Investment Management of the City's Financial Assets
The Capital Markets section of the Corporate Finance Division is responsible for the internal investment management of several City investment portfolios. In accordance with the Council-approved directive, the Capital Markets section manages the City’s funds in a manner that seeks to provide the highest investment return consistent with the maximum security of principal, while meeting the cash requirements of the City and conforming to all legislation governing the investment of the City’s funds.
Management must incorporate both the legislative constraints and the risk profile of each portfolio. Investment policies and procedures approved by Council annually provide guidelines for each portfolio.
Although specific policy limits with respect to issuer names and credit quality limits vary among the portfolios, the primary objectives for all City investment activities, in order of priority, are:
- Ensure safety of principal
- Maintain adequate liquidity to fund the City's daily cash needs
- Maximize the rate of return while conforming to the first and second objectives
In developing investment policies and goals for funds under management, primary consideration has been given to the objectives of each portfolio. Although the rate of return on assets is the principal measure of performance, the achievable rate of return is constrained by the parameters of the investment policy. This constraint has important implications for performance measurement and, in particular, the choice of a suitable benchmark with which to compare the rate of return.
City of Toronto 2009 Investment Report and Policy
Update
Capital Market Activities during 2010
and the Outlook for 2011
During 2010, the world economy continued to emerge from the most severe economic crisis since the Great Depression. In response to extraordinary policy actions taken by authorities in the major economies, the Canadian and U.S. economies continued their recovery during the second half of the year. However, the recovery in Canada and elsewhere has been more modest than the average recovery from post–World War II recessions. Nevertheless, Canada continued to perform better than other members of the G-20.
These countries responded to the deepening crisis with aggressive policy actions. Monetary authorities lowered interest rates to historic lows, and several central banks adopted monetary policy measures that were meant to increase liquidity in the banking and financial system. Fiscal authorities also introduced substantial stimulus measures and implemented initiatives to stabilize financial institutions.
For 2011, there is a growing concern that when the Canadian and US governments withdraw fiscal stimulus measures and concentrate on paying down their respective deficits and central banks begin the process of increasing interest rates, economic growth may exhibit a relatively weak recovery with sustained unemployment.
A number of macroeconomic risks to the recovery include the European sovereign crisis, triggered by the Greek sovereign risk situation that began in May 2010, the political unrest in Arab countries, the Japanese nuclear situation, and the rising costs of energy and food globally.
For 2011, the prospects for Canadian economic growth are encouraging and GDP is forecasted to grow by 2.7% with Canada’s jobless rate trending lower as the year progresses.
While it is forecasted that the US Federal Reserve will continue to hold on interest rates throughout 2011, marking the third straight year of no interest rate changes by the U.S. central bank, the Bank of Canada may move first, likely raising rates around the middle of the year. In Canada and the US, inflation will not be a concern, averaging around 2.1% during the year.
During 2010, the City issued the full $700 million of its approved debt program with a $600 million 30-year debenture issued in the public capital market and $100 million issued to the Canada Mortgage and Housing Company to take advantage of their low interest stimulus program. The public issuance received a good reception in a challenging and difficult bond market. The term-to-maturity of this issue blended current capital market conditions with the matching of the economic life of various capital expenditures. The structure and pricing of the transaction achieved the lowest cost of funds available relative to other potential structures, markets and currencies as permitted by provincial legislation.
Increasing the term-to-maturity of the City debt issuance to match the economic life of the City's infrastructure assets and proving liquidity to investors through larger bond issues were very important features of the City’s 2010 debt issuance program which has been structured to issue debt with a 30-year term and the ability to reopen bond issues, depending upon capital market conditions.
The City's Fixed Income Investment Portfolios:
The City manages several investment portfolios, each of which has specific objectives. Two individual portfolios that are managed interactively are the Bond and Money Market Portfolios. The Bond Fund is positioned towards funding the City's future reserve and reserve fund requirements and therefore takes a longer view of the market. The Money Market portfolio is primarily focused on ensuring that adequate liquidity is maintained to meet the immediate cash flow requirements of the City's daily operations.
When combined these portfolios provide the necessary diversification required in managing the City's total cash flow needs and the exposure to interest rate changes. Current revenues can be held in short-term investments until such time as the movement to longer-dated securities proves more suitable. Likewise, longer-dated securities can be sold to meet short-term expenditures if the opportunity to realize capital gains presents itself. Traditionally the Bond Fund provides an opportunity to obtain higher investment yields.
Investment Performance
The average daily balance of the Investment Portfolio in 2010 was $3.5 billion. The portfolio balance peaked at approximately $4.4 billion in September 2010. A higher proportion of the portfolio was placed in the Money Market Fund to meet the anticipated short-term cash requirements for social services and other cost which have risen in 2010.
The purpose of a conservative asset mix allocation for sufficient liquidity is to avoid forced sale of invested assets, especially during a period when interest rates are anticipated to rise, which could result in capital losses.
The financial crisis that negatively affected financial markets in 2008 extended into 2010.
Interest rates were volatile and reached historic lows, especially in the short end of the yield curve. The 5-year average of 10 years bonds during 2003-07 (pre-crisis period) yielded 4.388% while the average in 2010 yielded 3.236% resulting from the 115.2 basis points (bps) drop in interest rates. The 5-year average of 1-year Government of Canada Treasury Bill during 2003-07 yielded 3.445% and the average in 2010 dropped to 1.078% (a drastic 236.7 bps drop).
The overnight rate in 2010 reached a low of 0.25% and, for the year, the 30-day T-Bill return was only 0.43%. Such an historically low interest rate environment has negatively impacted the interest income of that portion of the City's portfolios which are invested in fixed income securities.
The investment return is based on earned revenues, which is comprised of earned interest income, realized capital gains/losses and amortized premiums/discounts. The 2010 distribution of investment earnings and their respective annual investment return is summarized in the following chart:
