To: Board of Supervisors of Sonoma County, Board of Directors of the Sonoma County Water Agency, Board of Commissioners of the Community Development Commission, Board of Directors of the Sonoma County Agricultural Preservation and Open Space District
Department or Agency Name(s): Auditor-Controller-Treasurer-Tax Collector
Staff Name and Phone Number: Jonathan Kadlec 565-6124
Vote Requirement: Majority
Supervisorial District(s): All
Title:
Title
Authority to Invest and Reinvest Funds, Approval of the Statement of Investment Policy, and Auditor-Controller-Treasurer-Tax Collector Informational Treasury Report
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Recommended Action:
Recommended action
A) Approval of the Concurrent Resolution of the Board of Supervisors of the County of Sonoma and all Districts governed ex-officio by the Board of Supervisors renewing authorization for the County Treasurer to assume full responsibility for all transactions and expenditures related to the investment and reinvestment of funds on deposit in the County Treasury.
B) Approval of the County of Sonoma Statement of Investment Policy
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Executive Summary:
This item provides for the annual review of the delegated authority of the Board to the Treasurer to invest and reinvest funds as provided for in County Ordinance 5037.
This item will also provide an overview of the investment function for the County Treasurer pooled investment fund and a discussion of evolving investment opportunities; Environmental, Social, & Governance (ESG) Investing; and review and approval of the Statement of Investment Policy.
Discussion:
The Board of Supervisors adopted County Ordinance 5037 on June 17, 1997. The Ordinance permits the annual delegation of the authority to invest and reinvest funds held on deposit in the Sonoma County Treasury, as well as the authority to sell or exchange securities. The County Treasurer then assumes full responsibilities for all transactions and expenditures related to the investment and reinvestment of funds on deposit in the Sonoma County Treasury until the annual delegation expires or until the Board revokes it delegation of authority by ordinance.
Authority is also requested in order to comply with the County of Sonoma Statement of Investment Policy, approved by the Board of Supervisors on January 9, 2018. Section 6 of the Policy states the Sonoma County Board of Supervisors, by resolution, has delegated investment responsibility for the Sonoma County Investment Program to the Auditor-Controller-Treasurer-Tax Collector.
Treasury Investment Primer
Overview
The Sonoma County Treasurer is responsible for safely managing the daily investment of the approximately $2.9 billion pooled investment fund (the “Fund”) on behalf of the County, schools, special districts, and other agencies. Agencies are either statutory or voluntary participants in the Fund. The below table outlines the percentages of each Fund participant type as of 6/30/2019:
|
Participants |
Percent |
|
School Trust Funds |
38.2% |
|
Agency Funds |
17.0% |
|
County Special Revenue Funds |
10.0% |
|
Other Governmental Entities |
6.0% |
|
Investment Trust Funds |
5.5% |
|
General Fund |
5.3% |
|
Sonoma County Water Agency |
5.0% |
|
Internal Service Funds |
4.8% |
|
County Enterprise Funds |
2.4% |
|
Special Districts Enterprise |
1.5% |
|
Community Development Comm. |
1.2% |
|
Independent Special Districts |
0.9% |
|
Capital Projects Funds |
0.6% |
|
Special Districts Spec. Rev. |
0.5% |
|
Special Districts Debt Service |
0.5% |
|
County Service Areas |
0.4% |
|
Private Purpose Trust Funds |
0.2% |
The Treasurer is responsible for the management of the daily cash flow needs of all Fund participants. Government Code Section 53601 guides the investment process, and requires the investing process be conducted following three key principles. They are: 1) Safety of Capital - invest as safely as possible in order to preserve principal, 2) Liquidity - assure the ability to meet the current and future cash flow needs of Fund participants, and 3) Maximum Rate of Return - to the extent possible the Fund should maximize yield once the first two rules are met. The code restricts the investments to fixed income securities with a final maturity of 5 years or less. Exceptions to the maturity rule are possible as is the case with the Fund’s investment in the Sonoma County Energy Independence Program (SCEIP). However, exceptions are rare and require the advance approval of the County Board of Supervisors. In addition, an Investment Policy Statement (“IPS”) that is reviewed and approved by the County Board of Supervisors guides the investment activity. The IPS closely mirrors the permitted investments as prescribed in Government Code in order to provide maximum flexibility to take full advantage of continually changing market investment opportunities in order to optimize the earnings of the Fund on behalf of participants. Sonoma County also maintains a Treasury Oversight Committee (“Committee”). The seven member Committee includes some representative members of the Fund and meets semi-annually. The requirement for a Committee arose due to the Orange County bankruptcy of the early 1990s, and was previously mandated by Government Code. The Committee’s sole authority is to call for the required annual audit of the Fund. The Committee also reviews the IPS each year, but has no authority to direct the investments of the Fund. Approximately 15 years ago, the State converted the Committee to a voluntary process; however, the Sonoma County Treasurer chose to continue the Committee as a best practice and provide transparency to Fund participants.
