Digging into City Investments

Where are city dollars being invested?

In a previous edition of this newsletter, we brought up one of the most important documents a local government can publish, its Comprehensive Annual Financial Report (CAFR).  Whereas a budget gives a plan on how dollars are to be collected and spent in a calendar year, the Comprehensive Annual Financial Report has a more broad view of the financial condition of the community.  

Looking through the City of Troy’s last CAFR, we can learn where the city invests some of its money for future use.  At the end of 2022, the City has over $86 Million invested in different bonds, securities and pooled funds to ensure that those dollars grow safely.  Here is where those dollars are invested and what those investments look like:

2022 Portfolio:

• Federal Home Loan Bank: $32,592,775

• Federal National Mortgage Association: $15,294,760

• Federal Farm Credit Bank: $10,879,565

• Federal Home Loan Mortgage Corporation: $10,408,110

• Money Market Funds: $492,635

• US Treasury Bills: $2,807,905

• US Treasury Notes: $6,405,575

• Negotiable Certificates of Deposit: $951,463

• Star Ohio: $6,775,901

Descriptions of Investment Types

Federal Home Loan Bank (FHLB)

• Description: FHLB bonds are issued by a network of regional banks to finance housing, community, and economic development. These are government-sponsored enterprises (GSEs) but not federally backed, hence they carry slightly higher risk than Treasury securities.

• Risk: Moderate credit risk due to lack of direct government backing, but generally considered safe due to the oversight and structure of the FHLB system.

Federal National Mortgage Association (Fannie Mae)

• Description: Fannie Mae is a GSE that operates in the secondary mortgage market, increasing the supply of money available for mortgage lending. Its securities are widely traded and are considered to have a higher credit rating, although not explicitly backed by the full faith and credit of the U.S. government.

• Risk: Similar to FHLB, Fannie Mae carries moderate credit risk and is sensitive to changes in housing market conditions.

Federal Farm Credit Bank

• Description: These securities are issued by a network of borrower-owned financial institutions that provide credit to the agricultural sector. Like other GSEs, they are not directly backed by the government but are part of a system with governmental oversight.

• Risk: Moderate risk, subject to the performance of the agricultural sector but typically stable due to the essential nature of agriculture.

Federal Home Loan Mortgage Corporation (Freddie Mac)

• Description: Freddie Mac is another GSE in the secondary mortgage market, like Fannie Mae. Its securities support the availability of mortgage credit.

• Risk: The risk profile is similar to Fannie Mae, with moderate credit risk and exposure to the housing market's performance.

Money Market Funds

• Description: These funds invest in highly liquid, short-term securities, including treasury bills and commercial paper. They are designed to offer high liquidity with a very low risk profile.

• Risk: Very low credit and liquidity risk, but the return is typically lower than other fixed-income securities.

Negotiable Certificates of Deposit (CDs)

• Description: CDs are time deposits with banks that offer a fixed interest rate for a specified term. Negotiable CDs can be sold in the secondary market, unlike traditional CDs.

• Risk: Low credit risk, especially if they are within insured limits. The risk increases slightly if they are held until maturity, depending on the issuing bank's creditworthiness.

Star Ohio

• Description: Star Ohio is an investment pool that allows government subdivisions to invest in a diversified portfolio of high-quality, short-term securities. It is managed by the State Treasurer's office and aims to provide safety, liquidity, and competitive yields.

• Risk: Low credit and liquidity risk due to its diversified, short-term nature and oversight by the State Treasurer’s office.

US Treasury Bills

• Description: Short-term government securities with maturities of less than a year. They are considered the safest investments as they are backed by the full faith and credit of the U.S. government.

• Risk: Very low credit risk due to government backing, but returns are typically lower compared to longer-term securities.

US Treasury Notes

• Description: Medium-term government securities with maturities ranging from one to ten years. Like Treasury bills, they are backed by the U.S. government.

• Risk: Very low credit risk. They carry slightly higher interest rate risk compared to Treasury bills due to their longer maturities.

Signficant Investment Changes between 2021 and 2022

Since the Comprehensive Annual Financial Report is published annually, we can look back to 2021 and see how the city’s investments fared and if there were any substantive changes.  Comparing the two years, the following points were noted:

Overall Portfolio Size: The total net asset value increased from $78,343,250 in 2021 to $86,608,689 in 2022, an increase of just over 11%.

Investment in Government Securities: Investments in Federal Home Loan Bank, Fannie Mae, Federal Farm Credit Bank, and Freddie Mac decreased in 2022, reducing exposure to these specific government-backed securities.

Introduction of US Treasury Bills and Notes: In 2022, the portfolio included US Treasury Bills and Notes, diversifying the investment types and increasing liquidity.

Decrease in Money Market Funds: A significant reduction in money market funds, from $1,989,062 to $492,635, indicates a shift away from highly liquid, low-return investments.

Increase in Star Ohio: The investment in Star Ohio increased substantially, suggesting a move towards more diversified, potentially higher-yield state-run investment pools.

Risk Analysis

Taxpayers will be happy to know that the investments made by the city are in securities designed for safety with lower risks. When we look at some of the aspects of risk with these investments, the following points should be considered:

Credit Risk: The portfolio, both in 2021 and 2022, is heavily invested in government and government-sponsored entities, which have low credit risk due to their strong backing and high credit ratings.

Interest Rate Risk: The weighted average maturity decreased from 3.66 years in 2021 to 3.12 years in 2022, indicating a shift towards slightly shorter-term investments. This could be a strategy to reduce sensitivity to interest rate changes.

Liquidity Risk: The introduction of US Treasury Bills and Notes and the increase in Star Ohio investments in 2022 enhance liquidity. However, the reduction in money market funds indicates a willingness to slightly decrease immediate liquidity for potentially higher returns.

Market Risk: The portfolio's diversification into various types of government securities reduces market risk. However, the overall concentration in government-backed securities still makes the portfolio susceptible to systematic market changes affecting these securities.

Growth Potential: The shift in investment strategy, particularly the reduction in money market funds and the increase in Star Ohio, suggests a move towards seeking slightly higher returns, albeit still within a conservative risk framework.

Portfolio Strategy

The City of Troy's portfolio in both 2021 and 2022 demonstrates a conservative investment approach, with a significant focus on government and government-related securities. This strategy minimizes credit risk but may limit potential returns. The shift in 2022 to include Treasury bills and notes indicates a diversification within the safety of government-backed securities, balancing liquidity (short-term bills) and slightly higher yields (medium-term notes).

The reduction in money market funds in 2022 and the increased investment in Star Ohio suggest a strategy to improve returns while maintaining a low-risk profile. This shift represents a nuanced balancing of liquidity needs against the potential for modestly higher yields.

The City of Troy's investment strategy between 2021 and 2022 shows a nuanced shift towards diversification and a slightly higher risk profile for potentially better returns. The focus remains on safety with a strong preference for government-backed securities, but the inclusion of different types of securities and the adjustment in investment terms indicate a dynamic approach to managing public funds. This strategy seems well-calibrated to balance the need for capital preservation, liquidity, and modest growth, aligning with the typical financial objectives of municipal governments.

Thanks for reading today’s Civic Capacity Newsletter. Please feel free to share this information with your friends and neighbors and feel free to leave your ideas and insights in the comment section!