INVEST PROGRAM
INVEST PROGRAM 2020 ANNUAL REPORT
Introduction
The following report provides an overview of the Pennsylvania Treasury Department's INVEST Program including the objectives, policies, and risks associated with the Program. In addition, performance results for the INVEST Daily and INVEST Community portfolios are included herein for the twelve-month period beginning January 1, 2020 through December 31, 2020.
Program Overview
The powers and duties of the Treasurer and Treasury are delineated for the most part in the Pennsylvania Fiscal Code and include the deposit, investment, and safekeeping of the money and securities belonging to the Commonwealth of Pennsylvania. Treasury manages and invests money that exceeds the ordinary operational needs of the Commonwealth. Treasury also possesses the investment authority for money derived from other specialized Treasury programs, including the Pennsylvania Treasury INVEST Program, which is designed for local governments and non-profit organizations. The INVEST Program currently consists of two Standard & Poor's rated pools, the Local Government Pool (INVEST Daily) and the Community Pool (INVEST Community).
The Local Government Pool consists of a single portfolio and is available to all governmental entities including: counties, cities, boroughs, incorporated towns, townships, school districts, other units of government, authorities, boards, and commissions.
The Community Pool also consists of a single portfolio and is available to non-governmental entities including but not limited to: colleges, community colleges and universities, hospitals, libraries, and fire companies.
In addition to the above rated pools, Treasury also offers non-rated custom pools to meet the unique needs or circumstances of specific governmental and community participants. The custom pools are comprised solely of domestic certificates of deposit.
Investment Objectives and Policies
The INVEST Program is administered by the Pennsylvania Treasury Department in accordance with Commonwealth law, including statutes related to local government, specific rules, and regulations. The Treasury Investment Policy for INVEST details the specific laws and strict guidelines followed in the execution of the investment philosophy. In addition, rated pools are further restricted to investments that also satisfy criteria established by Standard & Poor's. Treasury will immediately modify investment activity to comply with new or modified law consistent with all applicable laws, rules, and regulations.
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Treasury's objective is to provide maximum security and liquidity, and to maintain the highest possible rating for the INVEST Daily and INVEST Community Pools. Each pool is rated "AAAm", the highest stable principle fund rating assigned by Standard & Poor's. This rating signifies the pool's extremely strong capacity to maintain principal stability and to limit exposure to principal losses due to credit risk.
When evaluating a local government investment pool, Standard & Poor's analysis focuses primarily on the creditworthiness of the fund's investments and counterparties, and also its investments' maturity structure and management's ability and policies to maintain the fund's stable net asset value.
Both the INVEST Daily and INVEST Community Pools seek to provide current income while maintaining liquidity and a stable net asset value per share (NAVPS) of $1.00. Each portfolio invests in short-term, high-quality, fixed income securities and is managed to ensure that the weighted average maturity does not exceed 60 days at any time. Effective September 1, 2016, Treasury, in accordance with Act 10, expanded its allowable investments to include commercial paper and negotiable certificates of deposit.
As of December 31, 2020, the NAVPS of INVEST Daily and INVEST Community was $1.00 (1) and the average life of each portfolio was 45 days and 42 days, respectively.
Terms, Conditions and Fees
The following chart summarizes the terms, conditions and fees applicable to the participants in the INVEST Program.
Service Administrative Fee Transaction Fee Transactions Balance Requirement Term Accounts Deposits Interest Transaction Confirmation Statements
Daily
11 Basis Points
None
Unlimited
None
Same Day
Unlimited No Maximum No Minimum Calculated Daily Paid Monthly Next Business Day
Monthly
Community
11 Basis Points
None
Unlimited
None
Same Day
Unlimited No Maximum No Minimum Calculated Daily Paid Monthly Next Business Day
Monthly
(1) $1 is defined as being any amount between $0.9985 and $1.0015.
Custom
6 Basis Points
None
At Maturity As Per Specific
Investment Same Day or Designated Day
Unlimited
$100,000 Minimum
Paid at Maturity
Next Business Day Initial Deposit and Maturity
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Program Oversight
The Compliance Division within Treasury's Bureau of Cash Management and Investments has implemented investment-monitoring procedures for the INVEST Program to ensure strict adherence to the INVEST Investment Policy. In addition, the financial statements of the INVEST Program are audited annually by an independent Certified Public Accounting (CPA) firm and/or the Pennsylvania Department of the Auditor General.
Furthermore, Treasury's Investment Committee meets regularly to review the objectives and performance of the INVEST Program, as well as all other programs administered by the Department. The Investment Committee shall consist of the Treasurer; the Chief Investment Officer, who shall Chair meetings of the Committee; the Chief Counsel; and other persons whom the Treasurer may wish to appoint.
Pool Share Summary
The following chart reflects the combined monthly average and ending shareholder balances for the INVEST Program which includes INVEST Daily and INVEST Community. Fluctuations in shareholder balances represent net cash flows into or out of the Program.
