Report to/Rapport au :

Corporate Services and Economic Development Committee

Comité des services organisationnels et du développement économique

30 May 2008 / le 30 mai 2008

Submitted by/Soumis par : Marian Simulik, City Treasurer

Contact Person/Personne ressource : Gerry Mahoney, Manager Treasury

Financial Services/Services financiers

(613) 580-2424 x 21310, gerry.mahoney@ottawa.ca

City Wide/à l'échelle de la Ville

Ref N°: ACS2008-CMR-FIN-0025

SUBJECT:	investment and endowment fund report

OBJET :	RAPPORT DE 2007 SUR LE FONDS DE DOTATION ET L’INVESTISSEMENT

REPORT RECOMMENDATIONS

That the Corporate Services and Economic Development Committee recommend Council:

1. Approve the appointment of the Deputy Treasurer to the Endowment Fund Investment Committee; and

2. Receive this report on the results of the City’s investments for the year 2007 as required by Ontario Regulation 438/97 as amended to Regulation 39/07, Section 8 (1), and the City’s Investment Policy.

RECOMMANDATIONS DU RAPPORT

Que le Comité des services organisationnels et du développement économique recommande au Conseil :

1. D’approuver la nomination du trésorier adjoint au Comité d’investissement et du fonds de dotation; et

2. De prendre connaissance du présent rapport sur les résultats des investissements de la Ville pour l’année 2007, comme l’exige le Règlement de l’Ontario 438/97, modifié par le Règlement 39/07, paragraphe 8 (1), et la politique d’investissement de la Ville.

BACKGROUND

The City of Ottawa is authorized under Section 418 of the Municipal Act, 2001 to invest funds not immediately required. Ontario Regulation 438/97, as amended to O.Reg. 39/97, outlines the criteria for eligible investments which provides for a relatively conservative investment mix.

The City’s Investment Policy, as approved by Council on 25 June 2003, sets sector, issuer, credit and term limits and acts as the governing guideline in the management of the City’s investment portfolios. The reporting requirements in the City’s Investment Policy and Section 8 (1) of O. Reg. 438/97 require that a report be submitted to Council each year. The detailed reporting requirements of O. Reg. 438/97 are set out in Document 1.

Regulation 438/97 was amended on 12 December 2005, by Regulation 655/05. This regulation provides a wider range of eligible investments in Canadian corporate bonds and equities for the City's Endowment Fund. The regulation and the City’s adopted Statement of Investment Policies and Procedures require yearly reporting on the performance of the Endowment Fund which has been included in this report.

DISCUSSION

Financial Market Review 2007

The capital markets presented unusually difficult times for the investment of funds during 2007. The Canadian economy began 2007 on solid fundamentals. During the first half of the year the economy benefitted from strong global demand for commodities which resulted in a strong employment and housing market. This in turn resulted in inflation above Bank of Canada targets and on 10 July 2007 the Bank increased the overnight target by .25% to 4.50%.

However by the middle of August concerns over U.S. sub prime mortgage debt spread to the Canadian financial market. Generally, investors became cautious and directed investment funds to Government of Canada securities away from other classes of investments including corporate debt, and securities of federal crown corporations, provincial and municipal debt. The Bank of Canada as well as the U.S. Federal Reserve Board responded with various measures to provide liquidity to the system to help restore investor confidence. In December the Bank of Canada lowered rates by .25% and has further reduced rates by .25% on 22 January 2008 and by .50% each in March and April 2008 to bring the overnight rate to 3.00% at the time of writing this report.

The City responded to this change in financial markets by changing its investment strategy. In the first three quarters of the year the strategy was to extend term and holdings in the Long-Term Portfolio and reducing holdings in the Short-Term Portfolio to take advantage of rising interest rates. In the fourth quarter the strategy was adjusted to shorten the term of investments and increase credit quality. The Money Market Portfolio weighting in Canada T-bills was increased from 15% on 1 August 2007 to 20% by 31 December 2007. The Long Term Portfolio activity was limited to purchases of $5 million in Government of Canada Bonds and $2.5 million of a Toronto Dominion Bank Deposit Note.

Although the City did not hold any non-bank sponsored Asset Backed Commercial Paper (ABCP), the City did hold bank sponsored ABCP. As uncertainties for this market continued and investor interest diminished, the City reduced its holdings in ABCP to nil by year-end. The City continues to hold term Asset Backed Securities (ABS) in the amount of $66.6 million as of December 31, 2007 in the Long-Term Portfolio and the Sinking Fund. All of the City's holdings of ABS term investments maintain AAA ratings.

