4. 2005 INVESTMENT REPORT

RAPPORT SUR LES PLACEMENTS DE 2005

COMMITTEE RECOMMENDATION

That Council receive this report on the results of the City’s investments for the year 2005 as required by Ontario Regulation 438/97, Section 8 (1), and the City’s Investment Policy.

RECOMMENDATION DU COMITÉ

Que le Conseil municipal prenne connaissance du présent rapport sur les résultats des placements de la Ville pour l’année 2005 comme l’exigent le Règlement de l’Ontario 438/97, article 8 (1), et la politique de placements de la Ville.

DOCUMENTATION

1. Chief Corporate Services Officer’s report dated 02 May 2006
(ACS2006-CRS-FIN-0021).

2.

Report to/Rapport au :

Corporate Services and Economic Development Committee

Comité des services organisationnels et du développement économique

and Council / et au Conseil

02 May 2006 / le 02 mai2006

Submitted by/Soumis par : Greg Geddes, Chief Corporate Services Officer/

Chef des Services généraux

Contact Person/Personne ressource : Marian Simulik, Acting Director, Financial Services and City Treasurer/Directrice des services financiers et Trésorière municipale par intérim

Financial Services/Services financiers

(613) 580-2424 x 14159, Marian.Simulik@ottawa.ca

City Wide

Ref N°: ACS2006-CRS-FIN-0021xx

SUBJECT:	2005 INVESTMENT REPORT
OBJET :	RAPPORT SUR LES PLACEMENTS DE 2005

REPORT RECOMMENDATION

That the Corporate Services and Economic Development Committee and Council receive this report on the results of the City’s investments for the year 2005 as required by Ontario Regulation 438/97, Section 8 (1), and the City’s Investment Policy.

RECOMMANDATION DU RAPPORT

Que le Comité des services organisationnels et du développement économique ainsi que le Conseil municipal prennent connaissance du présent rapport sur les résultats des placements de la Ville pour l’année 2005 comme l’exigent le Règlement de l’Ontario 438/97, article 8 (1), et la politique de placements 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 by O. Reg. 265/02 and 399/02, outlines the criteria for eligible investments which provides for a relatively conservative investment mix.

The City’s Investment Policy, as approved by Council, 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 and must 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.

On 12 December 2005, the Province amended the regulations governing municipal investments through Ontario Regulation 655/05. This regulation provides for a wider range of eligible investments primarily through participation in a new fund(s) to be established by CHUMS Financing Corporation (a wholly owned subsidiary of the Municipal Finance Officers’ Association of Ontario) and Local Authority Services Limited (a wholly owned subsidiary of the Association of Municipalities of Ontario) to allow for investments in Canadian Corporate bonds and equities. O. Regulation 655/05 also provides the framework for the City’s Endowment Fund. The City is developing an investment policy for the Endowment Fund and will be reviewing its existing investment policies to recommend appropriate changes. The development of an investment policy for the Endowment Fund is underway and is expected to be considered by Council shortly. Any changes to the existing investment policies for the City’s other funds may take longer to develop until such time as the details of the new investment funds are announced by CHUMS and LAS.

DISCUSSION

Economic Review of 2005

During the first three quarters of 2005 interest rates in Canada diverged sharply from US rates as the Bank of Canada kept rates unchanged while the Federal Reserve Board in the US raised interest rates. It seems the Bank of Canada was more concerned with the strength of the Canadian dollar, its impact on the manufacturing sector and the risks of slowing global growth. Inflation pressures were not as evident in Canada.

The Bank of Canada continued to hold rates steady into the summer when at its July 12^th meeting it announced that the economy was operating close to capacity and that rates hikes were needed in the “near term”. In response, short term rates increased by almost ¼ of one per cent. Finally the Bank resumed its tightening program which it started almost a year earlier in September 2004 by raising the overnight target rate by ¼ of one per cent to 2.75 per cent in September 2005. Rates were increased two more times in the third and fourth quarters to 3.25 per cent. Yields in Canada rose significantly from September with one and two year yields increasing by 1 per cent by year-end.