Each year the Treasurer oversees the investment and reinvestment of over $4 billion primarily comprised of the inflow of property taxes ($1.2 billion), reinvestment of matured and called investments ($2.0 billion), State school funds ($480 million), sales tax revenues attributable to multiple measures ($240 million), and the receipt of school bond proceeds (varies from $50 - $300 million per year). The Fund executes approximately 350 purchase transactions per year and manages approximately 200 maturing or called bonds. The average investment transaction is approximately $13 million. Interest earnings are accrued and apportioned (paid) on a pro-rata basis to participants based on their average daily balance on deposit in the Fund during each reporting period. The Fund apportions interest on a quarterly calendar basis and paid $51,985,000 in interest over the last four calendar quarters to Fund participants.
Cash Flow Management
On a daily basis, the Treasurer’s Investment staff assesses the needs of Fund participants to assure that there is sufficient cash on hand to cover expenditures. Quarterly, Government Code Section 53646 (3) requires that the Treasurer state that the Fund has the ability to cover 6 months of participant expenditures. Annually, the Fund covers expenditures of approximately $3 billion. Significant items include vouchers payable of $1.4 billion, payroll for the County and schools of approximately $900 million, and schools and County bond debt service of $220 million. The ongoing liquidity needs of the Fund are managed by investment staff through continual communication with participants to understand their future expenditure requirements. Staff also utilizes a cash flow forecasting model that looks into the future to match revenues and investment maturities with projected expenditures.
Each day, staff reviews the cash needs of the Fund and manages the movement of cash between various financial institutions to cover all expenditures, investments, and other obligations of the Fund. After covering all other outstanding obligations, staff determines the level of cash available for investment and reviews the financial market for investment opportunities to safely optimize interest earnings.
The Investment Process
Pursuant to Sonoma County Ordinance 5037, Section 2-33-20, the County Board of Supervisors has delegated the authority to invest and reinvest the funds of the County and other depositors to the County Treasurer. The Treasurer assumes full responsibility for the transactions. The Board of Supervisors is required to review this delegation annually and makes a determination to renew or revoke the delegation.
Primary guidance for the investment process is provided in the IPS. The main purpose of the IPS is to prescribe the permissible amounts and types of investments that the Fund can purchase. The IPS provides a level of accountability for investment staff and promotes public trust. The IPS is an essential component of a disciplined approach to the investment process and when combined with quarterly reports as required by Government Code Section 53646(b)(2), helps to assure that the investment process adheres to a set of safe practices to aid in the protection of the investments in the Fund. The Treasurer is the Trustee of the Fund and is a fiduciary subject to the prudent investor standard. The stated investment objectives of the IPS are in order of importance: 1) Safety of Capital 2) Liquidity and 3) Maximum Rate of Return. Preservation of capital is the primary objective. Providing sufficient liquidity to meet all Fund depositor’s operating requirements is secondary. After the first two principals are met then maximizing the rate of return through careful consideration of market conditions, risk assessment, and consideration of economic cycles is desirable.
Prior to purchasing securities, the investment process takes into consideration various types of risk and the condition of the financial markets. The most common types of risk affecting a fixed income portfolio are Interest Rate, Market, and Credit risk. To a lesser degree Headline risk is also a concern. Interest Rate risk is the risk that rates will rise or fall causing an adverse effect on the value of investments in the Fund. Market risk (also known as systemic risk) is the adverse effect of recessions, political turmoil or other systemic issues that affect the entire market. Credit risk is the chance that a particular company will fail to meet their financial obligations resulting in possible non-payment of an obligation such as bond interest and principal due. Headline risk is the effect of news headlines negatively affecting the value of a company and their outstanding debt obligations.
In order to assess the most optimal investment opportunities, staff uses tools such as a Bloomberg computer terminal and a network of securities brokers to ascertain current market pricing for the different types of securities available for purchase. The main types of securities purchased by the Fund are:
1) United States Treasuries (Bills and Notes)
2) Fixed Income bonds issued by the Agencies/Government Sponsored Enterprises (GSE), such as Federal Home Loan Mortgage Corporation (FHLMC), Federal Home Loan Bank (FHLB), Federal Farm Credit Bank (FFCB), and the Federal National Mortgage Association (FNMA).
