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HomeMy WebLinkAboutOrdinance No. 3269-2022KENAI CITY OF KENAI ORDINANCE NO. 3269-2022 Sponsored by: Administration AN ORDINANCE OF THE COUNCIL OF THE CITY OF KENAI, ALASKA, AMENDING KENAI MUNICIPAL CODE SECTION 7.30:020, LAND SALE PERMANENT FUNDS, TO IDENTIFY THE CIRCUMSTANCES AND LIMITATION ON THE USE OF DERIVATIVE INVESTMENTS AND TO ADD TWO NEW CLASSES OF ASSETS TO THE LIST OF AUTHORIZED INVESTMENTS AND TO CODIFY THE APPLICABLE BENCHMARK BY WHICH THESE ASSET CLASSES WILL BE MEASURED AND EVALUATED. WHEREAS, derivative investments are investments whose value is dependent upon the value of another asset; and, WHEREAS, the most common examples of derivative investments are futures, forwards, options, and swaps; and, WHEREAS, the use of derivatives, as an investment management tool, is common, accepted, and continually evolving along with the world's markets; and, WHEREAS, to ban the use of derivatives as a tool could adversely impact the portfolio's return but because of inherent risk of derivatives, the adoption of guidelines for their use is both necessary and prudent; and, WHEREAS, limiting the use of derivatives to situations where the embedded leverage created by the derivative is fully collateralized, and the net exposure does not exceed the assets value, is needed to reduce the risk to the portfolio; and, WHEREAS, Kenai Municipal Code section 7.30.020 (b) identifies the allowable investments and their associated benchmarks for the City's permanent funds; and, WHEREAS, consistent with the City's portfolio management process of analysis, adoption and review, the City's investment advisors are recommending adding two new asset classes to the list of authorized investments; and, WHEREAS, the addition of U.S. Corporate High Yield Bonds, debt issued by companies with debt ratings below investment grade, is recommended because of projected lower risk adjusted returns as compared to international and emerging market equities; and, WHEREAS, the addition of Alternative Beta, investments and investment strategies designed to produce returns that do not correlate with the return of bonds or equities, is an opportunity to increase the diversification of a portfolio with little or no impact to the portfolio's return; and, New Text Underlined; [DELETED TEXT BRACKETED] Ordinance No. 3269-2022 Page 2 of 5 WHEREAS, the projected impact to the portfolio's expected return of adding U.S. Corporate High Yield Bonds and Alternative Beta as authorized investments is zero, but the expected annual risk of the portfolio is reduced from 11.0% to 10.1 %; and, WHEREAS, consistent with the goal of achieving the highest rate of return for the lowest level of risk, reducing the portfolio's overall risk with no impact to its expected return is in the best interest of the City. NOW, THEREFORE, BE IT ORDAINED BY THE COUNCIL OF THE CITY OF KENAI, ALASKA, as follows: Section 1. Amendment of Section of the Kenai Municipal Code: That Kenai Municipal Code, Section 7.30.020 Investments, is hereby amended as follows: 7.30.020 Investments. (a) The Land Sale Permanent Funds shall be managed by the Finance Director, with the following conditions: (1) The City will contract for the management of the investments for each Land Sale Permanent Fund with one (1) or more professional investment managers with experience handling institutional endowment investments subject to Council approval. (2) The Land Sale Permanent Funds shall be invested in such types of income producing investments as limited by subsection (b) of this section, Authorized Investments for the Land Sale Permanent Funds. The investments for each Land Sale Permanent Fund shall be approved by resolution annually, usually during the City budget process, in the form of an asset allocation plan, with each Land Sale Permanent Fund following the same asset allocation plan. The asset allocation plan shall have specific categories of investments for the funds with percentage targets that allow for reasonable fluctuations above and below the target percentage. The plan will establish benchmarks for evaluating the performance of each investment manager and asset classification. Investments shall be managed such that the target ranges of the asset allocation plan are adhered to. (3) Investments of the Land Sale Permanent funds will take a conservative posture on derivative securities by recognizing that derivatives may be utilized within investment vehicles as a portfolio management tool to create or enhance exposure to an asset class or implementation strategy while requiring that any embedded leverage created by their use be fully collateralized. Net exposure exceeding the asset value of the investment vehicle is prohibited. Exposure must be net long at all times. ([3]4) All income derived from investment of each Land Sale Permanent Fund, including interest income, realized gains, and undistributed earnings, can be distributed or reinvested into the respective Land Sale Permanent Fund and shall be invested in accordance with subsection (b) of this section, Authorized Investments for the Land Sale Permanent Funds. ([4]5) Appropriations from the Airport Land Sale Permanent Fund may be made as follows New Text Underlined; [DELETED TEXT BRACKETED] Ordinance No. 3269-2022 r, Page 2 of 5 (i) In any fiscal year, the amount available for appropriation for airport operations and capital needs will be based upon the five (5) year average of the fund's calendar year end market value. An amount not to exceed three and four-fifths percent (3.8%) of the five (5) year average market value may be distributed