Years Ended September 30, 2017 and 2016
Note 4 – Investments
The Board has the responsibility for the establishment of the investment policy and the oversight of the investments for the System and related entities. In order to facilitate System-wide investment objectives and achieve economies of scale, the Board established three distinct investment pools based primarily on the projected investment time-horizons for System funds: the Endowment Fund (“PEF”), the Long Term Reserve Pool Fund (“LTRP”), and the Short Term Liquidity Pool Fund (“STLP”); collectively, the “System Pools”. Pursuant to Board investment policies, each System or related entity may include all or a portion of their investments within the System-sponsored investment pools. These investment funds are considered “internal” investment pools under GASB Statement No. 31, Accounting and Financial Reporting for Certain Investments and for External Investment Pools, with the assets pooled on a market value basis. Separately managed funds that reside with each entity are to be invested consistent with the asset mix of the corresponding System investment pool. The following disclosures relate to both the System Pools, which include the investments of other System entities and other affiliated entities, and the University-specific investment portfolio.
Endowment Fund
The purpose of the Endowment Fund is to pool endowment and similar funds to support the System campuses, hospital and related entities in carrying out their respective missions over a perpetual time frame. Accordingly, the primary investment objectives of the Endowment Fund are to preserve the purchasing power of the principal and provide a stable source of perpetual financial support to the endowment beneficiaries. To satisfy the long-term rate of return objective, the Endowment Fund relies on a total return strategy in which investment returns are achieved through both capital appreciation and natural income. Asset allocation targets are established to meet the return objectives, while providing adequate diversification in order to minimize investment volatility.
Long Term Reserve Pool Fund
The Long Term Reserve Pool Fund is a longer-term pool used as an investment vehicle to manage operating reserves with a time horizon of three to seven years. This fund has an investment objective of growth and income and is invested in a diversified asset mix of liquid, semi-liquid, and illiquid securities. This fund can invest no more than 10% in illiquid assets.
Short Term Liquidity Pool Fund
The Short Term Liquidity Pool Fund serves as an investment vehicle to manage operating reserves with a time horizon of one to three years. This fund is also used to balance the other funds when looking at the System’s entire asset allocation of operating reserves relative to its investment objectives. The STLP has an investment objective of income with preservation of capital and is invested in intermediate-term fixed income securities. The fund holds at least one large mutual fund to provide daily liquidity.
Although the investment philosophy of the Board is to minimize the direct ownership of investment vehicles, with ownership preference in appropriate investment fund groups, certain direct investments are held in the name of the Board. All other investments in the Systems Pools are classified as commingled funds.
Land and Other Real Estate Held as Investments by Endowments
The University values land and other real estate held as investments by endowments at fair value.
The University holds, as part of its endowment investments, timber land located in fifteen counties in north and central Alabama totaling approximately 29,000 acres. In the University’s opinion, timber production and related commercial recreation is the highest and best use for the land individually and as a whole; the property is located in an area with a favorable climate for growing trees and contains good markets for forest products. Timber production is the predominant land use in the counties that contain the property. The fee simple market value of timber and land of $33.9 million and $30.2 million at September 30, 2017 and 2016, respectively, was derived through the application of the cost, sales comparison, and income capitalization approaches to value. The value of minerals and mineral exploitation rights contained in fee and mineral rights only and surface mining rights only for approximately 37,000 acres are valued at $35.3 million and $10.1 million as of September 30, 2017 and 2016, respectively. The fair value of these rights was determined using non-quantitative “menus” of incremental value, enhanced values for perceived early exploitation, risk discounted cash flow, and rules-of-thumb developed over time in appraising mineral assets. The number of acres evaluated for mineral values is assessed without regard for the ownership of the surface or land above and differs from the aforementioned timber land acres.
Fair Value Measurements
GASB 72 sets forth the framework for measuring fair value. That framework provides a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under GASB 72 are described as follows:
GASB 72 allows for the use of net asset value (“NAV”) as a practical expedient for valuation purposes. Investments that use NAV in determining fair value are disclosed separately from the valuation hierarchy as presented herein.
