Hornsby Shire Council

Attachment to Report No. CC25/09 Page 0

 

 

Council Investment Strategy

March 13

2009

This document outlines Hornsby Shire Councilís Strategy for the investment of surplus funds.

Version 1.1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 


 

Investment Strategy

 

Investment Objectives

 

The purpose of this Strategy is to establish the risk management framework that Hornsby Shire Council adopts in investing surplus funds that are not required to meet immediate operational and capital expenditure.The overall investment objective of Council is to ensure the security of investments through the prudent management of investment risks while maximising returns.

 

Council therefore has two primary objectives for its investment portfolio:

†† The preservation of the amount invested; and

†† To generate income from the investment that exceeds the 11 am cash rate from time to time.

Authority for Investment

All investments are to be made in accordance with:

†† Local Government Act 1993 - Section 625;

†† Local Government Act 1993 - Order (of the Minister) dated 31 July 2008;

†† The Trustee Amendment (Discretionary Investments) Act 1997 Ė Sections††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††††† 14A(2), 14C(1) & (2);

†† Local Government General Regulation 2005; and

†† Department of Local Government Circular 08-48.

†† Hornsby Shire Council Investment Policy

 

Implementation

This Investment Strategy sets out the intended approach to investments in market conditions that are expected to prevail over the medium to long term investment horizon.However, there will be periods, sometimes sustained, where ďnormalĒ market conditions do not apply.For example, periods where short term interest rates are higher than long term interest rates, or investments of similar credit quality offer different yields due to liquidity differences.In these circumstances, the investment approach taken at a given point in time may vary from strategy. Where this occurs, it is incumbent on Councilís advisors to explain the rationale for this variation as part of its recommendations to the Council executive and/or elected Councillors.

Investment Management Practices

The following investment management practices will be undertaken with the applicable outcomes and objectives in mind.

Risk Area

Outcomes & Objectives

Investment Policy Compliance

The portfolio is at all times compliant with Councilís Investment Policy and relevant regulation pertaining to Local Government.

Liquidity

Under this Investment Strategy, Council shall at all times maintain sufficient funds in ďWorking CapitalĒ to meet the anticipated liabilities of Council for the following 90 days.

In addition, sufficient capital shall be retained in Short Term Assets to meeting Councilís funding requirements, net of anticipated borrowings, for the following 3 to 12 month period.

Medium and long-term investments will have varying degrees of liquidity.An early exit from these investments may result in incurring penalties.

Regular reviews of Councilís allocation to these investments relative to Councilís underlying investment horizons should minimize the risk of having to exit an investment in adverse market conditions.Exposure to medium and long-term investments will be limited to the proportion of the portfolio identified for these investment horizons.

Security

Working Capital Funds, Short Term Funds and Short Ė Medium Term Funds (as defined in this document) are to be invested to target capital (principal) security over their nominated investment horizon to an extremely high probability level.Medium Term Funds and Long Term Funds (as defined in this document) are to be invested to target capital (principal) security over their nominated time horizon, and assuming they are held to maturity, to a high probability level.

This is achieved through investing in products of minimal credit risk and matching term to available investment term. Where possible, investments with external guarantees are preferred.

 

Income

As a minimum that Councilís requirement for investment income as quantified in operational budgets is provided for.

Total Return

Having provided for liquidity, security and income needs, total returns on Council funds are maximized with the view of achieving the stated investment objective.

Risk Management

All investments carry a trade-off between risk, liquidity and return.Further, risks can either be amplified or reduced when investments are combined within a portfolio.To address these risks the following mechanisms are in place:

†† Councilís investment policy is the key risk control document.This will be complied with at all times.

†† Council has determined a list of Investment Types that may be used for Council funds.These are set out in the table under ďPortfolio ConstructionĒ.

†† Council will manage its Counterparty risk by limiting the amount invested in any one financial institution to no more than 30% of the total portfolio balance.

†† Council will receive professional assistance with evaluation and monitoring of longer term investments to ensure they will meet Council needs.The advisor shall also assist Council to ensure that the commercial terms on which Council is offered investments by fund managers, issuers and brokers is fair and reasonable.