if the average market value is less than the fund's inflation adjusted principal balance. An amount not to exceed four and one-fifth percent (4.2%) of the five (5) year average market value may be distributed if the average market value is greater than the fund's inflation adjusted principal balance. ([5]D Appropriations from the General Fund Land Sale Permanent Fund shall be limited to the lesser of the cumulative earnings at calendar year end for the fund or four percent (4%) of the fund's fair market value as of December 31st of each year. "Cumulative earnings" is defined as the market value at calendar year end minus the fund's inflation adjusted principal balance. (b) Authorized Investments for the Land Sale Permanent Funds. (1) Investments authorized by KMC 7.22.030. (2) Corporate obligations of investment-grade quality as recognized by a nationally recognized rating organization. If, after purchase, these obligations are downgraded below investment grade, the obligations shall be sold in an orderly manner within ninety (90) days of downgrading. (3) Domestic equities which, taken as a whole, attempt to mirror the characteristics or replicate the Standard and Poor's 500 Index or another index of similar characteristics and approved by resolution of the Council as a component of the annual Land Sale Permanent Funds Asset Allocation Plan, including both mutual funds and exchange traded funds (ETFs). (4) Domestic equities which, taken as a whole, attempt to replicate the Standard and Poor's 400 Mid -Cap Index or another index of similar characteristics and approved by resolution of the Council as a component of the annual Land Sale Permanent Funds Asset Allocation Plan, including both mutual funds and exchange traded funds (ETFs). (5) Domestic equities which, taken as a whole, attempt to replicate the Standard and Poor's 600 Small -Cap Index or another index of similar characteristics and approved by resolution of the Council as a component of the annual Land Sale Permanent Funds Asset Allocation Plan, including both mutual funds and exchange traded funds (ETFs). (6) International equities which, taken as a whole, attempt to replicate the Financial Times Stock Exchange Developed ex North America Index or another index of similar characteristics and approved by resolution of the Council as a component of the annual Land Sale Permanent Funds Asset Allocation Plan, including both mutual funds and exchange traded funds (ETFs). (7) Equities which, taken as a whole, attempt to replicate the universe of domestic real estate investment trusts as represented by the Standard and Poor's REIT composite index or another index of similar characteristics and approved by resolution of the Li New Tex[ Undedined; [DELETED TEXT BRACKETED] Ordinance No. 3269-2022 Page 2 of 5 Council as a component of the annual Land Sale Permanent Funds Asset Allocation Plan, including both mutual funds and exchange traded funds (ETFs). (8) Emerging market equities which, taken as a whole, attempt to replicate the Financial Times Stock Exchange Emerging Index or another index of similar characteristics and approved by resolution of the Council as a component of the annual Land Sale Permanent Funds Asset Allocation Plan, including both mutual funds and exchange traded funds (ETFs). (9) Global infrastructure equities which, taken as a whole, attempt to replicate the STOXX Global Broad Infrastructure Index, or a substantially similar index, including both mutual funds and exchange traded funds. (10) Investment Grade Domestic bonds which, taken as a whole, attempt to mirror the characteristics or replicate the Bloomberg Barclays Aggregate bond index or another index of similar characteristics and approved by resolution of the Council as a component of the annual Land Sale Permanent Funds Asset Allocation Plan, including individual securities, mutual funds and exchange traded funds (ETFs). (11) High Yield Domestic bonds which taken as a whole attempt to mirror the characteristics component of the annual Land Sale Permanent Funds Asset Allocation Plan, utilizing mutual funds and/or exchange traded funds (ETFs). (12) Alternative beta funds which taken as a whole, attempt to provide systematic exposure identified in 7.30.020(a)(3). (c) Officers and employees involved in the investment process shall refrain from personal business activity that could conflict with proper execution of the investment program, or that could impair their ability to make impartial investment decisions. Such employees and officers shall disclose to the City Manager any material financial interests in financial institutions that conduct business with the City and such information shall be kept confidential to the extent otherwise allowed by law. Employees and officers shall subordinate their personal investment transactions to those of the City, particularly with regard to the timing of purchases and sales. A "material financial interest" in an entity is a financial interest of any kind, which, in view of all the circumstances, is substantial enough that it would, or reasonably could, affect the employee's or officer's judgment with respect to transactions to which the entity is a party. (d) The Finance Director shall submit to the City Council a quarterly investment report that summarizes recent and anticipated market conditions and that describes the City's investment portfolio in terms of transactions during the quarter, maturities, risk characteristics, and investment return compared with both benchmark performance returns and with the City's budgetary expectations. New Text Underlined; [DELETED TEXT BRACKETED] Ordinance