-2022
Attachment B - Certification of Quarterly Investment Report for the Quarter Ended 3-31-2022