Sofia Anastopoulos , CFA Senior Manager GFOA Research & Consulting 312-578-2292, sanastopoulos@gfoa.org

1. INVESTING BASICS SC GFOA Conference Sheraton Convention Center, Myrtle Beach,South Carolina October 13, 2008 Sofia Anastopoulos, CFA Senior Manager GFOA Research & Consulting 312-578-2292, sanastopoulos@gfoa.org

2. Investment Framework & Policy • Internal Control • Safekeeping • CDs and collateralization

3. TREASURY & INVESTMENT MANAGEMENT • All activities undertaken to insure liquidity and maximum investment return on government’s idle cash • Balancing act – • risk and return • liquidity while maximizing return

4. TREASURY MANAGEMENT • Cash mobilization • Get cash in as fast as you can • Cash concentration • Investing – Do something worthwhile with cash • Disbursement • Release cash efficiently

5. INVESTMENT FRAMEWORK & POLICY

6. FIDUCIARY • Individual or institution • Special relationship of trust with another person or group • Legally responsible for assets

7. FIDUCIARY EXAMPLES • Treasurers • Finance directors • Investment personnel • Oversight boards • Investment advisers • Brokers are NOT

8. FIDUCIARY • Legally bound to: • Make decisions in the best interest of the beneficiary • Act prudently • Always put the beneficiaries’ interests before their own

9. PRUDENCE • Original standard of investment care –Prudent Person • Consider safety and yield of an investment • “ to exercise the judgment and care, under the circumstances then prevailing, which persons of prudence, character and intelligence in the management of their own affairs, not in regard to speculation but in regard to the permanent disposition of their funds, considering the probable income as well as the probable safety of their capital.”

10. PRUDENCE • Limitations - did not address how investment fits into overall portfolio • Evolving standards of fiduciary duty • Prudent Investor • Prudent Expert

11. INVESTMENT POLICY • WHY? • Defines investment program • Legal & permitted activities • Who’s in charge • Measurement of results • Relationship to counterparties • Protection • Dynamic process

12. INVESTMENT POLICY COMPONENTS • Scope • Funds covered by policy • Different funds have different objectives

13. INVESTMENT POLICY COMPONENTS • Objectives • Safety • Liquidity • Yield/return (SLY) • Other • Conform to laws

14. INVESTMENT POLICY COMPONENTS • Standards of Care • Prudence • Ethics & conflict of interest • Existing guidelines for the entity • Expectations of investment personnel • Guidelines for handling deviations • Delegation of authority • Cite statutes • Identify personnel by title • Discuss personal liability

15. INVESTMENT POLICY COMPONENTS • Investment Instruments • State statutes - legality • Risk tolerance • Selection & purchase of investments • Collateralization • Authorized institutions

16. INVESTMENT POLICY Investing is fundamentally a balancing act risk and return • So investment policy should address risk & establish a risk tolerance • Diversification

17. INVESTMENT POLICY • Risks • Credit (default) risk • Risk that all / some of principal and interest will be lost To mitigate credit risk: • know your banks and/or broker-dealers • Require delivery-versus-payment • Limit investments to those of highest credit quality

18. INVESTMENT POLICY • Liquidity Risk • Ability to sell investment (prior to maturity) • Some short-term investments are relatively illiquid • Marketability – ability to sell security on short notice without incurring meaningful loss in price

19. INVESTMENT POLICY • Market Risk • Risk value decreases due to changes in market • Interest rate risk • Reinvestment Risk • Risk that cash flows from securities reinvested at a lower rate than original investment • callable

20. INVESTMENT POLICY • Reputational Risk • Risk that mistakes negatively harm reputation of government and official • Loss of stature

21. GFOA RP-DIVERSIFICATION Fiduciary responsibility to reach objectives: safety, liquidity, return • Greater risk typically increases returns • Effective management of risk critical to achievement of objectives

22. GFOA RP-DIVERSIFICATION • Diversification-useful strategy for managing risk • Establish risk profile • Use profile to determine levels of diversification • Can be achieved by investing in variety of securities with dissimilar risk characteristics • Areas where diversification can be achieved include: • Maturity distribution • Sector allocation • Issuer allocation • Structures

23. GFOA RP-DIVERSIFICATION Recommendations Government investors should: • Define objectives • Prepare cash flow – determine liquidity • Consider political climate • Use LGIPs, repos, MMMF to ensure liquidity day-to-day • Establish limits on • specific securities • specific business sectors

24. GFOA RP-DIVERSIFICATION Recommendations Government investors should: • Develop guidelines for investing in single classes • Limit investments in securities with high credit and/or market risk • Limit particular structures • Define maturity/duration ranges • Establish risk profile for portfolio

25. INVESTMENT POLICY COMPONENTS • Safekeeping • Third-party • Delivery versus payment (DVP) settlement • Internal Control

26. INVESTMENT POLICY COMPONENTS • Accounting • GAAP • Reporting • specify types and frequency of reports • provide information for wide audiences • both technical and easy-to-read • Monitoring and adjusting the portfolio • marking-to-market