2007 Investment Performance General Funds

As of 31 December 2007 the City's general funds were held in two investment portfolios[1] with a combined value including cash of $876.4 million[2]. The Short-Term Investment portfolio consists of investments with maturity dates of less than one year. The portfolio ranged in size from $265 million to $1,039 million during 2007. The Long-Term Fund portfolio contains funds which are invested for longer than one year. This portfolio averaged $421.9 million during 2007. In addition to these portfolio’s the City maintains a Sinking Fund portfolio which had a value of $173.8 million as at year-end.

The performance of the City's investment portfolios is summarized below. The investment returns shown below include interest income, realized capital gains and losses, and amortized premiums and discounts.

Portfolio

Average Portfolio Value

($ million)

Earned Income

($ millions)

Investment Return

(%)

Short-Term Investments

Long-Term Funds

Total General Funds

Sinking Funds

All Funds

713.4

427.4

1,140.8

169.2

1,310.0

31.8

20.3

52.1

8.8

60.9

4.46

4.75

4.57

5.22

4.65

The City's general funds generated income of $52.1 million during 2007 representing a return of 4.57%. This compares with earnings of $44.2 million and a return of 4.40% for 2006. The higher returns for 2007 result from rising interest rates during the first three quarters of the year and higher average investment holdings.

The City compares its returns to a variety of benchmarks to evaluate the performance of its investment portfolios. These benchmarks include ONE Fund, the Scotia Capital Three-Month Treasury Bill Index (now known as the DEX index) for comparison with short-term investments and a composite of the All Governments Short-Term and Mid-Term Bond Indices for comparison with long-term funds.

ONE Fund is a municipal pooled investment program designed specifically for the Ontario public sector, tailored to maximize returns using a conservative investment strategy based on current Ontario legislation pertaining to municipal investments. It is overseen by the CHUMS Financing Corporation and Local Authority Services Limited. ONE Fund offers municipal investors a Money Market Fund, a Bond Fund and a Canadian equity fund. The investment policy for ONE Fund Money Market fund has been changed to permit the fund to hold floating rate notes maturing in less than three years so it is no longer a truly valid comparison for the City’s Short-Term portfolio which only holds investments maturing within one year. Any investments maturing beyond a year are held in the Long-Term portfolio.

The DEX indices are widely used performance benchmarks for the fixed income markets in Canada. The T-Bill Index is composed of three-month Canada treasury bills, which are rolled into new bills at each Government of Canada Treasury bill auction. The All Governments Short-Term and Mid-Term Bond Indices consist of federal, provincial and municipal bonds with remaining effective terms greater than 1 year and less than or equal to 10 years. This year the performance of the City’s bond portfolios has been compared with a composite of the Short-Term and Mid-Term[3] DEX returns are stated without deduction for portfolio management fees or expenses while ONE Fund returns are shown after incurring investment management expenses while the City’s investment returns have been reduced by 4 basis points (bps) as an allowance for the costs incurred to manage these funds for the purpose of comparison with other investment alternatives and benchmarks.

The generally accepted standard to compare investment performance over time is to measure the changes in the market value of a portfolio including realized and unrealized gains and losses and interest income over the period. This is known as mark-to-market and is consistent with the Global Investment Performance Standards (GIPS) published by the Chartered Financial Analysts Institute.

2007 Comparison of Investment Performance

Portfolio

Average Portfolio Value

($ million)

City Market Return

(%)

ONE Fund Return

(%)

DEX Index Return

(%)

Short-Term Investments

Long-Term Funds

Total General Funds

Sinking Funds

All Funds

713.4

427.4

1,140.8

169.2

1,310.0

4.51

3.72

4.21

4.13

4.20

4.39

3.84

4.18

3.84

4.14

4.43

4.63

4.50

4.65

4.52

On a consolidated basis, the City's mark-to-market return was 4.20%, exceeding ONE Fund by 6 bps. but lower than DEX by 32 bps. The underperformance against the DEX indexes reflects the credit problems experienced in the financial markets which resulted in investors shifting funds to Government securities bidding up the price of all shorter term Government investments relative to other investment classes. The DEX index consists of Government securites exclusively, which strongly outperformed all other fixed income investment classes during 2007. For example the DEX Universal Bond Index, which includes corporate, provincial and municipal bonds had a return of 3.68% for 2007. Also any comparison to a DEX index should keep in mind that there are no transaction fees or expenses reducing the returns for the index, while City returns have been reduced by 4 bps representing the direct costs associated with investment activities.

Investments in City of Ottawa Long-Term and Short-Term Securities

O. Reg. 438/97 4. (1) requires that a municipality shall not invest more than 25 per cent of the total amount in all sinking and retirement funds in respect of debentures of the municipality, as estimated by its City Treasurer on the date of the investment, in short-term debt issued or guaranteed by the municipality.