1,400,000,000
1,300,000,000
1,200,000,000
1,100,000,000
1,000,000,000
900,000,000
800,000,000
700,000,000
600,000,000 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Avg. Monthly Balance
Ending Monthly Balance
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On December 31, 2020, the INVEST Program was comprised of 460 participants, with 279
participants comprising the INVEST Daily Pool and 181 participants comprising the INVEST
Community Pool. The illustration below displays the composition of Program shareholders based on December 31, 2020, participant assets. (3)
Boroughs Townships 1%
2%
Library/Education 4%
Conservation Districts 2%
Counties 26%
Authorities 24%
Cities 14%
Misc 13%
School Districts 13%
(3) Fire/Rescue, Associations, and Museum/Historical participants comprise less than 1% of the total program and are not visible in the illustration above.
Economic Review
Federal Reserve Policy: The year 2020 marked a return to a near-zero interest rate environment as the Federal Reserve cut interest rates in response to the negative economic impact of COVID19. In fact, at the beginning of the year, the federal funds target range was 1.50% - 1.75%, which it had been since October 2019 when the Fed finished its series of three consecutive rate cuts. Following the third rate cut in October 2019, the Fed said they seemed content to see the economy's response to the series of rate cuts intended to address low inflation, economic weakness overseas, and trade tensions. As the Fed waited to see the reaction the economy would have, COVID-19 started spreading throughout much of the United States and the rest of the world. In early March, the Fed delivered a 50-basis point rate cut in response to the risks COVID-19 posed to the economy. It was not enough. Less than two weeks later, on Sunday, March 15, the Fed took extraordinary actions to help stabilize the economy and financial markets under pressure from the impact of COVID-19. These actions included cutting rates by an additional 100 basis points to effectively zero and establishing many other facilities
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to support the markets, issuers, and financial institutions. The Effective Federal Funds Rate for the year 2020 is shown in Figure 1 on the previous page.
Throughout the rest of the year, the Fed maintained its course, as it left the federal funds rate unchanged, after cutting rates to 0.00% - 0.25% during the first quarter. Additionally, the Fed continued its purchases of Treasury and mortgage-backed securities. Following the Fed's meeting in December, Fed Chair Jerome Powell announced that the Fed would maintain the 0.00% - 0.25% target range until the labor markets have improved and inflation has risen to 2% and is on track to moderately exceed 2% for some time.
Inflation: The Fed's preferred measure of inflation, the Core Personal Consumption Expenditures (PCE) index, which excludes food and energy, continued to remain below the Fed's target inflation rate of 2.0%, ranging from 1.7% - 1.8% during 1Q20. During 2Q20, the PCE dropped as low as 1.0% due to the impact of COVID on the economy. Throughout the remainder of the year, the index saw modest increases but remained below the Federal Reserve's threshold for action.
Projections continue to show muted inflation levels going forward. For example, the summary of economic projections released by the Fed in December indicates that the Fed members do not expect inflation to exceed the 2% target through 2023. Fed Chair Jerome Powell spoke to this following the Fed's December meeting, saying, "There are significant disinflationary pressures around the world. And there have been for a while. It is not going to be easy to have inflation move up. It took a long time to get inflation back to 2% in the last crisis."
Labor Markets: The beginning of 1Q20 picked up where 4Q19 left off, posting relatively strong numbers, as there were at least 200,000 new jobs created in January and February. Through these first two months of the quarter, the unemployment rate remained around 3.5% 3.6%, a near half-century low. As we went into March, however, COVID-19 has a significant negative impact on the labor markets. In March, there were around 700,000 jobs lost, which caused the unemployment rate to spike to 4.4% to close out the first quarter. Nonetheless, the employment reports' survey periods occurred before many of the statewide closures across the country. Looking at filings for Initial Jobless Claims, a weekly indicator that measures first-time filings for unemployment benefits, the end of March signaled what was to come in 2Q20.
In April 2020, the unemployment rate increased by 10.3%, bringing the unemployment rate to 14.7%, which marked the highest level and the largest over the month increase in the history of the data. The unemployment rate declined from this peak and fell to 7.9% by the end of the third quarter. While the unemployment rate continued to show improvement during 4Q20, the pace of progress slowed as lockdowns reemerged throughout the country. By year-end, the unemployment rate was 6.7%. Although it was much lower at the end of the year than the April highs, it is still nearly twice as high as the pre-pandemic levels.
National Accounts: Gross Domestic Product (GDP) decreased by 5% during 1Q20. The decline in GDP was, in part, due to the spread of COVID-19 and state and local government stay-athome orders. These factors led to rapid changes in demand, as businesses either switched to remote work or canceled operations, and consumers stopped or restricted their spending.
