TO:Corporate Services Committee

FROM:Chief Financial Officer and Treasurer

SUBJECT:CITY OF TORONTO 1998 INVESTMENT REPORT

Purpose:

To summarize the City's 1998 investment results and outline investment practices being used.

Financial Impact:

Interest earnings of the City accrue to the reserve funds, pension funds and sinking funds established to retire the City's debt. Unrestricted earnings are allocated to the corporate revenue accounts in the operating budget. The Reserve Funds are combined and invested in one pooled fund. Each Reserve Fund holds a percentage ownership in the income on all investments made through the investment pool proportionate to its percentage ownership interest in the investments made through the fund.

In 1998, the total investment income earned by the City's investment portfolio amounted to $73.6 million. This amount represents $21.1 million earned by the Operating Fund and $52.5 million earned by the Reserve Funds. In addition, the Operating Fund earned $12.5 million in interest income on temporary loans to the school boards at an average rate of 5.15%. This reversed the 1997 experience when the former Municipality of Metro Toronto paid interest to the School Boards for funds held by the municipality. In addition to the above, the City sustained borrowing expenses related to waterworks of $1.7 million in 1998 for an overall total of $31.9 million in income earned.

Actual interest income prior to waterworks expenses for the City Operating Fund amounted to $33.6 million, on a gross and net basis, as compared to the 1998 estimate of $46.6 million. The shortfall of $13.0 million was due solely to the impact on the City's cashflow from the provincial delay in the return of assessment rolls.

In addition to the above earnings, the "Sinking Fund" portfolios earned $45.8 million and "Other Portfolios" earned $4.2 Million in 1998.

Recommendations:

It is recommended that this report be received for information.

Council Reference:

On January 2, 1998, Council approved the City's Investment Guidelines as one of the first acts of the new City. Further, a report to the March 1, 1998 meeting of the Audit Committee entitled, "Investment Policy Compliance" outlined suggested improvements to the investment procedures for the City.

Background:

This report responds to and fulfils the requirements of the Municipal Act - Section 167, Regulation 438/97 - to prepare and provide to the Council of the City of Toronto each year an investment report that shall contain:

(1)A statement by the Treasurer as to whether or not, in his or her opinion, all investments were made in accordance with the investment policies and goals adopted by the municipality.

(2)A statement about the performance of the portfolio of investments of the municipality during the period covered by the report.

(3)A statement of the estimated proportion of the total investments of a municipality that are invested in its own long term and short term securities to the total investments of the municipality and a description of the change, if any, in that estimated proportion since the previous year's report.

(4)A record of the date of each transaction in or disposal of its own securities, including a statement of the purchase and sale price of each security.

(5)Such other information that the Council may require or that, in the opinion of the Treasurer, should be included.

Comments:

In compliance with the regulations contained in the Municipal Act, the performance and composition of the City's investment portfolios has been reviewed and is presented for information as set out under the following headings:

(1)1998 Performance of the Investment Portfolio

(2)Summary of Investment Practices

(3)Investment in City of Toronto Securities

(4)Record of Security Transactions

(1)1998 Performance of the Investment Portfolio

The City of Toronto had a successful year in investment markets. Treasury operations were consolidated on January 2^nd as one of the first acts of Council and a new investment policy was approved. Over the year, investment returns outperformed investment benchmarks and added additional earnings to revenues for the City.

The actual earnings in 1998 for the operating budget totalled $33.6 million compared to a budgeted amount of $46.6 million. The shortfall was due to provincial actions in respect to delays in assessment rolls. The budgeted amount for temporary borrowings of $8.0 million was not required during the year. These variances produced a net shortfall of $5.0 million for the year in investment earnings. This was previously reported to Council at its meeting on October 28, 1998 through a report (October 19, 1998) to the Strategic Policies and Priorities Committee from the CFO and Treasurer, "Financial Impact to the City of Toronto - Recent Provincial Actions".

Total investment returns depend on three components:

(i)Cash balances - this determines the amounts to invest. As a result of the delay in the assessment rolls, the City's cash balances during July through September were below budget.

(ii)Term - generally, but not always, longer term investments generate higher rates of return. This must be balanced between the projected receipt of funds and the projected need during the year for the City to make payments, e.g. payroll, welfare, etc.

(iii)Interest rates - short-term interest rates rose during the year before declining somewhat by year-end. Long term interest rates were stronger throughout the year producing good investment returns.