An interesting development in the Canadian corporate bond market was the increased issuance of Canadian denominated bonds by non-Canadian issuers, so called “Maple Bonds”. Issuance jumped from $950 million in 2004 to $ 5.08 billion in 2005 due the attractiveness of Canadian rates and the removal of foreign content restrictions on pensions funds and retirement plans. The affect this will have on the yields paid by provincial government and municipal issuers remains to be seen.

According to Scotia Capital stocks in Canada were by far the best performing asset class with the S&P/TSX index increasing over 24 per cent in 2005 in comparison to the S&P 500 equity index in the US which provided a rate of return of 4.9 per cent. Performance in Canada was led by the energy sector which gained 60 per cent due to high oil and gas prices.

2005 Investment Performance

As at 31 December 2005, the City’s general funds were held in two investment portfolios[1] with a combined value of $756.8 million[2]. The Short-Term Investment portfolio consists of investments with maturity dates of less than one year and ranged in size from a low of $122 million to a high of $763 million during 2005. Long-Term Funds, which may be invested for periods longer than a year, averaged $479.8 million during 2005. The City’s Sinking Funds were held separately and had a value of $155.1 million at year-end.

The performance of the City’s investment portfolios is summarized below. During 2005, the City’s general funds generated income in the amount of $36.3 million and the Sinking Funds generated $8.7 million representing investment returns of 3.83 per cent[3] and 5.82 per cent respectively. Investment returns are comprised of interest income, realized capital gains and losses and amortized premiums or discounts.

2005 Investment Income Performance

Portfolio	Average Portfolio Value ($mil)	Earned Income ($mil)	Investment Return (%)
Short-Term Investments	465.8	12.5	2.68
Long-Term Funds	479.8	23.8	4.95
Total General Funds	945.6	36.3	3.83
Sinking Funds	148.8	8.7	5.82
All Funds	1,094.4	45.0	4.10

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 for comparison with short-term investments and a composite of the Scotia Capital All Governments Short-Term and Mid-Term Bond Indices for comparison with long-term funds. While none of these benchmarks precisely reflect the investment policy, goals and objectives of the City of Ottawa, they serve as a reasonably acceptable basis for comparison purposes.

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 and a Bond Fund.

The Scotia Capital indices (SCI) 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 SCI[4].

SCI returns are stated without deduction for portfolio management fees or expenses while ONE Fund returns are shown after incurring investment management expenses. The City’s investment returns have been reduced by 3 basis points[5] (bps) as an allowance for the direct 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. In 2003 the City began measuring the performance of its Short-Term Investments on a total market return basis; Long-Term and Sinking Fund Investments were subsequently added in 2004.

2005 Comparison of Investment Performance

Portfolio	Average Portfolio Value ($mil)	City Market Return (%)	ONE Fund Return (%)	Scotia Index Return (%)
Short-Term Investments	465.8	2.53	2.52	2.58
Long-Term Funds	479.8	3.85	2.09	3.41
Total General Funds	945.6	3.20	2.30	3.00
Sinking Funds	148.8	5.00	2.09	4.24
All Funds	1,094.4	3.45	2.27	3.17

On a consolidated funds basis, the City’s mark-to-market return was 3.45 per cent, exceeding the ONE Fund by 118 bps. The City also performed well versus the SCI, exceeding it by 28 bps[6].

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

O. Reg. 438/97 (4) 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 2005. In 2005, the Sinking Funds 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 Funds to participate in the earnings of the City’s Short-Term Investments portfolio. The highest point of Sinking Funds advances to the City in 2005 was $5.3 million, representing less than ½ of one per cent of all investment portfolios.

At 31 December 2005, the City of Ottawa held $77.0 million, or 10.2 per cent of total investment assets, in its own long-term debentures. This was lower than the $82.2 million held in 2004.