The level within the hierarchy is based on the lowest level of input that is significant to the fair value measurement. Valuation techniques used need to maximize the use of observable inputs and minimize the use of unobservable inputs.
The determination of what constitutes observable requires judgment by the University’s management. University management considers observable data to be that market data which is readily available, regularly distributed or updated, reliable, and verifiable, not proprietary, and provided by multiple independent sources that are actively involved in the relevant market.
The categorization of an investment within the hierarchy is based upon the relative observability of the inputs to its fair value measurement and does not necessarily correspond to University management’s perceived risk of that investment.
The following is a description of the valuation methods and assumptions used by the University to estimate the fair value of its investments. There have been no changes in the methods and assumptions used at September 30, 2017. The methods described may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. University management believes its valuation methods are appropriate and consistent with other market participants. The use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different fair value measurement at the reporting date.
When available, quoted prices are used to determine fair value. When quoted prices in active markets are available, investments are classified within Level 1 of the fair value hierarchy. The University’s Level 1 investments primarily consist of investments in mutual funds, exchange traded funds, and both domestic and foreign equity funds. When quoted prices in active markets are not available, fair values are based on evaluated prices received from the University’s custodian of investments.
The University’s Level 2 investments consist of mutual funds that are priced or traded at the end of the day.
The University’s Level 3 investments primarily consist of two very illiquid securities. Changes in valuation techniques may result in transfers into or out of an assigned level within the disclosure hierarchy. Valuation techniques utilized by the University are appraisals, entry price at the date of donation, and other valuations typically based on management assumptions or expectations.
At September 30, 2017 and 2016, the fair value of the University’s investments based on the inputs used to value them is summarized as follows:
2017 | | | | |
|---|---|---|---|---|
Cash & Receivables: | ||||
Regions Cash Trust | $157,021,019 | $ - | $ - | $157,021,019 |
South African Gold Coins | 39,810 | - | - | 39,810 |
Equities: | ||||
Common Stock | 5,567,358 | - | - | 5,567,358 |
Fixed Income Securities: | ||||
U.S. Government Obligations | 177,508 | - | - | 177,508 |
Commingled Funds: | ||||
U.S. Equity Funds | 3,226,126 | 66,082 | - | 3,292,208 |
Non-U.S. Equity Funds | 666,981 | - | - | 666,981 |
U.S. Bond Funds | 2,327,309 | 122,210 | - | 2,449,519 |
Private Equity Funds | - | - | 2,442,387 | 2,442,387 |
Real Estate | - | - | 86,726,445 | 86,726,445 |
$169,026,111 | $188,292 | $89,168,832 | $258,383,235 | |
UA Portion of System Pool Investments: | ||||
Endowment Fund | 708,505,976 | |||
Long Term Reserve Pool Fund | 542,739,479 | |||
Short Term Liquidity Pool Fund | 306,933,431 | |||
| Total Reported Value with System Pooled Investments | $1,816,562,121 | |||
| | | | |
Cash & Receivables: | ||||
Regions Cash Trust | $37,786,080 | $ - | $ - | $37,786,080 |