3) Medium Term Corporate Notes
4) Mutual Funds
5) Negotiable Certificates of Deposit
6) Obligations of the International Bank for Reconstruction and Development (IBRD)
7) Bonds and notes issued by local agencies
The Fund’s investment holdings are structured using a laddered approach to provide a regular source of liquidity through a regular schedule of maturing investments that match with known future liabilities. Generally, the Fund holds investments to maturity and does not actively buy and sell investments. This strategy ensures that the Fund can meet the future obligations of the Fund’s participants.
Investment decisions are made based on current market offerings from brokers who have a constantly changing supply of qualified securities available for purchase. As market conditions change, staff tracks the direction of interest rates (the yield curve) and assesses various types of risk to make investment decisions that meet the primary objectives of the Fund. A normal part of the investment process involves a continual assessment of market changes enabling staff to negotiate optimal pricing with the broker, which results in additional income for Fund participants. Throughout the year, staff performs several continuous portfolio management functions. Those functions include 1) continuously monitoring the portfolio for advantageous reinvestment opportunities, 2) monitoring the companies whose bonds we own and evaluating them for credit worthiness based on the ratings provided by the major credit rating agencies such as Standard & Poor’s, Fitch, and Moodys, 3) monitoring and if needed rebalancing the mix of investment types and holdings, and 4) tracking the mix and level of sector diversification for owned corporate securities.
Lastly, there is a robust audit program in place and several periodic audits are performed each year to help assure that Treasury Investment staff comply with relevant Government Code requirements when administering the investment function. An annual compliance audit is performed by an independent outside auditor who reviews the annual activity of the Fund to assure compliance with all applicable State codes. Quarterly, an audit of the assets of the Fund are accounted for and reconciled. Finally, the County’s external auditors perform random testing of investment activity to check for compliance with relevant statutory requirements.
Environmental, Social & Governance (ESG) Investing
ESG investing is the most recent iteration of an investment trend that started out as either Socially Responsible Investing (SRI) or one of the various divestment movements from the 1970s and later, e.g.: divestment from South Africa in the 1980s. It seeks to both broaden and deepen the impact of focused investment by bringing certain investment portfolio concepts into consideration.
The earliest approach utilized negative signaling to drive investment decisions. SRI and divestment can both be categorized as utilizing capital flow to punish dis-favored companies in the financial world, by making the cost of capital to a targeted corporation more expensive. This is sometimes known as an “Avoidance” strategy. The drawback to Avoidance is that without wide-spread take up of the action by other players, the impact on capital cost is usually de-minimis as other players in the global market will step in to fill the departing investor’s role. Additionally, if the company is fairly mature, or without much need to access capital for new funding, the target could resist the movement for long periods of time making this approach relatively ineffective.
The second iteration switched from an Avoidance strategy, to an “Advancement” strategy. The object of Advancement was to search out corporations that were pursuing goals the investor wanted to advance. This is highlighted most dramatically in the climate change arena, where equity investors funded startups in sustainable or renewable energy fields as a way to spur advancement in the science with a goal of lowering of costs for consumers. Fixed income investors also played a role in this sector, focusing on “Green Bonds” issued by entities to fund new climate-friendly projects or to retrofit older activities in sustainable ways. Because the Advancement strategy utilized incentives given to willing recipients it produced much better and faster results than the older Avoidance strategies achieved.
There is a natural tension between the Avoidance and Advancement strategies, as is illustrated by one of the recent holdings in the Treasury pool, BNP Paribas. This bank has been called out for facilitating the funding of private prisons. Several interest groups have called upon BNP to divest its holdings of and cease funding of the two main private prison operators in the US. BNP announced on July 12th, 2019, that it would cease financing private prisons. Publicly available data as of Sept. 30th, 2019 indicate a position of 130,611 shares ($2.0 million valuation) in Core Civic and 34,213 shares ($500,000 valuation) in Geo Group held by a managed fund advised by BNP. Given that the stock is not held by BNP, and that they have committed to ending their banking relationship, it is an open question whether divestment is called for if the only consideration is avoiding companies that are involved in the private prison sector.
In this case, the tension results from a consideration of the other activities BNP pursues. It is one of the larger players in Green Finance, with a commitment to €15 billion of financing of renewables by 2020 (with their last reported position of €12.3 billion in 2017). They launched an initiative to subsidize personal finance loans for sustainable renovation, with €2 billion of commitments outstanding. BNP has started a seed-funding program to drive technological innovation in renewable energy technology start-ups. For an investor looking to Advance the development of a post-carbon energy future, BNP is clearly a qualified investment.