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GDP contracted even further during 2Q20, with the final numbers showing a decline of 32.9%, the largest quarterly decline ever, as COVID-19 caused businesses to remain closed for some or all of the quarter, millions of people became unemployed, and consumers and businesses reduced, restricted, or redirected their spending.
On June 8, 2020, the National Bureau of Economic Research announced the U.S. economy was officially in recession since February 2020, ending the 128-month expansion that began in June 2009, which was the longest economic expansion in the history of business cycles dating back to 1954.
Nonetheless, during 3Q20, GDP rebounded sharply, posting an increase of 33.4%, which was the fastest pace the U.S. economy has ever grown, breaking the previous record set post World War II in 1950. The expansion continued into the fourth quarter with an increase of 4.3%; however, total GDP levels remained below pre-recession levels.
Fixed Income Markets: In 2020, yields in the short-term fixed income markets declined due to the Fed's near-zero interest rate policy. Additionally, as set by the Fed, the federal funds rate acts as an anchor for the shortest maturities on the yield curve, which is the primary driver of investment yields in the short-term markets. Figure 2 shows the U.S. Treasury curve at the beginning and end of the year.
The commercial paper market experienced a brief period of uncertainty beginning in March 2020. With economies closing globally and uncertainty related to the overall duration and impact the COVID virus would have on global output, investors headed towards cash and sold prime money market funds and purchased government money market funds. In turn, this impacted the broader market for commercial paper, broker-dealers, and corporations.
Prime money market funds are the most significant participants in the short-term markets. Large outflows in prime money market funds resulted in illiquidity in the commercial paper markets in March 2020. Without the largest commercial paper buyers participating in the market, spreads widened to entice buyers to purchase securities, i.e., same supply but much lower demand.
During the same period dealer balance sheets were at capacity resulting in limited secondary market transactions. With dealer balance sheets at capacity, they were unable to transact in the market--not unwilling. Essentially the market was frozen to sellers.
As the cost to corporations of rolling commercial paper increased, i.e., as yields rose due to the lower demand, many companies re-thought how they should finance their capital structures. In some cases, it was cheaper for corporations to draw down revolvers, and in other cases, for highquality issuers, decisions were made to term out debt in the corporate bond market.
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With these factors combined, during a time when the Fed cut rates to zero, the 3-month Treasury Bill yield declined from ~1.50% to ~0.10% or lower (see Figure 3), and commercial paper spreads widened significantly, i.e., the difference between the yield on commercial paper and Treasury Bills increased. The factors above suggested at the time that the increase in spreads wasn't necessarily a credit quality problem but it was a liquidity problem.
Nonetheless, market conditions reversed over April as the various Fed programs' prior announcements to support financial markets began to take effect. The short-term commercial paper market normalized by the end of 2Q20, followed by yields trending lower for the remainder of the year.
Investment Strategy
Throughout 2020, and especially during the tumultuous period in March 2020, Treasury's investment strategy for the Invest program was one of careful risk management to safeguard principal while ensuring ample liquidity to meet any redemptions. In order to safeguard principal during the period of stress in the markets, Treasury utilized a conservative approach and suspended many commercial paper issuers from our approved issuer list due to heightened risk of downgrades resulting from the economic slowdown. Additionally, restrictions were temporarily placed on maximum maturities and focus was shifted to higher quality Treasury and agency securities.
With yields trending lower through the year, Treasury made significant reductions in prime money market fund holdings in exchange for owning individual securities due to a decline in prime money market fund yields. Allocations to prime funds decreased from ~15% at the beginning of the year to ~1% at year end.
The Invest Daily and Community portfolios are highly liquid and well diversified among sector, issuer and maturities. As previously mentioned, interest rates set by the Fed are the primary driver of investment yields in the short-term markets, and with short-term yield declining precipitously in 2020, Invest Daily and Community earnings also decreased. In conjunction with the yield decline Treasury's investment strategy focused more on individual security selection instead of targeting specific weighted average maturities for the pools.
Treasury's strategy in managing the assets of the INVEST Program is safety, liquidity, compliance with policies and regulations, and yield, in that order. In order to maintain safety, the program invested in the highest quality money market securities permitted by the Investment Policy Statement in conjunction with guidance provided by PNC Capital Advisors for individual issuer selection. Liquidity is managed based on GASB 79 requirements for daily and weekly liquidity as well as analyzing historical and projected participant cash flows. Compliance is adhered to by following the investment policy statement, GASB 79, and the requirements from Standard & Poor's to maintain AAAm ratings. Yield is optimized by carefully evaluating and
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scrutinizing investment options for the best possible returns available within approved parameters.
Asset Distribution
The following chart reflects the month-end asset class distribution of the INVEST Program, in percentage terms, for the period January 1, 2020 to December 31, 2020.
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0% Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
US Govt Agencies Certificates of Deposit Commercial Paper
Money Market Funds World Bank Treasuries
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