South African Gold Coins | 40,710 | - | - | 40,710 |
Equities: | ||||
Common Stock | 4,537,286 | - | - | 4,537,286 |
Fixed Income Securities: | ||||
U.S. Government Obligations | 194,213 | - | - | 194,213 |
Commingled Funds: | ||||
U.S. Equity Funds | 3,409,896 | 57,057 | - | 3,466,953 |
Non-U.S. Equity Funds | 607,922 | - | - | 607,922 |
U.S. Bond Funds | 2,526,026 | 119,762 | - | 2,645,788 |
Private Equity Funds | - | - | 2,440,046 | 2,440,046 |
Real Estate | - | - | 40,909,636 | 40,909,636 |
$49,102,133 | $176,819 | $43,349,682 | $92,628,634 | |
UA Portion of System Pool Investments: | ||||
Endowment Fund | 637,645,668 | |||
Long Term Reserve Pool Fund | 519,181,036 | |||
Short Term Liquidity Pool Fund | 294,516,869 | |||
| Total Reported Value with System Pooled Investments | $1,543,972,207 |
At September 30, 2017 and 2016, the fair value of the investments for the System Pools based on the inputs used to value them is summarized as follows:
| | | | | |
|---|---|---|---|---|---|
Receivables: | |||||
Accrued Income Receivables | $ - | $ - | $ - | $ - | $737,344 |
| Total Receivables | - | - | - | - | 737,344 |
Cash Equivalents: | |||||
Money Market Funds | 79,594,084 | - | - | - | 79,594,084 |
| Total Cash Equivalents | 79,594,084 | - | - | - | 79,594,084 |
Equities: | |||||
U.S. Common Stock | 94,939,223 | - | - | - | 94,939,223 |
Foreign Stock | 34,902,583 | - | - | - | 34,902,583 |
| Total Equities | 129,841,806 | - | - | - | 129,841,806 |
Fixed Income Securities: | |||||
U.S. Government Obligations | - | 8,498,567 | - | - | 8,498,567 |
Mortgage Backed Securities | - | 6,136,259 | - | - | 6,136,259 |
Corporate Bonds | - | 21,041,058 | - | - | 21,041,058 |
Non-U.S. Bonds | - | 3,038,650 | - | - | 3,038,650 |
| Total Fixed Income Securities | - | 38,714,534 | - | - | 38,714,534 |
Commingled Funds: | |||||
Non-U.S. Equity Funds | - | 224,559,339 | - | - | 224,559,339 |
U.S. Bond Funds | - | 58,363,636 | - | - | 58,363,636 |
Non-U.S. Bond Funds | - | 29,063,500 | - | - | 29,063,500 |
Hedge Funds | - | - | - | 506,943,088 | 506,943,088 |
Private Equity Funds | - | - | - | 123,786,463 | 123,786,463 |
Real Estate Funds | - | - | - | 203,564,413 | 203,564,413 |
| Total Commingled Funds | - | 311,986,475 | - | 834,293,964 | 1,146,280,439 |
| Total Fund Investments | 209,435,890 | 350,701,009 | - | 834,293,964 | 1,394,430,863 |
| Total Fund Assets | 209,435,890 | 350,701,009 | - | 834,293,964 | 1,395,168,207 |
| Total Fund Liabilities | - | - | - | - | (223,940) |
| Affiliated Entity Investments in Funds | - | - | - | - | (222,871,294) |
| Total Net Asset Value | $209,435,890 | $350,701,009 | $ - | $834,293,964 | $1,172,072,973 |
| | | | | |
Receivables: | |||||
Accrued Income Receivables | $ - | $ - | $ - | $ - | $754,939 |
| Total Receivables | - | - | - | - | 754,939 |
Cash Equivalents: | |||||
Money Market Funds | 37,501,965 | - | - | - | 37,501,965 |
| Total Cash Equivalents | 37,501,965 | - | - | - | 37,501,965 |
Equities: | |||||
U.S. Common Stock | 86,163,991 | - | - | - | 86,163,991 |
Foreign Stock | 22,222,905 | - | - | - | 22,222,905 |
| Total Equities | 108,386,896 | - | - | - | 108,386,896 |
Fixed Income Securities: | |||||
U.S. Government Obligations | - | 11,635,633 | - | - | 11,635,633 |
Corporate Bonds | - | 22,046,299 | - | - | 22,046,299 |
Non-U.S. Bonds | - | 4,897,595 | - | - | 4,897,595 |
| Total Fixed Income Securities | - | 38,579,527 | - | - | 38,579,527 |
Commingled Funds: | |||||
Non-U.S. Equity Funds | - | 248,254,069 | - | - | 248,254,069 |
U.S. Bond Funds | - | 59,563,636 | - | - | 59,563,636 |