The City of Ottawa did not issue short-term securities in 2007. In 2007, the Sinking Fund made short-term advances to the City in order to have funds available for anticipated strategic investment opportunities. As the nature of the Sinking Funds portfolio is longer-term, money market instruments are not normally carried on its books, but advances to the City allows the Sinking Fund to participate in the earnings of the City’s Short-Term Investments portfolio. The highest point of Sinking Funds advances to the City in 2007 was $10.7 million, representing less than 1% of all investment portfolios.

At 31 December 2007, the City of Ottawa held $76.5 or 7.8% of total investment assets, in its own long-term debentures.

Compliance with Investment Policy

For the year 2007, all investments were made in accordance with the investment policies and goals adopted by City Council. Details of investments by issuer categories for the City’s investment portfolios are shown in Document 2.

Limiting investment purchases to high-quality investment-grade securities controls credit exposure for each of the investment portfolios. Some exposure, within approved policy limits, to lower-rated and unrated municipal issuers allows the City to capture higher yields over higher-rated issuers. As of 31 December 2007, 100 per cent of investments held in the Short-Term Investments portfolio were rated R-1 mid or better. Details of the credit exposure by Rating are shown in Document 2.

The Long-Term and Sinking Fund portfolios are weighed more heavily towards highly rated federal, provincial and municipal debt. 100 per cent of the assets held in these portfolios are invested in securities rated AA or better as at 31 December 2007. Details are shown in Document 2.

There was a change in the term exposure of the General Funds compared to 2006. The strategy for the first eight months of the year was to extend term as interest rates rose. This strategy was adjusted in the fourth quarter as a result of the sub-prime and credit concerns in the markets. Investments were shortened and the credit quality of new purchases raised as a defensive stance in response to these liquidity issues. To take advantage of rising short-term interest rates, funds were invested in shorter investments. As of 31 December 2007, the weighted term-to-maturity of the Short-Term Investment portfolio was 41 days and the Long-Term Funds portfolio was 3.7 years, for a total blended weighted average term of 1.8 years.

Sinking Fund assets were invested in longer-term securities consistent with future commitments, while at the same time capturing higher returns for longer-dated securities. The weighted term-to-maturity of the Sinking Fund portfolio as of 31 December 2007 was 4.6 years.

Term Exposure for the General and Sinking Funds as at 31 December

Maturity	General Funds (%)		Sinking Funds (%)
Maturity	2007	2006	2007	2006
Less than 1 year	61	51	12	9
1 - 5 years	27	32	62	52
5 – 10 years	11	16	17	26
10 years or more	1	1	9	13
	100	100	100	100

Transactions in own Securities

Long-term City of Ottawa debentures are purchased from time to time when such securities are available and when it is beneficial for the City to acquire a portion of its own outstanding debt in the capital markets. During 2007 the City purchased $8,425,000 par value of its own debenture issues. $3,425,000 maturing 28 February 2011 with a coupon interest of 10.750% at a price of 123.83 ($4,241,177) for the Sinking-Fund Portfolio and $5,000,000 maturing 10 September 2019 with a coupon interest of 6.20% at a price of 114.863 ($5743,150) for the Long-Term Portfolio.

Investment Management Expenses

The City’s investment returns are adjusted for costs associated with the management of these funds for the purpose of comparison with other investment alternatives and benchmarks. The City’s portfolio management fees are estimated by measuring the costs associated with the investment section relative to the size of the assets under management. Direct costs include staff salary, custodial services, market information systems, portfolio management software and other miscellaneous expenses.

In 2007, direct costs associated with managing the City’s investments represented 4 basis points on the average total amount of all invested funds including the Endowment Fund of $1.513 billion. These costs compare favourably to the management fees of the ONE Fund which charges 19 basis points for its Money Market Fund and 40 basis points for its Bond Fund, or 29 basis points at the City’s average term composition for the year.

Endowment Fund Performance

The City of Ottawa Endowment Fund (the Fund) was established from the proceeds received from Hydro Ottawa in early 2005 when Hydro Ottawa completed it’s refinancing and paid the City $200 million. The Province broadened the scope of eligible investments specifically for these funds in late 2005 to include Canadian equities and Canadian corporate bonds. Council adopted an investment policy and procedures statement and established the Investment Committee on 14 June 2006.

The Investment Committee consists of the City Manager, City Treasurer, City Solicitor or appointee, Manager Treasury and the Chief Corporate Services Officer. With the implementation of Business Transformation Services, the position of Chief Corporate Services Officer was no longer required thus creating a vacancy on the Investment Committee. The Investment Committee met on 18 December 2007 and is recommending that Council appoint the Deputy Treasurer to the Committee and delete the Chief Corporate Services Officer position. The Deputy Treasurer is responsible for corporate controls, is familiar with investments and financial issues facing the City and thus is a good candidate for membership on the Committee.