No. 3269-2022 Page 2 of 5 (e) The Finance Director shall establish custody and safekeeping procedures with regard to all investments authorized by this chapter. All such investment securities, or their related collateral securities, shall be either held by the City or by a custodial agent for the City. Section 2. Severability: That if any part or provision of this ordinance or application thereof to any person or circumstances is adjudged invalid by any court of competent jurisdiction, such judgment shall be confined in its operation to the part, provision, or application directly involved in all controversy in which this judgment shall have been rendered, and shall not affect or impair the validity of the remainder of this title or application thereof to other persons or circumstances. The City Council hereby declares that it would have enacted the remainder of this ordinance even without such part, provision, or application. Section 3. Effective Date: That pursuant to KMC 1.15.070(f), this ordinance shall take effect 30 days after enactment. ENACTED BY THE COUNCIL OF THE CITY OF KENAI, ALASKA, this 2nd day of February, 2022. ZLST: Michel M. S ne MMC, City Clerk Av • MAYOR Introduced: January 19, 2022 Enacted: February 2, 2022 Effective: March 4, 2022 New Text Underlined; [DELETED TEXT BRACKETED] KENAI City of Kenai 1 210 Fidalgo Ave, Kenai, AK 99611-7794 1907.283.7535 I wwwkenaixity MEMORANDUM TO: Mayor Gabriel and Council Members THROUGH: Paul Ostrander, City Manager FROM: Terry Eubank, Finance Director DATE: January 11, 2022 SUBJECT: To Recommend Enactment of Ordinance 3269-2022 Ordinance 3269-2022, if enacted, will amend Kenai Municipal Code 7.30.020 to add a new paragraph which identifies the circumstances and limitations on the use of derivative investments as a tool in managing the portfolio and will add two new asset classes to the list of authorized investments for the City's Land Sale Permanent Funds. The City's investment advisor, Alaska Permanent Capital Management (APCM), is recommending these additions, not to enhance the portfolio's returns but to reduce its projected volatility (risk). While APCM recommends these changes, the overall impact to the portfolio is relatively small. Based upon APCM's knowledge and expertise, the administration recommends Council consider enacting these changes but should not consider them absolutely necessary. Derivative investments are investments whose value is based upon the value of another asset. The most common examples of derivatives are futures, forwards, options and swaps. The use of derivatives is a tool which can create or enhance exposure to an asset class or investment implementation strategy. The use of derivatives and derivative strategies is common and growing and in order to maintain the conservative nature of the City's Land Sale Permanent Fund investments, it is recommended to place some limitations upon their use. Often derivatives are utilized to multiply the impact of a move in the market by applying leverage, borrowing, to increase exposure. Applying leverage significantly increase risk. The recommended language will limit the use of derivatives to situations where embedded leverage must be fully collateralized and the net exposure may not exceed the value of the investment vehicle. Exposure must be net long at all times. In addition to applying side boards to the use of derivative investments, Ordinance 3269-2022 will authorize the use of two new asset classes to the list of authorized investments for the City's Land Sale Permanent Funds, U.S. Corporate High Yield Bonds and Alternative Beta. The addition of U.S. Corporate High Yield Bonds, debt issued by companies with debt ratings below investment grade, is being recommended because of its projected lower risk adjusted returns as compared to international and emerging market equities. Bonds are higher in the capital hierarchy when compared to common stock and are projected to provide similar returns in the coming years. The addition of U.S. Corporate High Yield Bonds will lower the overall risk of the portfolio without negatively impacting its projected return. The necessity to analyze the credit of the issuing company when investing in high yield bonds adds complexity and additional risk. To mitigate this risk the authorization to invest in high yield bonds will be limited to mutual and/or exchange traded funds (ETFs) of High Yield Domestic bonds. This limitation will eliminate the portfolio's exposure to the debt of individual or small groups of companies and the necessity to analyze their creditworthiness. The addition of Alternative Beta, investments and investment strategies designed to produce returns that do not correlate with the return of bonds or equities, is an opportunity to increase the diversification of a portfolio with little or no impact to the portfolio's return. The usefulness of an asset class that does not closely correlate with bonds or equities is increased in times where the return of bonds and equities are likely to positively correlate, such as times of high inflation. Adding Alternative Beta as an asset class will reduce the portfolio's projected risk without negatively impacting its projected returns. The projected impact to the portfolio's expected return of adding U.S. Corporate High Yield Bonds and Alternative Beta as authorized investments is zero, but the expected annual risk of the portfolio is reduced from 11.0% to 10.1 %. This is consistent with the City's goal of achieving the highest rate of return for the lowest level of risk in our investments. Page 2 of 2 The City o y � Kenai www.�Cenai.cit