Non-U.S. Bond Funds | - | 26,423,526 | - | - | 26,423,526 |
Hedge Funds | - | - | - | 466,576,876 | 466,576,876 |
Private Equity Funds | - | - | - | 103,746,336 | 103,746,336 |
Real Estate Funds | - | - | - | 178,180,675 | 178,180,675 |
| Total Commingled Funds | - | 334,241,231 | - | 748,503,887 | 1,082,745,118 |
| Total Fund Investments | 145,888,861 | 372,820,758 | - | 748,503,887 | 1,267,213,506 |
| Total Fund Assets | 145,888,861 | 372,820,758 | - | 748,503,887 | 1,267,968,445 |
| Total Fund Liabilities | - | - | - | - | (164,929) |
| Affiliated Entity Investments in Funds | - | - | - | - | (200,896,480) |
| Total Net Asset Value | $145,888,861 | $372,820,758 | $ - | $748,503,887 | $1,066,907,036 |
2017 Long Term Reserve Pool Fund | | | | | |
|---|---|---|---|---|---|
Receivables | |||||
Accrued Income Receivables | - | - | - | - | $2,371,886 |
| Total Receivables | - | - | - | - | 2,371,886 |
| 1 | |||||
Cash Equivalents: | |||||
Money Market Funds | 58,259,515 | - | - | - | 58,259,515 |
| Total Cash Equivalents | 58,259,515 | - | - | - | 58,259,515 |
| 1 | |||||
Equities | |||||
U.S. Common Stock | 176,807,415 | - | - | - | 176,807,415 |
Foreign Stock | 50,575,577 | - | - | - | 50,575,577 |
| Total Equities | 227,382,992 | - | - | - | 227,382,992 |
| 1 | |||||
Fixed Income Securities: | |||||
U.S. Government Obligations | - | 14,142,677 | - | - | 14,142,677 |
Mortgage Backed Securities | - | 11,840,312 | - | - | 11,840,312 |
Corporate Bonds | - | 35,515,741 | - | - | 35,515,741 |
Non-U.S. Bonds | - | 5,479,805 | - | - | 5,479,805 |
| Total Fixed Income Securities | - | 66,978,535 | - | - | 66,978,535 |
| 1 | |||||
| 1 | |||||
Commingled Funds: | |||||
Non-U.S. Equity Funds | - | 425,447,446 | - | - | 425,447,446 |
U.S. Bond Funds | - | 67,342,316 | - | - | 67,342,316 |
Non-U.S. Bond Funds | - | 47,096,969 | - | - | 47,096,969 |
Hedge Funds | - | - | - | 754,979,975 | 754,979,975 |
Real Estate Funds | - | - | - | 112,894,275 | 112,894,275 |
| Total Commingled Funds | - | 539,886,731 | - | 867,874,250 | 1,407,760,981 |
| 1 | |||||
| Total Fund Investments | 285,642,507 | 606,865,266 | - | 867,874,250 | 1,760,382,023 |
| Total Fund Assets | 285,642,507 | 606,865,266 | - | 867,874,250 | 1,762,753,909 |
| Total Fund Liabilities | - | - | - | - | (378,908) |
| 1 | |||||
| Affiliated Entity Investments in Funds | - | - | - | - | (119,531,938) |
| 1 | |||||
| Total Net Asset Value | $285,642,507 | $606,865,266 | $ - | $867,874,250 | $1,642,843,063 |
| 1 | |||||
| | Level 2 | Level 3 | NAV | Total Fair Value |
Receivables | |||||
Accrued Income Receivables | $ - | $ - | $ - | $ - | $ 1,005,513 |
| Total Receivables | - | - | - | - | 1,005,513 |
Cash Equivalents | |||||
Money Market Funds | 47,260,189 | - | - | - | 47,260,189 |
| Total Cash Equivalents | 47,260,189 | - | - | - | 47,260,189 |
| 1 | |||||
Equities | |||||
U.S. Common Stock | 153,820,643 | - | - | - | 153,820,643 |
Foreign Stock | 34,992,179 | - | - | - | 34,992,179 |
| Total Equities | 188,812,822 | - | - | - | 188,812,822 |
| 1 | |||||
Fixed Income Securities | |||||
U.S. Government Obligations | - | 13,315,542 | - | - | 13,315,542 |
Corporate Bonds | - | 26,606,940 | - | - | 26,606,940 |
| 1 | |||||
Non-U.S. Bonds | - | 5,796,426 | - | - | 5,796,426 |
| Total Fixed Income Securities | - | 45,718,908 | - | - | 45,718,908 |
Commingled Funds | |||||
Non-U.S. Equity Funds | - | 365,311,576 | - | - | 365,311,576 |
U.S. Bond Funds | - | 65,616,121 | - | - | 65,616,121 |
Non-U.S. Bond Funds | - | 42,818,930 | - | - | 42,818,930 |
Hedge Funds | - | - | - | 630,395,465 | 630,395,465 |