†† Council will be limited to investing with financial institutions that have an Australian Banking Licence and are regulated by the Australian Prudential Regulation Authority (APRA).

†† Council will receive professional assistance with portfolio construction so that:

8†† The overall risk of the portfolio can be appropriately assessed.

8†† The portfolio can be adjusted over time as circumstances warrant.

8†† Regulatory changes are accommodated.

8†† This Investment Strategy can be properly reviewed from time to time and recommendations made for improvement where required.

 

Portfolio Construction

The Investment Strategy shall be developed to support Councilís investment objectives for liquidity, security and return.

Councilís investment portfolio strategy shall be built around allocation of Council funds into appropriate categories based on time horizon of investment.Within each time horizon, funds shall be allocated amongst approved investment types.The investment categories, and approved forms of investment within each, are set out in the following table.

 

 

 

 

 

 

Investment Category & Net Performance Target

 

Investment Horizon

Investment Types

Comments

Benchmark

Working Capital

Cash Rate

 

0-3 months

11 am call accounts

Term deposits in ADIs

TCorp cash facility

 

Funds need to be available at short notice.

With exception of call account funds should be diversified to take advantage of the Federal Government Deposit Guarantee and minimise counterparty risk.

11am Indicative Cash Rate

Short Term Funds

>benchmark

 

3-12 months

Term deposits in ADIs

Should be diversified to take advantage of the Federal GovernmentDeposit Guarantee and minimise counterparty risk.

11am Indicative Cash Rate

Short-Medium Term Funds

>benchmark

 

1-2 years

Term deposits in ADIs

Should be diversified to take advantage of the Federal GovernmentDeposit Guarantee and minimise counterparty risk.

11am Indicative Cash Rate

Medium Term Funds

>benchmark

 

2-5 years

Capital Guaranteed Structured Products

 

Collateralised Debt Obligations

 

TCorp Long Term Growth Facility

 

Currently suspended Ė hold to maturity

 

 

Currently suspended Ė hold to maturity

 

UBSA Bank Bill Index

 

 

 

UBSA Bank Bill Index

 

 

Morningstar Growth Net Fund Median

Long Term Funds

>benchmark

 

5 years plus

Capital Guaranteed Structured Products

 

Collateralised Debt Obligations

 

TCorp Long Term Growth Facility

 

Currently suspended Ė hold to maturity

 

 

Currently suspended Ė hold to maturity

 

UBSA Bank Bill Index

 

 

 

UBSA Bank Bill Index

 

 

Morningstar Growth Net Fund Median

 

Allocation of Funds

The Target Asset Allocation (TAA) will be determined by Council from time to time having regard to the economic conditions that are prevalent.The following table outlines the present TAA adopted by Council.The TAA will be established between the minimum and maximum allocation range shown in the table below.

 

 

 

Investment Category

Investment Horizon

Minimum Allocation

Maximum Allocation

Working capital funds

0-3 months

10.0%

100.0%

Short term funds

3-12 months

20.0%

100.0%

Short-Medium term funds

1-2 years

0%

70.0%

Medium term funds

2-5 years

0%

50.0%

Long term funds

5 years

0%

25.0%

 

 

Rebalancing

Each investment category will be re-balanced back to the target asset allocation weight at least quarterly.The tolerance range outside of the target asset allocation is reflected in the table below.

Investment Category

Tolerance range outside of target asset allocation

Working capital funds

+ 10.0%

Short term funds

+ 10.0%

Short-Medium term funds

+ 7.5%

Medium term funds

+ 7.5%

Long term funds

+ 5.0%

Benchmarking and Monitoring

Each investment in the portfolio is to be evaluated and monitored against a performance benchmark appropriate to the risk and time horizon of the investment concerned.The objective is to ensure that all investments considered can deliver a level of return commensurate with their risk profile and that they are competitive with an appropriate peer group of alternative investment options.

The performance of each investment will be assessed against the benchmarks listed in the table below.It is Councils expectation that the performance of each investment will be greater than or equal to the applicable benchmark.

