Florida Tax Collectors Association
2014 Spring Education Forum
Fixed Income Security Types
Marco Island
May 5, 2014
Presented by:
Michael R. Varano, Managing Director and Senior Portfolio Manager
varanom@pfm.com
PFM Asset Management LLC
300 South Orange Avenue, Suite 1170
Orlando, FL 32801
© 2013 PFM Asset Management LLC
0
Types of Fixed Income Securities
Money Market
Bonds
•
U.S. Treasury Bills
•
•
Federal Agency Discount
Notes
U.S. Treasury
Notes/Bonds
•
Federal Agency
Notes/Bonds
•
Mortgage Backed
Securities
•
Corporate Notes
•
Mutual Funds
(aka Bond Funds)
•
Commercial Paper
•
Bankers’ Acceptances
•
Repurchase Agreements
•
Certificates of Deposit
•
Money Market Mutual
Funds
Mature in < 1 Year
© 2013 PFM Asset Management LLC
Mature in > 1 Year
1
Credit Ratings
S&P
Moody’s
AAA
Aaa
High quality. Smallest degree of investment risk
AA
Aa
High quality. Differs only slightly from highest-rated
issues.
A
A
Adequate capacity to pay interest and repay principal.
BBB
Baa
More susceptible to adverse effects of changes in
economic conditions.
BB
Ba
Has speculative elements; future not considered to be well-assured.
B
B
Generally lack characteristics of desirable investment.
CCC
Caa
Poor standing. Vulnerability to default.
C
C
Extremely poor prospects.
D
D
In default
© 2013 PFM Asset Management LLC
Explanation of Rating
2
Security Types
U.S. Government
Corporates
•
U.S. Treasuries
• Commercial
Paper
•
SLGS
• Bankers’
Acceptances
•
Federal Agencies
•
Mortgage
Backed
Securities
• Corporate
Notes
Municipals
• General
Obligation
Bonds
• Revenue
Bonds
• Certificates of
Deposit
Repurchase Agreements
Mutual Funds
© 2013 PFM Asset Management LLC
3
U.S. Treasury Obligations
Issuer:
Credit Quality:
Liquidity:
Custody:
U.S. Government
“Risk Free”
High (active market)
Federal Reserve (Book entry)
Type
Term to Maturity
Interest
Price Quotes
Maturity
BILLS
1, 3, 6, 12 months
Interest at Maturity
Discount
(Not equal to yield)
Thursdays
NOTES
2-10 years
Semi-Annual Coupon
Price per $100
BONDS
10-30 years
Semi-Annual Coupon
Price per $100
STRIPS
3 months-30 years
Interest at Maturity
Discount
(Not equal to yield)
© 2013 PFM Asset Management LLC
15th or last day of month
4
Federal Agency/GSE Obligations
Issuer:
Federal agencies
Government sponsored enterprises (GSE)
Credit Quality:
Most are AA+ (S&P) / Aaa (Moody’s)
Most do not carry explicit U.S. Government guarantee (full
faith and credit)
Term of Maturity: 1 day to 30 years
Liquidity:
Generally high, but depends on structure
Custody:
Federal Reserve (Book entry)
Return:
Higher than U.S. Treasury obligations
Caution:
May have complicated structures
May be callable
© 2013 PFM Asset Management LLC
5
Most Common GSE Issuers
• Fannie Mae (previously, Federal National Mortgage Association)
• Federal Home Loan Banks (FHLB)
• Freddie Mac (previously, Federal Home Loan Mortgage
Corporation)
• Federal Farm Credit Banks (FFCB)
• Government National Mortgage Association (GNMA or
“Ginnie Mae”)
© 2013 PFM Asset Management LLC
6
Repurchase Agreements
• An agreement in which an investor buys securities from a counterparty who
agrees to buy the securities back at a later date at an agreed upon price
and rate
• Yield determines the “repurchase price”
Investor
Counterparty
Cash
Transaction Begins
Delivery vs. Payment
Securities
Transaction Ends
Securities
Returned to broker/dealer who
“re-purchases” them
Cash +
Interest
© 2013 PFM Asset Management LLC
7
Repurchase Agreements
Issuer:
Banks and brokerage firms
Credit Quality:
Varies
Term of Maturity:
1 day to several years
Liquidity:
Generally none prior to maturity
Custody:
Book entry (collateral)
Return:
Generally higher than Treasuries
Caution:
Investors should require a third party
custodian
Monitor credit quality of counterparty and
collateral value
© 2013 PFM Asset Management LLC
8
Commercial Paper
Issuer:
Domestic and foreign corporations
Credit Quality:
Investment grade
Term of Maturity:
1 to 270 days
Liquidity:
Moderate to high
Custody:
Depository Trust Company (Book Entry)
Return:
Moderate to high
Caution:
Unsecured promissory note
Bankruptcy risk extends for 90 days after
maturity
May be asset-backed
© 2013 PFM Asset Management LLC
9
Asset Backed Commercial Paper
• CP issued by a special purpose corporation to finance receivables or purchase
assets
• Allows institutions to shift liabilities off of their balance sheets
$++
Special
Purpose
Corporation
(Conduit)
$
$
Investors
$+
Liquidity Provider
Credit Enhancement
© 2013 PFM Asset Management LLC
10
Bankers’ Acceptances
Issuer:
Commercial banks
Credit Quality:
Based on bank rating
Irrevocable obligation of issuing bank
Term of Maturity:
Up to 180 days
Liquidity:
Moderate to high
Custody:
DTC (Book entry) or Physical
Return:
Moderate to high
Caution:
Foreign banks may impose additional credit risks
Time drafts used in international trade.