Compliance with Investment Policy

For the year 2005, all investments were made in accordance with the investment policies and goals adopted by City Council. During the last quarter 2005, the weighted average term for the Short-Term Investment Portfolio was longer than the Policy guideline of 120 days and as at 31 December 2005 exceeded the guideline by 68 days. This resulted from decisions taken in September and October to acquire one-year Government of Canada treasury bills at what appeared to be attractive yields. However interest rates increased and as a result it was not possible to switch from these longer dated bills to shorter maturities on a profitable basis. This position negatively impacted fourth quarter returns for the Short-Term Portfolio as well as during the first quarter of 2006. The weighted average term was returned to within the policy guidelines in March 2006. Details of investments by issuer categories for the City’s investment portfolios are shown in Table 1 of Appendix A.

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 can be at times very desirable allowing the City to capture higher yields over higher-rated issuers.

As of 31 December 2005, 100 per cent of investments held in the Short-Term Investments portfolio were rated R-1 mid or better.

Short-Term Investments Credit Exposure as at 31 December

Rating	2005 (%)	2004 (%)
R-1 High	80	57
R-1 Mid	20	34
R-1 Low	0	9
	100	100

The Long-Term and Sinking Funds portfolios are weighed more heavily towards highly rated federal, provincial and municipal debt. Over 95 per cent of the assets held in these portfolios are invested in securities rated AA or better.

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

Rating	Long-Term (%)		Sinking Funds (%)
	2005	2004	2005	2004
AAA	55	49	54	53
AA	40	50	46	47
A	4	0	0	0
BBB and Unrated	1	1	0	0
	100	100	100	100

There was no significant change in the term exposure of the General Funds compared to 2004. As of 31 December 2005, as mentioned previously, the weighted term-to-maturity of the Short-Term Investments portfolio was198 days and the Long-Term Funds portfolio was 4.0 years, for a total blended weighted average term of 3.0 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 Funds as of 31 December 2005 was 4.8 years.

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

Maturity	General Funds (%)		Sinking Funds (%)
	2005	2004	2005	2004
Less than 1 year	37	40	14	8
1 - 5 years	38	31	21	32
5 – 10 years	24	28	58	56
10 years or more	1	1	7	4
	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. No purchases of City debentures were made in 2005.

Investment Management Expenses

The City’s investment returns are adjusted for certain direct 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 can be estimated by measuring the direct 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 2005, direct costs associated with managing the City’s investments represented 3 basis points on the average total amount invested of $1.094.4 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 31 basis points at the City’s average term composition for the year. If the City had invested all its funds with ONE Fund, the additional management fees alone would have reduced investment earnings by $3 million for the year. .

Sinking Funds Activity

When sinking fund or term debentures are issued, an annual contribution is made to the sinking fund, which together with interest earnings derived from the investment of these funds, will accumulate to an amount which will be sufficient to pay the debentures on maturity.

In 2005, the Sinking Funds were composed of 6 active debenture issues with actuarial rates of 3.5 per cent and 5 per cent for a total commitment at maturity of $300 million.

As at 31 December 2005, all active by-laws were in surplus positions with fund balances higher than their actuarial requirements, for a combined surplus of $21.1 million. Further details are contained in Table 2 of Appendix A.

On 11 May 2005, Council approved a reduction in the levy for By-Law 126 of 1989 by $1,262,129.36 to $250,000 commencing 15 May 2005 and agreed to reduce the levy for By-law 33 of 1991 from $3,024,258.71 to $2,000,000.00 commencing 28 February 2006, because the accumulated balances and projected future earnings were expected to be more than sufficient to pay the principal of the debt at each of the respective maturity dates.

The Sinking Funds investment portfolio is managed using a matching strategy, which ensures that the term structure of the portfolio equals the term structure of the by-law commitments. This allows the Sinking Funds portfolio to be hedged, or have some protection, from fluctuations in market interest rates.