 

Investment

Performance Benchmark

Cash/Term Deposits

11am Indicative Cash Rate

Cash Enhanced Funds/ FRNís, CDOís, Capital Guaranteed Products

UBSA Bank Bill Index

NSW T-Corp Long Term Growth Facility

Morningstar Growth Net Fund Median

 

 

 

 

Ministerís Order

Following the release of the Cole Report in April 2008, the Department of Local Government issued Circular 08-10 advising that the NSW Government has adopted all 8 recommendations. These recommendations can be summarised as follows:

8†† All investment instruments be defined to include principal and interest income

8†† Grandfather the right to retain existing investments that will no longer be eligible

8†† Exclude manufactures and distributors of investment products from acting as investment advisors to councils

8†† Suspend councilís right to utilise specific credit ratings until December 2009

8†† Retain a partial deregulation model for governing local government investments

8†† Ensure councils are better aware of their investment obligations

8†† Tighten the current Ministerís Investment Order to limit investment options

8†† Issue investment policy guidelines for councils

 

Given the grandfathering provisions contained in the Department of Local Government Circular 08-10 Council is not enforced to rebalance existing investments nor dispose of non-compliant investments if significant losses could be realised. Given the current economic climate and recent market valuations of structured financial products Council has determined that liquidation is not economically viable and has elected to hold these to maturity for the moment. Council will continue to monitor performance and seek regular valuations and advice from its investment advisor. Should favourable conditions return Council will look towards liquidation if losses can be guaranteed to be minimised.

 

Federal Government Deposit Guarantee Scheme

In November 2008, legislation was passed by the Australian Parliament to guarantee a range of deposit products and other securities up to and including $1 Million for a period of 3 years with Approved Deposit-taking Institutions (ADIís). This mirrors other schemes internationally.

Council will seek advice on the conditions and implications of the Guarantee schemes and prioritise investments supported by external guarantees.

 

Current Investment Portfolio

 

Financial Markets

 

The second half of 2008 was a period of severe stress in financial markets; a rapidly deteriorating macroeconomic outlook saw credit markets factor in significant write-downs and equity indices fall to multi-year lows. The events to date follow on from the bursting of the US housing bubble in 2007, which set off a long chain of global events culminating in the greatest financial crisis since the Great Depression. The failure of Lehman Brothers and the US Federal Reserveís reversal of their Ďtoo big to failí strategy Ė set off a cascade of market freeze ups and corporate bankruptcies.

 

As concerns grew over the depth of the underlying problems in these markets, trading in structured financial products effectively stalled and the lack of willing investors in the market drove down the deterioration of the capital value of these securities. The lack of investor confidence in markets also flowed over from credit markets into the stock markets causing equity prices to fall.

 

 

Portfolio Mix at 31 January 2009

 

 

Although councilís investment portfolio did not directly purchase any US sub-prime mortgage backed securities, the markets reacted on a global basis and the Council was not immune from the impact of the credit crisis and the decline in equity markets. Council from mid 2007 shifted its strategy as it became evident that the market volatility was not going to correct itself in the short term. This shift in strategy has been towards cash/term deposits which now represent 50% of the total portfolio while compared to July 2007 cash represented 12% of the total portfolio.Managed funds at July 2007 represented 33% of the total portfolio and were subsequently liquidated due to on-going volatility and uncertainty that was evident in respect of equity markets.

 

 

 

 

 

 

Analysis Of Investment options

 

The Revised Ministerial Investment Order dated 31 July 2008 limits new investment options until 31 December 2009 to

††† Term Deposits with Approved Deposit-taking Institutions (ADIís)

††† Other ADI securities that must rank equally with APRA regulated deposits

††† Investments with NSW Treasury Corporation (T-Corp)

 

Cash/Term Deposits (50%)

 

Councilís portfolio has around $16.6M (50%) invested in cash/term deposits, one of the basic investment types still allowed following the release of the Cole Report.

Given the interest rate risk inherent in an RBA rate hiking environment, Council will restrict the term of these deposits to fairly short term durations.