External investment Managers for the Endowment Fund were selected in late 2006 and early 2007, however due to clarifications required on the Provincial limitations governing the eligible investments for the Fund, moneys were only transferred to each of the two investment managers in May and August 2007. The City invested the Funds in eligible short-term investments until that time.

As at 31 December 2007 the market value of the Fund was $203.7 million. However this return does not take into account the $4.5 million in interest earnings, which the Fund earned prior to being placed with the external fund managers. The amount of $4.5 million was transferred from the Fund to the City in December 2007. Based on the market value of the Fund at year-end and including the $4.5 million in additional interest earnings, the total annualized return for the year was 4.1%. This return is less than the targeted return of 6.5%, however the external investment managers did not have the funds for the full year and were building the Fund’s portfolios during a period when Canadian equity markets were declining. While the funds were kept with the City they were invested in short-term products, in order to allow the transfer to the external managers, which did not earn as much as a longer-term product would have.

Following a period of exceptional returns for Canadian equities (17.3% for 2006 and 24.1% for 2005) a strategy of gradually building the Fund’s portfolio in Canadian equities was implemented recognising that the exceptionally high returns of recent years could not be sustained indefinitely. Thus at year end the Fund’s portfolios were evenly distributed in Canadian equities (35.2%), bonds (31.7%) and short-term investments (33.1%). If the Fund had larger holdings in equities overall returns may have been less favourable as Canadian equities declined by 1.2% during the last quarter of 2007. As the outlook for equity investments becomes more favourable, the investment managers are expected to increase their holdings of equities which will hopefully enhance returns over the longer term.

CONSULTATION

The public consultation process is not applicable.

FINANCIAL IMPLICATIONS

It is the opinion of the City Treasurer that all investments were made in accordance with the City’s Investment Policy during 2007.

SUPPORTING DOCUMENTATION

Document 1 - Reporting requirements of O. Reg. 438/97

Document 2 - Investment portfolios Short and Long-Term Credit Exposure.

DISPOSITION

Following consideration by Corporate Services and Economic Development Committee, this report will be forwarded to Council for its consideration.

Document 1

REPORTING REQUIREMENTS OF ONTARIO REGULATION 438/97

8. (1) If a municipality has an investment in a security prescribed under this Regulation, the council of the municipality shall require the treasurer of the municipality to prepare and provide to the council, each year or more frequently as specified by the council, an investment report.

(2) The investment report referred to in subsection (1) shall contain,

(a) a statement about the performance of the portfolio of investments of the municipality during the period covered by the report;

(b) a description 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 investment of the municipality and a description of the change, if any, in that estimated proportion since the previous year's report;

(c) 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;

(d) 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; and

(e) such other information that the council may require or that, in the opinion of the treasurer, should be included.

Document 2

INVESTMENT PORTFOLIO 2007

ALL FUNDS	Par Value ($1,000)		% of Total		Policy
(excluding Endowment Fund)	2007	2006	2007	2006	Range (%)
Cash	14,554	12,854	1	1
Federal	230,777	197,865	22	21	20 – 100
Provincial	176,995	164,282	17	17	5 – 75
Municipal	139,942	145,948	13	16	0 – 50
City of Ottawa	68,894	65,039	7	7	0 – 50
Schedule I Bank	234,627	99,459	22	11	0 – 70
Schedule II Bank	66,000	60,000	6	6	0 – 25
Commercial Paper	65,000	60,000	6	6	0 – 20
Asset-Backed Commercial Paper	0	71,700	0	8	0 – 20
Asset-Backed Securities	64,615	59,115	6	6	0 – 25
Other	2,814	4,278	0	0	0 – 25
Grand Total	1,064,218	940,540	100	100

Short-Term Investments Credit Exposure as at 31 December

Rating	2007 (%)	2006 (%)
R-1 High	71	73
R-1 Mid	29	27
R-1 Low	0	0
	100	100

Long-Term and Sinking Fund Credit Exposure as at 31 December

Rating	Long-Term (%)		Sinking Funds (%)
Rating	2007	2006	2007	2006
AAA	52	54	60	60
AA	48	42	40	40
A	0	4	0	0
BBB and Unrated	0	0	0	0
	100	100	100	100

[1] Excluding $2.8 million held in an external bond fund on behalf of the OC Transpo Self-Insurance Fund and $.7 million held in escrow in the form of a guaranteed investment certificate as security for a transaction initiated by the former City of Gloucester.

[2] Unless otherwise indicated, portfolio assets are stated on an amortized book basis plus accrued interest.

[3] The City uses a composite of the Short-Term and Mid-Term SCI All Governments indices according to the respective average monthly durations for each of the City’s bond portfolios. Duration is a measurement of how long in years it takes for the purchase price of a bond to be repaid by its internal cash flows. It is an important measure for investors to consider, as bonds with higher durations have higher price volatility than bonds with lower durations.