Real Estate Funds | - | - | - | 100,534,353 | 100,534,353 |
| Total Commingled Funds | - | 473,746,627 | - | 730,929,818 | 1,204,676,445 |
| 1 | |||||
| Total Fund Investments | 236,073,011 | 519,465,535 | - | 730,929,818 | 1,486,468,364 |
| Total Fund Assets | 236,073,011 | 519,465,535 | - | 730,929,818 | 1,487,473,877 |
| Total Fund Liabilities | - | - | - | - | (272,799) |
| 1 | |||||
| Affiliated Entity Investments in Funds | - | - | - | - | (86,586,181) |
| 1 | |||||
| Total Net Asset Value | $236,073,011 | $519,465,535 | $ - | $730,929,818 | $1,400,614,897 |
2017 Short Term Liquidity Pool Fund | | | | | |
|---|---|---|---|---|---|
Receivables: | |||||
Accrued Income Receivables | $ - | $ - | $ - | $ - | $3,222,354 |
Total Receivables | - | - | - | - | 3,222,354 |
Cash Equivalents: | |||||
Money Market Funds | 100,227,735 | - | - | - | 100,227,735 |
Total Cash Equivalents | 100,227,735 | - | - | - | 100,227,735 |
Fixed Income Securities: | |||||
U.S. Government Obligations | - | 244,194,221 | - | - | 244,194,221 |
Mortgage Backed Securities | - | 149,207,687 | - | - | 149,207,687 |
Collateralized Mortgage Obligations | - | 11,990,320 | - | - | 11,990,320 |
Corporate Bonds | - | 165,646,257 | - | - | 165,646,257 |
Non-U.S. Bonds | - | 61,129,470 | - | - | 61,129,470 |
Total Fixed Income Securities | - | 632,167,955 | - | - | 632,167,955 |
Commingled Funds: | |||||
U.S. Bond Funds | - | 205,630,016 | - | - | 205,630,016 |
Total Commingled Funds | - | 205,630,016 | - | - | 205,630,016 |
| Total Fund Investments | 100,227,735 | 837,797,971 | - | - | 938,025,706 |
| Total Fund Assets | 100,227,735 | 837,797,971 | - | - | 941,248,060 |
| Total Fund Liabilities | - | - | - | - | (243,098) |
| Affiliated Entity Investments in Funds | - | - | - | - | (62,963,316) |
| Total Net Asset Value | $100,227,735 | $837,797,971 | $ - | $ - | $878,041,646 |
| | | | | |
Receivables: | |||||
Accrued Income Receivables | $ - | $ - | $ - | $ - | $2,902,429 |
Total Receivables | - | - | - | - | 2,902,429 |
Cash Equivalents: | |||||
Money Market Funds | 111,156,636 | - | - | - | 111,156,636 |
Total Cash Equivalents | 111,156,636 | - | - | - | 111,156,636 |
Fixed Income Securities: | |||||
U.S. Government Obligations | - | 206,021,290 | - | - | 206,021,290 |
Mortgage Backed Securities | - | 166,643,153 | - | - | 166,643,153 |
Collateralized Mortgage Obligations | - | 12,035,018 | - | - | 12,035,018 |
Corporate Bonds | - | 176,571,588 | - | - | 176,571,588 |
Non-U.S. Bonds | - | 64,904,675 | - | - | 64,904,675 |
Total Fixed Income Securities | - | 626,175,724 | - | - | 626,175,724 |
Commingled Funds: | |||||
U.S. Bond Funds | - | 199,067,054 | - | - | 199,067,054 |
Total Commingled Funds | - | 199,067,054 | - | - | 199,067,054 |
| Total Fund Investments | 111,156,636 | 825,242,778 | - | - | 936,399,414 |
| Total Fund Assets | 111,156,636 | 825,242,778 | - | - | 939,301,843 |
| Total Fund Liabilities | - | - | - | - | (309,260) |
| Affiliated Entity Investments in Funds | - | - | - | - | (75,561,002) |
| Total Net Asset Value | $111,156,636 | $825,242,778 | $ - | $ - | $863,431,581 |
Investment Risk Factors
Many factors can affect the value of investments. Some, such as custodial credit risk, concentration of credit risk and foreign currency risk, may affect both equity and fixed income securities. Equity securities respond to such factors as economic conditions, individual company earnings performance, and market liquidity, while fixed income securities are particularly sensitive to credit risks and changes in interest rates.