27. INVESTMENT POLICY COMPONENTS • Performance evaluation • Benchmarks • Criteria for selecting benchmarks • Minimum yield standards • Methods of calculation

28. INVESTMENT POLICY COMPONENTS • Appendices • Authorized personnel - title • Statutes, ordinances, etc. • Authorized broker-dealers • Authorized depositories • B-D questionnaire and certification

29. INVESTMENT POLICY COMPONENTS • Appendices (cont’d) • Master repurchase agreement • Safekeeping agreement • Wire transfer agreement • Collateralization agreement • Sample investment reports • Formulas for returns • Internal control checklist • GFOA recommended practices

30. INVESTMENT POLICY ADDITIONALPOLICYTHOUGHTS • Internal document • Involve staff responsible for investments • External document • Distribute to outside parties • Board approval • As resolution, ordinance, etc. • Annual reviews & updates

31. INVESTMENT POLICY HELP • Government Finance Officers Association “Sample Investment Policy” www.gfoa.org

32. INTERNAL CONTROL

33. There are two ways to steal funds from governments… On the way in and on the way out! INTERNAL CONTROL

34. Citizens/tax payers have 2 expectations for their money Safeguarded Spent wisely for authorized purposes INTERNAL CONTROL

35. Process determined by an organization's people and information technology (IT) systems designed to help the organization accomplish specific goals helps direct, monitor, measure entity’s resources protects from fraud, misuse, poor decisions, errors, loss INTERNAL CONTROL

36. INTERNAL CONTROL ORGANIZATIONAL STRUCTURE Management’s attitude • Familiarize staff with formal procedures and internal control • Train managers to detect erratic employee behavior • Mandate reporting of perceived impropriety or errors • Implement and communicate consequences • Provide professional development

37. INTERNAL CONTROL ORGANIZATIONAL STRUCTURE OR DESIGN Segregate duties • Authorization of transactions • Clear lines of authority and authorizations • Level of authorizations spelled out in procedures • One “go-to” person for questions • Execution of transactions • Recording of transactions • Reconciling of transactions • Maintaining custody / control of assets • Custody separate from accounting collusion

38. INTERNAL CONTROL ORGANIZATIONAL STRUCTURE OR DESIGN Segregate duties • Harder for small entities but “do-able” • Management’s awareness of issue helps • Perhaps other controls implemented • Mandatory vacations • Rotating tasks

39. INTERNAL CONTROL ORGANIZATIONAL STRUCTURE HR – PERSONNEL • Pre-employment screening • Check references and credentials • Strict screening for financial positions with bona fide security requirements • Check background and credit • Test skills, knowledge and accuracy • Require drug tests

40. INTERNAL CONTROL ORGANIZATIONAL STRUCTURE HR –Human Resources • Mandatory Vacations • Hard to cover up when someone else takes over the position • Document policies • Train, train, train

41. INTERNAL CONTROL PRE-EMPLOYMENT SCREENING • Check references and credentials • Strict screening for financial positions with bona fide security requirements • Check background for criminal activity • Test skills, knowledge and accuracy • Require drug tests

42. INTERNAL CONTROL TRAININING • Minimize loss from judgment errors and technical mistakes • Familiarize staff with formal procedures and internal control • Train managers to detect erratic employee behavior • Mandate reporting of perceived impropriety or errors • Provide professional development

43. INTERNAL CONTROL RISK ASSESSMENT Asses risks, determine risk tolerance and develop response • Identify - What loss could occur? • Evaluate - What is probability it might occur? frequency ? magnitude of loss or negative effect? • Risk appetite • What is our response? avoid? • Do the costs of establishing IC outweigh benefits ?

44. INTERNAL CONTROL IMPLEMENTATION • Employees must buy into and understand the need for controls • Procedures should be understandable and make sense • Consequences for noncompliance or willful neglect of procedures should be established and enforced

45. INTERNAL CONTROL MONITORING • Internal audits • Authorization and execution • Recording and accountability • Exception monitoring • Safeguards • External audits • Routinely change external audit firms

46. INTERNAL CONTROL RED FLAGS OF FRAUD • Ineffective IC • Limited or NO segregation of duties • No reconciliation • Lifestyle changes • New cars, jewelry, houses, trips • Significant personal problems • Debt or credit problems • High turnover • Refusal to take vacation • Reluctance to provide info to auditors • Frequent disputes with auditors • Frequent changes in external auditors

47. INTERNAL CONTROL RED FLAGSOF FRAUD • Excessive number of checking accounts • Frequent changes in banking accounts • Excessive year end transactions • Photocopied or missing documents • Stuff that just doesn’t seem right

48. SECURITY DELIVERY • Strongly recommend delivery vs. payment (DVP) ONLY • Settlement procedure where payment for securities is simultaneous to transfer of purchased securities. • Ensures funds are released only upon receipt of securities, thus protecting government • Delivered to your custodian who is your agent • Perfected ownership • In your control through your custodian

49. CONCLUSION • Plan • Policies and procedures • Internal Control

50. LEARN MORE • http://www.gfoa.org/ • GFOA • Cash Committee • Resources • Reference Library • samples, agreements