Investing: More Than Just Safety, Liquidity, and Yield
From school districts to cities and towns, whatever your local government may be, you likely have a mission and a plan based on a set of values that are shared by your community. The same should be true when it comes to investing your local government’s money. As a shepherd of your taxpayers’ dollars, it is your fiduciary responsibility to keep those funds safe while earning a competitive rate of return.
The current economic and regulatory environment has presented some interesting challenges for local governments when it comes to investing: rates are on the rise, but the yield curve has remained relatively flat; smaller community banks are finding it hard to house public dollars due to regulations and costs imposed on them; and new investment opportunities present themselves almost daily. So, how familiar are you with these new investments and varying options?
You’d be hard pressed to find an investment professional in the government sector that wouldn’t tell you the primary objectives of investing public funds are always safety, liquidity, and yield (in that order). We at NYCLASS recommend that transparency and diversification be considered, as well. Let’s walk through each of these key features of investing.
Safety: the importance of getting your principal back.
When investing, you are buying creditworthiness. In the case of buying a U.S. Treasury, you are relying on the ability of the U.S. Government to repay its debt. When buying commercial paper, you are relying on the ability of a bank or corporation to repay its debt. Investing in repurchase agreements involves counterparty risk, defined as the risk that one party of the transaction fails to meet its obligation (most likely the borrower). In the unlikely event that a counterparty defaults, the collateral posted for that repurchase agreement would be liquidated to repay the obligation. To provide enhanced security, the collateral in NYCLASS only includes U.S. Treasuries which are the most liquid securities in the market and are equal to 102% of the repurchase agreement trade.
U.S. Treasuries are referred to as “risk-free assets” meaning that there is no implied risk that the U.S. Government will not repay its debt. That said, every investment you buy carries some degree of risk. All bonds eligible for investment in New York carry some sort of rating by a nationally recognized statistical rating organization such as S&P Global Ratings. Credit ratings can serve as a guideline for risk but should not be used as the sole source of information when making investment decisions.
Liquidity: how quickly can I sell my investment and turn it into cash?
A simple example would be fine art. Let’s say you own the Mona Lisa. There is no doubt it is worth a lot and could be a fine investment. But how quickly can you find a buyer for the painting and convert that value to cash? Probably not very quickly. Conversely, cash-like investments such as local government investment pools (LGIP) are considered highly liquid investments in which you can convert your investment into cash within a day without suffering a loss or penalty for doing so. Always make sure you have adequate liquidity to cover your specific cash flow needs.
Yield: what am I earning on my investment?
The yield component is the most often referenced aspect of investing and rightfully so. If we were not concerned about yield, we would just keep our funds in a savings account. The potential pitfall is when an investor focuses primarily on yield while ignoring the safety and liquidity components of investing. Focusing primarily on yield could be detrimental to the overall strategy of limiting risk and satisfying liquidity requirements.
Transparency: do you understand and have access to information about your investments?
There are a couple of ways to look at transparency when it comes to investments. First, are your investments transparent to you? Make sure you know what you are investing in. If you are using an LGIP, you should be able to see the underlying assets in that pool. Another way to look at transparency is from the taxpayer side. Are you being transparent with the investments made on behalf of your entity? Investment reports are a great tool to be transparent with the public. These can be made on a monthly, quarterly, or annual basis.
Diversification: are all your eggs in one basket?
You’ve heard the saying “don’t put all your eggs in one basket.” Well, the same can be said when investing public funds. This is especially true as you get into riskier asset classes. If you are an entity that is buying corporate bonds, it is highly recommended that you are well-diversified.
When considering all of the components of successful public funds investing, it is most important to fully understand what you are investing in. That is done through careful consideration of each of the five factors and how they impact your local government. If you are not comfortable or do not understand your investments, it is best to take a pause and ask investment professionals for help. Feel free to contact your local NYCLASS representatives with any questions.