© 2013 PFM Asset Management LLC
11
Certificates of Deposit
Issuer:
Commercial Banks, Savings & Loans
Credit Quality:
Varies
First $250,000 insured by FDIC*
May be secured by pledged collateral
Term of Maturity:
Greater than 7 days
Liquidity:
Low to moderate
Custody:
DTC (Book entry) or Physical
Return:
Moderate (depends on credit quality)
Caution:
Non-negotiable CDs have withdrawal
penalties
*Passage of Dodd-Frank Wall Street Reform and Consumer Protection Act permanently raises the
current standard maximum deposit insurance amount (SMDIA) to $250,000.
© 2013 PFM Asset Management LLC
12
Corporate Notes
Issuer:
Publicly owned corporations
Credit Quality:
Varies
Term of Maturity:
1 - 40+ years
Liquidity:
Moderate
Custody:
DTC (Book Entry)
Return:
High, depends on credit and structure
Caution:
Unsecured promissory note
Credit analysis required
© 2013 PFM Asset Management LLC
13
How Maturity Impacts Long-Term Returns
• Longer maturities typically generate higher returns over time.
• But, longer maturities experience greater volatility.
Risk/Return of Various Benchm arks
10 Years Ended 3/31/2014
Merrill Lynch Index
Duration
Average
Annual
Cum ulative
10-Year Std. Dev.
Quarters With
Value of
of Annualized
Negative
Return
$100,000,000
Quarterly Returns
Returns
3-Month Treasury Bill
0.22 Years
1.65%
$117,762,461
0.04%
1 out of 40
1 Year Treasury Index
0.99 Years
2.03%
$122,256,503
0.20%
4 out of 40
1-3 Year Treasury Index
1.92 Years
2.48%
$127,741,624
0.73%
7 out of 40
1-5 Year Treasury Index
2.72 Years
2.96%
$133,875,703
1.57%
12 out of 40
1-10 Year Treasury Index
3.91 Years
3.59%
$142,375,180
3.21%
13 out of 40
Source: BofA Merrill Lynch Indices;
Cumulative values based on $100 million growing at the rate of return of the index; Investors cannot invest directly in indexes.
© 2013 PFM Asset Management LLC
14
Money Market Funds and Pools
The History of Money Market Funds
• Money market funds are a type of mutual fund developed in the 1970s as an option for
investors to purchase a pool of fixed income securities that generally provided higher
returns than interest-bearing bank accounts.
• They have since grown significantly and currently hold more than $2.9 trillion in assets,
the majority of which is in institutional funds.
• Under Investment Company Act Rule 2a-7, these funds must limit their portfolio
investments to high-quality, short-term debt securities and are mandated to have a
weighted average maturity of <60 days.
• Unlike other mutual funds, money market funds seek to maintain a stable share price
(typically $1.00) through the use of certain valuation and pricing methods permitted
under Rule 2a-7.
• The typical experience for a money market fund investor is that when they invest a
dollar, they are able to get back a dollar on demand (plus the yield that was earned
during the course of the investment).
• As a result, money market funds have become popular cash management vehicles for
retail and institutional investors.
Other “Money Markets”
Examples of Money Market Securities
• U.S. Treasury Bill & Notes
• Federal Agency Discount Notes
• Federal Agency Floating Rate Securities
– Index – Fed Funds, T-Bills, or LIBOR
• Commercial Paper
• Certificates of Deposit
– Negotiable
– Non-Negotiable
• Bankers Acceptances
• Repurchase Agreements
• Municipal Bonds
• Money Market Funds
© 2013 PFM Asset Management LLC
17
LGIPs vs. RICs
• Local Government Investment Pools (LGIPs)
– Money Market Funds setup by public entities with a common purpose
(i.e. States, Local Governments, School Board Associations).
– These funds are typically managed by in state departments or large Asset
Management Firms
• Registered Investment Companies (RICs)
– Money Market Funds that are registered with the SEC.
• Subject to further regulation
– Can be marketed to a larger client base (not state specific).
– Rule 2a-7 of the Investment Company Act of 1940
© 2013 PFM Asset Management LLC
18
Market Forces Affecting Funds
Money Market Funds
What drives rates for money market securities?
• FOMC - “The Fed”
• LIBOR
• Other supply/demand factors
– (i.e. Flight to quality causes
Treasury Bill yields to fall)
© 2013 PFM Asset Management LLC
20
FOMC - “The Fed”
Federal Open Market Committee
• Led by chair Janet Yellen
• FOMC meets about every 6 weeks to
determine monetary policy.
• Sets Fed Funds Rate- rate at which
commercial banks lend to each other on
an overnight basis.
• Achieves target through Open Market
Operations (the buying and selling of
Treasury securities in market- basically
controlling supply and demand).
© 2013 PFM Asset Management LLC
21
Historic Federal Funds Target Rate
© 2013 PFM Asset Management LLC
22
LIBOR
What is LIBOR?
• “London Interbank Offer Rate”
• Daily reference rate at which banks in this international system
could borrow from each other on an unsecured basis.
• Rates published daily in London by the British Bankers Association
(through a survey of worlds largest banks)
• The most widely used benchmark rate for short-term fixed income
markets and a benchmark for commercial paper and CD’s
© 2013 PFM Asset Management LLC
23
LIBOR
© 2013 PFM Asset Management LLC
24
Disclaimer
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 guaranty of future results. The information contained in
this presentation is not an offer to purchase or sell any securities.
© 2013 PFM Asset Management LLC
25