“Investing The Main Street Way”

1. “Investing The Main Street Way” California Municipal Treasures Association 2007 Annual Conference Long Beach, California May 2, 2007

2. THE PERFECT HUSBAND

3. Key Learning Outcomes • Illustrate a performance measure for “Investing The Main Street Way” • Understanding budgeting “The Main Street Way” • Politics - GASB 31 • Wall Street - Total Return • Main Street – Market Rate of Return

4. Main Street Money Manager “Ladies and gentlemen of the council, I have great news! Our unit of local government is in the top 1% quartile of all professional money managers using the Merrill Lynch 1-3 year Government Index. “We lost only 2.00% of the publics money while our Merrill Lynch benchmark lost 2.50%.”

5. After more then a decade of asking the question-“Do you believe a public fund should manage their money like Wall Street?” I realized that while important difference clearly exist there was no comprehensive study that educated stakeholders/public to what these differences were.

6. A key conclusion from research on my book - Communities are losing millions of dollars each year not through poor investment management or market volatility but through performance measurement practices that are simply irrelevant and which often time confuse the public about the skill and expertise of main street money managers.

7. Public Funds Are Not Pension Funds I.Scope This policy applies to the investment of short-term operating funds. Longer-term funds, including investments of employees' investment retirement funds and proceeds from certain bond issues, are covered by a separate policy. GFOA Sample Investment Policy

8. If public funds are not pension funds then why use pension fund objectives, strategies, and performance measureswhen main street investing?

9. What performance measure is most suited to measure the performance of a public fund?

10. Main Street Investing should be measuring stewardship

11. Stewardship Over What? Stewardship over how well the public fund has balanced or is balancing the need to preserve principal with the want to earn a market rate of return.

12. Is the current Wall Street model of performance reporting consistent with “Investing The Main Street Way”

13. The Policy - Rank The Risk SAFETY % LIQUIDITY % INCOME % Total: 100 %

14. The Policy - Rank The Risk SAFETY 40 % LIQUIDITY 40 % INCOME 20 % Total: 100 %

15. Yet what is the most frequent question asked about the portfolio?

16. Is Performance Reporting Practice Consistent With Investment Policy? “Return on investment is of secondary importance compared to the safety and liquidity objectives described above” GFOA Sample Investment Policy

17. Why Is Performance Reporting Not Consistent With Main Street Practice • Using A Market Benchmark • Peer Group Comparison

18. Characteristics Of A Benchmark • Unambiguous • Investable • Measurable • Appropriate • Specified in advance

19. Market BenchmarksRelevant and Appropriate? Current performance reporting as a Wall Street model places to much importance on one policy objective “return”. Total return performance reporting increases political pressure on Main Street to defend portfolio returns in the context of beating some market index

20. Peer Groups Peer group comparisons provide little relevant insight into the performance between public funds Peer group comparisons increase political pressure to compete for highest returns a practice counter to the spirit of most investment policies

21. CITY OF ME 100mm Portfolio Policy Priorities Safety Liquidity Income Portfolio Holdings 80% MMF 20% Disc Notes Return = 3.00% CITY OF ME TOO 100mm Portfolio Policy Priorities (same) Safety Liquidity Income Portfolio Holdings 20% MMF 80% 1-5 yr Agency’s Return = 4.00% Relevance – No Risk Adjustment

22. CITY OF ME 100mm Portfolio Policy Priorities Safety Liquidity Income Portfolio Holdings 20% MMF 80% 1-5 yr Agency’s Return =3.75% CITY OF ME TOO 100mm Portfolio Policy Priorities (same) Safety Liquidity Income Portfolio Holdings 20% MMF 80% 1-5 yr Agency’s Return = 4.00% Relevance – Community Priorities

23. Peer Group Comparisons Why peer group comparisons are irrelevant • Same policy objectives does not mean same risk • Same size portfolio does not mean same risk • No common standard for reporting returns • Different budgets (established versus new city) • No risk adjusted return is practiced

24. Fiduciary Benchmark Investment Policy Peer Group

25. How A Fiduciary Benchmark Works • Differentiates legal vs. suitable portfolio • Captures all investment policy objective • Uses five components to define suitability • Provides compliance a early warning monitor for potential problems

26. Five Components Of Suitability • Adequate liquidity to meet obligations without needing to sell security • Appropriate level of interest rate risk • Diversified portfolio that also avoids concentration risk • Consist of legal holdings • Earn a market rate of return

27. Main Street Performance Model Static to Dynamic Legal to Suitable Policy Plan Defines Suitability Links Practice To Policy Portfolio

28. Toward Financial Stewardship Policy Rulebook Plan Playbook Stewardship Suitable Portfolio

29. Budgeting “The Main Street Way”

30. “Investing The Main Street Way” And Budgeting • Why have yield included as a investment policy objective • What yield is recommended by GFOA Investment Policy Statement • Market rate of Return • Total Return • What is Main Street’s investment goal • Income • Growth

31. Why Have Yield Included As An Investment Policy Objective • Increase Public Services • Mitigate Tax Burden On Citizens • Help Pay For Government Operations

32. What Yield Is Recommended by GFOA Sample Investment Policy “The investment portfolio shall be designed with the objective of attaining a marketrateofreturn throughout budgetary and economic cycles taking into account the investment risk constraints and liquidity needs. Return is of secondary importance compared to the safety and liquidity objectives” GFOA Sample Investment Policy

33. What is Main Street’s Investment Goal And Standard of Care “Investments shall be made with judgment and care, under circumstances then prevailing, which persons of prudence, discretion and intelligence exercise in the management of their own affairs, not for speculation, but for investment, considering the probable safety of their capital as well as the probable income to be derived.” GFOA Sample Investment Policy

34. Budgeting “The Main Street Way” Why is budgeting a market rate of return method the most suitable standard for balancing preservation of principal with maximizing income.

35. Why Market Rate of Return • Market rate of return more closely approximates the real buying and selling practices of public funds • Market rate of return avoids the extreme volatility of total return • Market rate of return is more predictable then total return.

36. ObservationsTotal Return – Market Rate Return • Neither GASB 31, GASB 40, or GFOA sample investment policy uses total return. • Public funds rarely if ever budget paper gains or losses • Public funds spend coupons making total return difficult at best

37. Source: Stanford Group Company

38. Which Portfolio Manager Produces Optimum Budget With Minimum Principal Risk? • The GASB 31 Portfolio: 3mo duration / 3mo TB • The Total Return Portfolio: 1.80yr / 2yr USTN • The Market Rate Of Return Portfolio: 1.80 / 12 mo moving average 2yr USTN

39. Source: Stanford Group Company

40. Source: Stanford Group Company

41. Conclusions“Investing The Main Street Way” • The key performance focus is on stewardship and demonstrating the portfolio is suitable • Main Street has only one peer Investment Policy • Main Street benchmark Fiduciary Benchmark consisting of all investment policy objectives • Budget using market rate of return

42. STANFORD GROUP COMPANY Stanford Group Company does not guarantee nor make any representation as to the accuracy of any projections, rate of returns or outcome from any information or scenarios presented.