Credit Risk
Fixed income securities are subject to credit risk, which is the chance that a bond issuer will fail to pay interest or principal in a timely manner, or that negative perceptions of the issuer’s ability to make these payments will cause security prices to decline. These circumstances may arise due to a variety of factors such as financial weakness, bankruptcy, litigation, and/or adverse political developments. Certain fixed income securities, primarily obligations of the U.S. government or those explicitly guaranteed by the U.S. government, are not considered to have significant credit risk.
A bond’s credit quality is an assessment of the issuer’s ability to pay interest on the bond, and ultimately, to pay the principal. Credit quality is evaluated by one of the independent bond-rating agencies, for example Moody’s Investors Service (“Moody’s”) or Standard and Poor’s (“S&P”). The lower the rating, the greater the chance— in the rating agency’s opinion—that the bond issuer will default, or fail to meet its payment obligations. Generally, the lower a bond’s credit rating, the higher its yield should be to compensate for the additional risk.
Board policy recognizes that a limited amount of credit risk, properly managed and monitored, is prudent and provides incremental risk adjusted return over its benchmark. Credit risk in each investment pool is managed primarily by diversifying across issuers and limiting the amount of portfolio assets that can be invested in non-investment grade securities. Fixed income holdings in a single entity (excluding obligations of the U.S. government and its agencies) may not exceed 5% of a manager’s portfolio measured at market value.
The investment policy recognizes that credit risk is appropriate in balanced investment pools such as the Endowment and Long Term Reserve Pool Funds, which are tracked against the Barclays U.S. High Yield Index for U.S. investments and the J.P. Morgan Non-U.S. GBI Index for international investments benchmarks for the fixed income portion of these pools. Fixed income investments within the Endowment and Long Term Reserve Pool Funds include corporate and U.S. treasury and/or agency bonds. In addition, approximately $18.0 million and $1.2 million in the Endowment and Long Term Reserve Pool Funds (collectively), at September 30, 2017 and 2016, respectively, is invested in unrated fixed income securities, excluding fixed income commingled funds. Fixed income commingled funds were approximately $339.7 million and $279.2 million in the Endowment and Long Term Reserve Pool Funds (collectively), at September 30, 2017 and 2016, respectively.
The Short Term Liquidity Pool Fund is benchmarked against the 1-3 Year Barclays Government Credit Index with funds invested with four separate fund managers. Fixed income investments include corporate, mortgage backed, asset backed, collateralized mortgage and U.S. treasury and/or agency bonds. As of September 30, 2017 and 2016, approximately $79.4 million and $78.1 million, respectively, was invested by the Short Term Liquidity Pool Fund in unrated fixed income securities; excluding commingled bond funds and money market funds. Fixed income commingled funds and money market funds totaled approximately $305.9 million and $310.2 million at September 30, 2017 and 2016, respectively.