The latest style of focused investment goes under the moniker of ESG, and can be thought of as “Integrative”, as opposed to purely Advancement or Avoidance. The approach takes a portfolio view, and seeks to find a balance between various positives and negatives among a wide range of factors that the investor seeks to emphasize in their strategy.
There are three areas of emphasis for ESG investors: Environmental, where potential investments are weighed based on the corporation’s impact on climate, air and water quality, and other environmental impacts. Social, where corporate behavior is analyzed with respect to human rights, diversity & inclusion, education, etc... Governance focus on whether the managerial and ownership structure of the corporation includes protection for stakeholders and looks to minimize the potential for abusive ownership structures.
Since the three areas of ESG investing are different, it is common that potential investments may score highly in one or two areas, and less well in another. In reality, all potential investments are imperfect. The ESG strategy is to weigh these investment decisions around the totality of the corporation. In the case of industries that will be severely impacted by climate change, the most important question is whether the corporation is meaningfully committed to transitioning, and if they are actively pursuing that transition.
Historically, ESG strategies have been primarily focused on the stock market, as capital raised by new ventures is typically equity and not debt. The debt market is dominated by larger, long-established and higher-rated issuers, including governments and agencies, which are typically placed outside ESG considerations due to their public missions. This left a smaller opportunity set for ESG debt investments to be impactful. The rise of the Green Bond market was instrumental in showing that there can be focused ESG investments in bonds. Similar approaches have been tried for other programs, such as financing education and health initiatives by multi-lateral supranational organizations, but have yet to reach critical size. There are preliminary efforts to develop an ESG styled debt market for much needed new infrastructure projects and rehabilitation of existing infrastructure stock using sustainable concepts.
ESG investment is a values exercise. Each investor has different views on where to place emphasis within the universe of ESG considerations. Some may prefer to rank climate ahead of diversity or cultural needs. Others might see a need to weight business ethics behind waste & water management. As such, ESG investment solutions are unique to the investor, with much care being given to the construction of the investment policy.
Where does ESG fit in with respect to the County’s Investment Pool? Our investments are governed by California Code, and must comply with those stipulations and limitations. Many ESG investments, unfortunately, fall outside of those guidelines. Some only issue stock, which is not a permissible investment for the Treasurer. Some are rated too low, while others are illiquid, and holding either within the pool would not be prudent. We have researched some ESG models and found that virtually none of their approved firms offer bonds that were qualified to be purchased by the County Treasurer’s Investment Fund.
We have analyzed our holdings, using the MSCI ESG ratings scale, and our average corporate holding is ranked "A-" on that scale. The MSCI ESG criteria look at a wide range of critical exposures and management metrics, and compares a firm to peers within the same industry group. MSCI is a financial data and index provider, formerly known as Morgan Stanley Capital International; it is now independent.
The Treasury team researched socially responsible investing polices of other counties and believe that a more active and positive approach (Advancement) is preferable to enacting a restrictive list of corporations and agencies in which not to invest. The County Treasurer supports and recommends the inclusion of ESG considerations in the investment process and has provided an updated IPS for your Board’s consideration. This recommendation promotes social and environmental causes that align with the Board of Supervisors’ priorities to the extent that such investments achieve substantially equivalent safety, liquidity and rate of return as required by state law.
Prior Board Actions:
12-11-18 - Board of Supervisors approved Resolution #18-0507 Delegating Authority to Invest and Reinvest
01-09-2018 - Board of Supervisors approved the Statement of Investment Policy and Resolution #18-0006 Delegating Authority to Invest & Reinvest
01-10-2017 - Board of Supervisors approved the Statement of Investment Policy and Resolution #17-005 Delegating Authority to Invest & Reinvest
12-15-2015 - Board of Supervisors approved the Statement of Investment Policy and Resolution #15-0489 Delegating Authority to Invest & Reinvest
These have been approved yearly prior, since 1997.
Fiscal Summary
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FY 19-20 Adopted |
FY20-21 Projected |
FY 21-22 Projected |
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Narrative Explanation of Fiscal Impacts:
There are no fiscal impacts.
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Staffing Impacts: |
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Narrative Explanation of Staffing Impacts (If Required):
There are no staffing impacts.
Attachments:
Invest & Reinvest Resolution
County of Sonoma Statement of Investment Policy
Related Items “On File” with the Clerk of the Board:
Power point presentation.