Using Benchmarks to Assess Portfolio Risk and Return

Treasury and Investment Management

Performance Measures for Government Investment Portfolio Objectives*

Governments should measure performance of all key components of its investment policy.

Governments need to measure investment portfolio performance ensuring all objectives of the organization’s investment policy are analyzed. Solely measuring yield/return on the portfolio is not sufficient for evaluating the performance of public fund investment portfolios. Stewardship of public funds means measuring all objectives of an organization’s investment policy with safety and liquidity being higher priorities than return. Determining a government’s performance must take into consideration the unique characteristics of its total cash and investments [1], while maintaining the primary objectives of the safety of its public funds and with consideration of the entity’s unique cash flow needs.

Governments are ultimately responsible for this evaluation, regardless of whether it is managed internally or externally.

Governments are entrusted with managing public funds safely, responsibly, and transparently. Public funds are generally defined as money collected from taxpayers and ratepayers to finance government services and projects, as opposed to pension, trust and other funds which have different investment objectives. Effective stewardship of public funds requires a government to measure how well their investment portfolio meets three key investment objectives: preserving principal (safety), ensuring sufficient cash flow (liquidity), and earning reasonable income (yield/return). In public investing, safety and liquidity are the highest priorities over income generated from investments. These investment objectives are embedded in legal requirements, defined within investment policies, and provide guidance for investment strategies unique to the public sector. By measuring the portfolio on all three objectives, governments can strengthen their accountability, enhance transparency, best assess their investment decisions, and have a common understanding with staff, leadership, the public, and with external investment advisers and partners, of the entity’s investment objectives.

Key steps to measure investment portfolio performance may include, but are not limited to:

Determine staff responsible for designing tracking and analyzing performance measures
- Incorporate public investing education into investment program
Measure and report on all key investment objectives – safety, liquidity and return
- Determine performance measures
- Compare actual results to performance measures at least quarterly
- Analyze and communicate explanations for significant variances
Ensure compliance with the entity’s investment policy
- If using an external investment adviser, ensuring the advisor is managing the entity’s portfolio in compliance with the entity’s investment policy
Understand and re-affirm the entity’s choice to utilize passive or active management of the portfolio at least annually
When using an investment adviser, ensure data from the advisor is measuring the portfolio’s true performance and not adviser’s reported performance
Other measures relevant to your government

Safety of Funds

Governments should determine performance measures for the safety of funds that best align with the entity’s legal parameters, investment policy objectives, and risk tolerance. The results of these policy-driven measures should include regular reporting of targets and actual results.

Performance measures related to safety may include, but are not limited to:

Permissible investment types, concentration of investments and durations (dictated by state and local law, code, or policy)
Investment policy is followed, which includes factors related to credit, market and interest rate risks:
- Credit rating criteria of investments
- FDIC insurance and collateralization of bank deposit balances are in place and maintained
- Diversification strategy for holdings and entities where funds are held to avoid concentration risk
- Ongoing monitoring of entire portfolio for legal and policy compliance
- Maximum maturities and/or portfolio weighted-average-maturity (WAM) are not exceeded
When managing a portfolio with a third-party investment professional, governments should verify the professional performs scope of responsibilities established by the entity including tracking and reporting on safety performance measures. The government should also monitor that the professional is adhering to their discretionary or non-discretionary authority as permitted by the entity.
Professional education on public investing
Other measures relevant to your government

Liquidity Needs

Governments should determine which liquidity performance measures best align with the entity’s legal parameters and investment policy objectives that ensures adequate cash flow for anticipated and unanticipated expenditures. The results of these policy-driven measures should include regular reporting of targets and actual results.

Performance measures related to liquidity may include, but are not limited to:

Cash flow forecasts are prepared and regularly updated to estimate the timing of inflows and outflows.
Minimum liquidity balance (e.g., three months of operating expenses or a target dollar amount after an adjustment for risk mitigation) is maintained
Cash flow responsibilities are met
- Investment maturities match cash flow needs
- Avoid sales of investments before maturity to meet cash flow requirements
- Validate target level of cash liquidity is maintained
Other measures relevant to your government

Yield/Return

The third investment objective for public funds investment portfolios is to earn a market-based return [2]. While return is the third and lowest priority investment objective after safety and liquidity, an investment portfolio should be managed to earn reasonable interest income given the legal and policy constraints of public funds investing. Governments should measure their return based on income earned on their total investment portfolio during a specific time period (e.g., monthly or quarterly). Entities should monitor the return performance compared to an appropriate benchmark or reference rate that reflects similar investments.

Governments should not rely solely on a total return calculation, even when one is used to value an actively managed (frequent buying and selling) account.

Portfolio characteristics to evaluate performance on return may include, but are not limited to:

Establish its time frame for measuring return
Define and justify its benchmark or reference rate [3] for comparison of portfolio return
Calculate return after the end of each time frame
Perform simple variance analysis between its return and benchmark/reference rate
At least annually, review the benchmark and reference rate selection
Other measures relevant to your government

Developing Custom Performance Measures

GFOA provides a resource (Investment Portfolio Performance Measures) to help governments design performance measures tailored to their investment policy objectives. The model supports a comprehensive approach to evaluating investment portfolios, accounting for unique entity needs and constraints. Governments should regularly review and adjust, when necessary, their measurement approach to ensure it continues to reflect their policies, priorities and risk tolerance.

	Has process in place for measuring the three key public investing components
	Measures for the safety of funds
	Measures for the liquidity of funds
	Measures for the return of funds
	Reports performance of measures quarterly

NOTES:

*This BP applies to governmental general funds investing, not pension or special funds investing.

1 Total cash and investments – an entity’s total investments which includes funds at LGIPs, bank accounts, CDs, investment accounts, sweeps, money market funds, money market mutual funds, and other holdings.

2 A further discussion on the differences between return and yield metrics to evaluate portfolio performance can be found in the Resource.

3 For the purposes of this Best Practice, a benchmark or reference rate refers to an indicator(s)/index(es) that the entity’s portfolio return performance is compared against. See more on appropriate benchmarks and reference rates for public sector investing in the Resource.

Other Resources –