The credit risk for fixed and variable income securities, for the System Pools, at September 30, 2017 and 2016 is as follows:
| | | |
|---|---|---|---|
Fixed or Variable Income Securities | |||
U.S. Government Obligations | $8,498,567 | $14,142,677 | $244,194,221 |
Other U.S. Denominated: | |||
AAA | - | - | 57,770,342 |
AA | 2,827,897 | 4,895,316 | 45,669,400 |
A | 8,297,086 | 14,267,929 | 98,995,277 |
BBB | 9,469,093 | 15,722,458 | 94,842,218 |
BB | 2,472,128 | 4,358,741 | 3,200,172 |
B | 1,013,505 | 1,751,103 | 5,216,578 |
C and < C | - | - | 2,868,608 |
Unrated | 6,136,259 | 11,840,312 | 79,411,138 |
Commingled Funds: | |||
U.S. Bond Funds: Unrated | 58,363,636 | 67,342,316 | 205,630,016 |
Non-U.S. Bond Funds: Unrated | 29,063,500 | 47,096,969 | - |
Money Market Funds: Unrated | 79,594,084 | 58,259,515 | 100,227,735 |
| Total | $205,735,755 | $239,677,336 | $938,025,705 |
| | | |
Fixed or Variable Income Securities | |||
U.S. Government Obligations | $11,635,633 | $13,315,542 | $206,021,290 |
Other U.S. Denominated: | |||
AAA | - | - | 66,722,557 |
AA | 4,935,622 | 5,902,771 | 62,277,161 |
A | 11,351,391 | 13,602,107 | 94,456,013 |
BBB | 9,710,555 | 11,642,153 | 96,922,375 |
BB | 396,562 | 581,625 | 12,178,203 |
B | - | - | 6,109,639 |
C and < C | - | - | 3,388,143 |
Unrated | 549,764 | 674,710 | 78,100,343 |
| v | |||
Commingled Funds: | |||
U.S. Bond Funds: Unrated | 59,563,636 | 65,616,121 | 199,067,054 |
Non-U.S. Bond Funds: Unrated | 26,423,526 | 42,818,930 | - |
Money Market Funds: Unrated | 37,501,965 | 47,260,189 | 111,156,636 |
| Total | $162,068,654 | $201,414,148 | $936,399,414 |
In accordance with the Board policy disclosed previously, credit risk for the University’s fixed and variable income securities held outside of the System Pools is managed by diversifying across issuers and limiting the amount of portfolio assets that are invested in non-investment grade securities.
The credit risk for fixed and variable income securities, for the University’s investments, at September 30, 2017 and 2016 is as follows:
| | | |
|---|---|---|
Fixed or Variable Income Securities | ||
U.S. Government Guaranteed | $177,508 | $194,213 |
Other U.S. Dollar, Money Market Funds, and Commingled Bonds | ||
AAA | 839,423 | 950,773 |
AA | - | 261,837 |
A | 743,016 | 396,092 |
BBB | 582,413 | 651,464 |
BB | 228,329 | 331,969 |
B | 46,073 | 44,312 |
Below B | 10,021 | 8,862 |
Unrated | 244 | 479 |
| Total | $2,627,027 | $2,840,001 |
Custodial Credit Risk
Custodial credit risk is the risk that in the event of a corporate failure of a custodian, the investment securities may not be returned.
Investment securities in the System Pools and the University’s separately held portfolio are registered in the Board’s name by the custodial bank as an agent for the System. Other types of investments (e.g. open-ended mutual funds, money market funds) represent ownership interests that do not exist in physical or book-entry form. As a result, custodial credit risk is remote.
Concentration of Credit Risk
Concentration of credit risk is the risk associated with a lack of diversification, such as having substantial investments in a few individual issuers, thereby exposing the organization to greater risks resulting from adverse economic, political, regulatory, geographic, or credit developments.
As previously mentioned, credit risk in each investment pool and the University’s separately held investment portfolio is managed primarily by diversifying across issuers and limiting the amount of portfolio assets that can be invested in non-investment grade securities. As of September 30, 2017 and 2016, no investment in a single issuer represents 5% or more of total investments held by any single investment manager of the System Pools or the University’s separately held investment portfolio, except for investments issued by the U.S. government and money market fund investments.
Interest Rate Risk
Interest rate risk is the risk that the value of fixed income securities will decline because of changing interest rates. The prices of fixed income securities with a longer time to maturity, measured by effective duration, tend to be more sensitive to changes in interest rates and, therefore, more volatile than those with shorter durations. Effective duration is the approximate change in price of a security resulting from a 100 basis points (1 percentage point) change in the level of interest rates. It is not a measure of time. The Board does not have a specific policy relative to interest rate risk. As such, there are no restrictions on weighted average maturity for each investment pool as they are managed relative to the investment objectives and liquidity demands of the investors.
Although the Board does not have a specific policy relative to interest rate risk, the University has historically invested funds outside of the investment pools in fixed income and variable income securities with short maturity terms.