Following is a chart and graph of the December 31, 1998 balance of the City's investment portfolio. This investment portfolio of $1.646 billion creates interest earnings for the operating fund and reserve funds (ie. total money market). The principal outstanding represents the face value of the securities without consideration of any premium or discount. The market value represents the price the investments will command when buying or selling in the financial markets.

Investment Portfolio Totals

(Principal $000$)

* The Market Return applies only to Metro Pension, Police Pension and Home For the Aged. The interest income amount excludes Trust Funds.

Value of Investment Portfolios

The total blended market investment return for the General Fund - bond and money market component - amounted to 6.2% on assets that totalled $ 1,671,245,769.19 on a market value basis which represents $1,646,000,000 in principal assets outstanding as of December 31, 1998. In the short term General Fund's component the market value of investments is frequently below the principal outstanding value of the portfolio due to the discounted positions held in the portfolio. The money market component of the General Fund produced an investment return of 5.14% in 1998. This investment return compares favourably with the Scotia McLeod 30 Day T-Bill Index which returned 4.60% for 1998.

The Association of Municipalities of Ontario manages a money market fund on behalf of the municipalities of Ontario called the LAS Fund. In 1998, its investment return was 4.77% net of management fees. At present, the City is in the process of completing the legal documentation to participate in the AMO sponsored fund and will be considering investing in the fund in 1999.

The Bond Component of the General Fund Portfolio had an average term of 8.9 years and an average duration of 5.696 years in 1998. The average term and duration of the Scotia McLeod Universe Index was 9.3 years and 5.7 years respectively with an annual return of 9.18%. The portfolio closely tracked the characteristics of the Universe Index with investment returns 3 basis points above the index of 9.18%.

In review, the City's money market portfolios benefited from a rise in short term interest rates over the year garnering higher interest income from security markets. Because these portfolios have near term maturities it was possible to reinvest funds at higher rates during the year. At the same time, the bond portfolio with longer term maturities benefited from rising prices in that part of the yield curve adding to the capital value of the portfolio. For information purposes "Appendix D" provides the end of the year investment positions of each of the portfolios.

Although a solid economy in 1998 produced real GDP growth of 2.9%, influences flowing from the global economy kept the currency and short term interest rates from moving in a positive direction. However, these factors did not prevent longer term bonds from increasing in value.

Notwithstanding a low inflation rate of 1% for the year, increased government surpluses and a strong industrial sector the currency dropped sharply on the coat-tails of declining commodity prices and a slowing world economy. By mid year interest rates responded to the currency's weakness rising to stem the tide of the dollar's decline.

Short term interest rates were most impacted by the dollar's decline. Thirty-day banker's acceptances moved from 4.44% in early January to a high of 5.48% in September before rallying again to close the year at 5.07%. The Prime Rate rose from a low of 6.00% in January 1998 to a high of 7.50% in September before declining to 6.75% by year-end. Despite the downturn in the short term market the long term government of Canada bonds rallied in 1998. Yields moved gradually lower over the year from 5.70% in January 1998 to approximately 5.10% by the end of the year. This end of the yield curve benefited from low inflation numbers and solid surpluses generated by the federal and a number of provincial governments.

The following Table compares the performance of the City's portfolios with the selected indexes for 1998. Investments which are not benchmarked versus these industry standards are not reviewed in this report.

More detail in respect to the above noted Funds is contained in Appendix "D". Due to the small positions in the Trust Group of Funds no performance evaluation is presented here. As well, information on the Toronto Atmospheric Fund is not currently a part of Appendix "D" nor are its performance results presented here.

Following is a summary of the Interest Income for the City's Investment Portfolios for 1998:

*MM - Money Market; SF - Sinking Funds

The Gross General Funds interest income reflects investment earnings prior to the distribution of income to various reserves and reserve funds.

Average Investment Returns of City Portfolios in 1998

Percentage Returns %

* MM - Money Market

Summary of Investment Practices

It is the practice of the City to invest the City's funds in a manner which will 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 monies.

These investment practices apply to all investments made on behalf of the City and its applicable agencies, boards and commissions including but not limited to operating funds, reserves, reserve funds, trust funds, sinking funds and any new fund created by the City unless specifically exempted. A report to the Audit Committee will outline the applicability of the City's investment policies and procedures to those agencies not currently part of the City's investment portfolio, for example the Parking Authority.