 

Deposits in ADIís up to $1M automatically qualify for the Federal Government Deposit Guarantee which will be utilised. Many institutions are offering attractive spreads given alternative funding constraints which should see Council realise above published rates.

 

Floating Rate Notes (6%)

 

Councilís portfolio contains $2M (6%) of floating rate notes. Given its current yield, the investment remains an attractive one compared to redeeming at the unwind price and reinvesting.

 

T-Corp Long Term Growth Facility (3%)

 

Councilís portfolio contains $859K (3%) of Treasury Corporation managed funds. These funds will continue to be monitored in respect of performance; however returns in recent years have been volatile. Given poor performance additional investments in this category is unlikely in the short term.

 

Collaterised Debt Obligations (CDO) (19%)

 

Councilís portfolio contains $6.5M (19%) in CDOís which can no longer be acquired under the revised criteria but may be grandfathered. CDO prices remain significantly below face value; driven by structural weakness, higher expected defaults and the lack of a secondary market. Given the current absence of a secondary market, investors have no other option but to retain these assets. The most appropriate strategy is to hold these investments until they mature or until the markets recover. However any opportunities to sell these products at a beneficial price will be separately evaluated and considered on their merits to switch to an alternative investment on profitable terms.

 

 

 

Capital Guaranteed Products (CGP) (22%)

 

Councilís portfolio contains $7.550M (22%) in CGPís which can no longer be acquired under the revised criteria but may be grandfathered.

Equity market falls, accelerating over September to December 2008 have been detrimental to the asset values of all Capital Guaranteed Products. While the capital is guaranteed the underlying drop in the net asset value has resulted in no coupons being paid. The most appropriate strategy is to hold these investments until they mature or until the markets recover. However any opportunities to sell these products at a beneficial price will be separately evaluated and considered on their merits to switch to an alternative investment on profitable terms.

 

 

REPORTING

 

A monthly report will be provided to Council, detailing the investment portfolio in terms of performance, security, credit rating and counterparty percentage exposure of total portfolio.

The report will also detail investment income earned versus budget year to date and confirm compliance of Councilís investments within legislative and policy limits.

For auditing purposes, certificates must be obtained from the banks/fund managers/custodian confirming the amounts of investment held on Councilís behalf at 30th June each year.

 

Authority to Amend Strategy

The General Manager may amend this strategy at any time where it is in the Councilís interest to do so, or to meet a changing regulatory environment.

Authority to Implement Strategy

The following officers have delegated authority to invest surplus funds in accordance with the Investment Policy and Investment strategy:

††† Executive Manager Corporate and Community Division

††† Manager Financial Services

††† Other senior financial officers ( as per Councilís delegation manual)

 

Each investment recommendation is to be approved by two authorised signatories.

Investment recommendations exceeding $3 Million dollars require one of the two authorised signatories to be the General Manager, Executive Manager Corporate & Community, or the Manager Financial Services.

Investments other than in approved deposit taking institutions (ADIís), and/or investments with maturity terms that are in excess of 5 years will require written authority by any of two of the General Manager, Executive Manager Corporate & Community and Manager Financial Services.

Professional Advice

Council currently retains CPG Research & Advisory to provide assistance in Investment Strategy formulation, portfolio implementation and monitoring. Council may change the advisor at any time provided any person or organization engaged to provide advice is reputable and independent.

 

 

SAFE CUSTODY ARRANGEMENTS

 

Where necessary, investments may be held in safe custody on Councilís behalf as long as the following criteria are met:

††† Council must retain beneficial ownership of all investments.

††† Adequate documentation is provided, verifying the existence of the investments.

††† The Custodian conducts regular reconciliation of records with relevant registries and/or clearing systems.

††† The Institution or Custodian recording and holding the assets will be:

8 Austraclear;

8 An institution with an investment grade Standards and Poors or Moodyís rating; or

8 An institution with adequate insurance, including professional indemnity insurance and other insurances considered prudent and appropriate to cover its liabilities under any agreement.