The effective durations presented in years for fixed or variable income securities, for the System Pools, at September 30, 2017 and 2016 are as follows:
(The information presented below does not take into account the relative weighting of the portfolio components to the total portfolio.)
| | | | | |||
|---|---|---|---|---|---|---|
2017 | 2016 | 2017 | 2016 | 2017 | 2016 | |
| U.S. Government Obligations | 8.7 | 8.1 | 8.4 | 8.4 | 1.9 | 1.9 |
| Corporate Bonds | 4.8 | 4.7 | 5.0 | 4.6 | 1.9 | 2.1 |
| Non-U.S. Bonds | 4.8 | 4.7 | 5.0 | 4.6 | 1.9 | 2.1 |
| Commingled Bond Funds | 2.4 | 1.8 | 2.1 | 1.5 | 2.8 | 2.8 |
The effective durations for fixed or variable income securities, for the University’s separately held investments, at September 30, 2017 and 2016 are as follows:
Investments may also include mortgage pass through securities and collateralized mortgage obligations that may be considered to be highly sensitive to changes in interest rates due to the existence of prepayment or conversion features. At September 30, 2017 and 2016 the fair market value of these investments, for the System Pools, are as follows:
2017 | | |
|
|---|---|---|---|
| Mortgage Backed Securities | $6,136,259 | $11,840,312 | $149,207,687 |
| Collateralized Mortgage Obligations | - | - | 11,990,320 |
| Total Fixed | $6,136,259 | $11,840,312 | $161,198,007 |
2016 | | | |
| Mortgage Backed Securities | $ - | $ - | $166,643,153 |
| Collateralized Mortgage Obligations | - | - | 12,035,018 |
| Total Fixed | $ - | $ - | $178,678,171 |
Mortgage Backed Securities. These securities are issued by the Federal National Mortgage Association (“Fannie Mae”), Government National Mortgage Association (“Ginnie Mae”) and Federal Home Loan Mortgage Association (“Freddie Mac”) and include short embedded prepayment options. Unanticipated prepayments by the obligees of the underlying asset reduce the total expected rate of return.
Collateralized Mortgage Obligations. Collateralized mortgage obligations (“CMOs”) generate a return based upon either the payment of interest or principal on mortgages in an underlying pool. The relationship between interest rates and prepayments makes the fair value highly sensitive to changes in interest rates. In falling interest rate environments, the underlying mortgages are subject to a higher propensity of prepayments. In a rising interest rate environment, the opposite is true.
At September 30, 2017 and 2016, the effective durations for these securities held in the System Pools are listed below. At September 30, 2017 and 2016, the University did not hold any investments in these security types outside of the System Pools.
| | | |
|---|---|---|---|
Mortgage Backed Securities | 3.5 | 3.3 | 1.0 |
Collateralized Mortgage Obligations | - | - | 2.2 |
| | | |
Mortgage Backed Securities | - | - | 0.9 |
Collateralized Mortgage Obligations | - | - | 1.7 |
Foreign Currency Risk
The strategic asset allocation policy for the Endowment Fund and the Long Term Reserve Pool Fund includes an allocation to non- United States equity and fixed income securities. Currency hedging of foreign bonds and stocks is allowed under System policy. As of September 30, 2017 and 2016, all foreign investments in the System Pools are denominated in U.S. dollars and are in international commingled funds, which in turn invest in equity securities and bonds of foreign issuers except for approximately $61.1 million and $64.9 million of foreign bonds denominated in U.S. dollars and held by the Short Term Liquidity Pool Fund at September 30, 2017 and 2016 respectively. At September 30, 2017 and 2016, the University did not hold any foreign securities in its separately held investment portfolio.
Securities Lending
The System permits security lending as a mechanism to augment income. Loans of the securities are required to be collateralized by cash, letters of credit or securities issued or guaranteed by the U.S. Government or its agencies. The collateral must equal at least 102% of the current market value of the loaned securities. Securities lending contracts must state acceptable collateral for securities loaned, duties of the borrower, delivery of loaned securities and acceptable investment of the collateral.
At September 30, 2017 and 2016, no securities were on loan from the investment pools.