However, for the purposes of this report, the investment review and performance measurement comparisons are provided for the General Fund (comprising the cash assets of working capital, Reserves and Reserve Funds), The Police Benefit Fund, The Metro Pension Fund and Homes for the Aged. The City only manages the money market component of the Police, Metro Pension and HFA Funds.

A separate report will be submitted for the City's sinking funds portfolios which details the performance and activity within these portfolios. These portfolios are designed to accumulate financial assets to meet the requirements of the City's maturity schedule for debentures outstanding. This report touches briefly on the market value of the assets in the sinking fund portfolios.

In compliance with the City's Investment Policy, investments shall be made with judgement and care - under the circumstances then prevailing - which persons of prudence, discretion and integrity exercise in the management of investments, considering the necessity of safety of capital as well as the probable income to be derived.

The standard of prudence to be used by investment officials shall be the "prudent person" standard and shall be applied in the context of managing an overall portfolio. Investment officers acting in accordance with written procedures and the investment policy and exercising due diligence shall take all necessary actions to ensure the maximum performance of investments on a portfolio wide basis, subject to the prescribed risk parameters dictated by the investment policy.

The following chart highlights the Sector Distribution of the City of Toronto Group of Investments and highlights the important role financial institutions play in generating investment returns for the City. The Canadian Banks offer investments with high yields to specific dates which cannot be found elsewhere. Products such as term deposit receipts and bankers depository notes are designed to meet the clients' requirements in respect to term and yield.

For reasons related to yield enhancement and the availability of products, it is sometimes practicable to exceed the limits set for financial institutions. As long as the risk parameters for the portfolio are still within reasonable limits, this practice improves investment returns and cash flow without negatively impacting the portfolio. The second chart indicates the top four investment positions among the Schedule "1" Banks. These banks have a Dominion Bond Rating Service rating of "R-1 Middle" for short-term debt - one of the highest investment ratings available.

Investments by Sector for Toronto Group of Funds

Investment Total of $1.646 Billion

As at December 31, 1998

Top Four Schedule "1" Bank Positions

Investment Total of $823.3 Million

As at December 31, 1998

For information purposes, Appendix "A" further details the nature of the City's investment policy and practices and Appendix "B" details the process of establishing Performance Benchmarks.

Investment in City of Toronto Securities

As of December 31, 1998, the total investments outstanding for the City of Toronto amounted to $2,514,000,000.00 of which $279,884,000.00 were investments in City of Toronto's own short and long-term securities. The "Toronto Group of Funds" held investments in the amount of $20,720,000.00 and the "Sinking Fund" portfolios held investments in the amount of $259,164,000.00. This represents 11.1% of the total portfolio of investments. An attachment entitled, "Outstandings by Issuer and Sector" - Appendix D - indicates the value of City of Toronto investments in the various portfolios managed by the Finance Department. Because this is the City's first year operating as an amalgamated corporation, a meaningful comparison to former year's investment ratios cannot be made. However, next year's report will include a comparison to the 1998 investment values with comments on any changes which may arise.

The Municipal Act also requires that a municipality shall not invest more than 25% of the total amount in all sinking and retirement funds in respect of debentures of the municipality, as estimated by the Treasurer on the date of the investment, in short term debt issued or guaranteed by the municipality.

In 1998, there were no short- term debt issuances by the City of Toronto and consequently no holdings of this type of debt in the sinking or retirement funds.

Record of Security Transactions

One of the requirements of the Municipal Act is that a record be prepared of the date of each transaction in or disposal of it own securities, including a statement of the purchase and sale price of each security.

In 1998, the City of Toronto purchased a total of $44,931,000.00 of its own securities. These investments are part of the City's Sinking Fund Portfolios and General Fund Bond Portfolio. Details of these transactions are contained in Appendix C for information.

Conclusions:

Investments made on behalf of the City of Toronto in 1998 were made in accordance with the investment policies and goals adopted by the City. It is therefore recommended this report be received by City Council for its information.

Contact Names:

Martin Willschick, Manager, Treasury Services - Phone No. 392-8072, Fax No. 392-3649

E-mail: mwillsch@mta1.metrodesk.metrotor.on.ca

Len Brittain, Director, Treasury & Financial Services - Phone No. 392-5380

E-mail: lbrittai@toronto.ca

Wanda A. Liczyk

Chief Financial Officer and Treasurer

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Attach.

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