Endowment Fund

In 2004, Council indicated that the proceeds of the Hydro Ottawa financing was to be set up as an Endowment Fund to provide an on-going source of revenue to the City’s capital program. It was also recognized at the time that the Province would need to agree to a broader list of eligible investments in order to achieve, over the long-term, investment returns which would provide an attractive revenue source. Investments for the Endowment Fund were kept short in money market investments during 2005 while a decision from the Province was pending. As indicated previously, the Province did adopt Regulation 655/05 in December 2005 which will allow for Canadian equity and corporate bond investments to be held by the Endowment Fund.

During 2005, the book return for the Endowment Fund was 2.63%. On a mark to market basis the return was 2.57% which compares to ONE Fund of 2.52% and the Scotia Capital three-month Treasury Bill index return of 2.58%.

With the implementation of new eligible investments for the Endowment Fund as a result of Regulation 655/05 a new investment policy and asset allocation strategy will be considered by Council in the near future and will provide different investment returns and benchmark comparisons in the future.

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.

SUPPORTING DOCUMENTATION

APPENDIX A – Table 1: Distribution of Investments by Sector at 31 December 2005 and 2004

– Table 2: Sinking Fund Earnings for 2005 ($mil)

DISPOSITION

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

APPENDIX A

Table 1: Distribution of Investments by Sector as at 31 December 2005 and 2004

ALL FUNDS	Value ($1,000)		% of Total		Policy
	2005	2004	2005	2004	Range (%)
Cash	7,034	13,222	1	2
Federal	260,104	174,534	39	22	20 – 100
Provincial	98,926	222,460	15	28	5 – 75
Municipal	134,551	132,262	20	17	0 – 50
City of Ottawa	43,273	82,231	7	10	0 – 50
Schedule I Bank	47,859	52,802	7	7	0 – 70
Schedule II Bank	11,994	45,681	2	6	0 – 25
Commercial Paper	12,620	32,433	2	4	0 – 20
Asset-Backed Commercial Paper	0	2,998	0	0	0 – 20
Asset-Backed Securities	43,216	32,041	6	4	0 – 25
Other	5,575	1,940	1	0	0 – 25
Grand Total	665,152	792,605	100	100

Table 2: Sinking Fund Earnings for 2005 ($mil)

Maturity	By-Law	Opening	Levies	Earned	Capitalized	Surplus	Closing	Actuarial	Debt
Date	Number	Balance	Received	Interest	Interest	to be Paid	Balance	Requirement	Maturity
May 15, 2006	102 of 1986	15.00	0.00	0.95	0.67	0.96	15.00	14.28	15.00
May 31, 2009	126 of 1989	41.45	0.25	2.47	1.72	0.00	44.16	36.82	50.00
Feb 28, 2011	33 of 1991	66.85	3.02	4.18	2.92	0.00	74.06	61.76	100.00
Apr 15, 2012	81 of 1992	8.712	3.98	0.81	0.56	0.00	13.49	12.98	50.00
Sep 14, 2018	68 of 1998	1.056	1.04	0.08	0.05	0.00	2.17	2.13	20.00
Sep 10, 2019	72 of 1999	1.964	3.21	0.16	0.10	0.00	5.34	5.15	65.00
		135.03	11.50	8.65	6.02	0.96	154.22	133.12	300
Notes:
Opening balance is the sum of actuarial and surplus balances.
By-laws 68 of 1998 and 72 of 1999 use a 3.5 per cent actuarial rate.

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[1] Excluding $3.6 million invested with an external bond fund held on behalf of the OC Transpo Self-Insurance Fund and $0.7 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 composite returns for the City’s portfolios are weighted by portfolio size.

[4] 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.

[5] A basis point is 1/100^th of a percentage point.

[6] The margin over SCI is smaller than over the ONE Fund because while the composite SCI indices have been weighed to match the City’s longer-term composition, the ONE Fund’s bond portfolio has an average term composition that is consistently shorter than the City’s. Longer-term securities generally provide higher returns.