Market-Value Decline: Is it Really an Issue for Cities?

In May of 2013, many cities saw the market value of their investments head south faster than a Minnesotan in mid-January. And like winter, we all hoped the change would be short-lived, yet the market failed to rebound by year-end. Some cities even saw market values sitting well below what they had initially paid—on investments that constituted a significant portion of their portfolio.

While unnerving, for most cities this adjustment is no reason for panic: it has long-term, net-zero effect on the investment if it’s held to maturity. Cities can expect to get their money back. However, those that are unable to hold on to investments may find market-value decline to be a real issue.

Here are three practices every city should implement—or reexamine—to help minimize the effects of market-value decline:

Establish a cash-flow plan
Cities that don’t know their cash flow may overinvest in the market and run out of liquid cash. When this happens, they’re forced to cash in their longer-term investments—and recognize the loss. What’s more, cities that use a basic pooled approach tend to pool their investments without considering maturity dates. Every city should ask themselves: Do we have a cash-flow plan in place that matches maturities with future spending needs?

Create a sound investment policy
All cities that that invest funds should have an investment policy in place. Often we find that policies get drafted in a boilerplate format without much thought to the key drivers of risk and performance. A sound investment policy sets maturity limits, identifies acceptable investments, has monitoring in place, and includes a mechanism for reporting to administrators and the city council. All of these areas are important and need specific consideration. Also, the policy should be well known throughout the organization.

Report results quarterly
Reporting results—both markets and cost—quarterly can go a long way toward limiting unwelcome surprises. Cities must provide administrators with enough information to evaluate what’s happening. And even if a city has a good reporting process in place, it’s never a bad idea to take it to a third party for evaluation.

It’s important to keep in mind that accounting standards require all investments to be adjusted to market value. (There’s no out that keeps an investment from being subject to market value!)

Cities should also make sure they’re in compliance with GASB Accounting Standard 31, which provides an authoritative source for fair value reporting. With its most recent amendment, cities now have the option to separate out interest income from market-value change. Although some cities are doing this as a communication tool, I find it doesn’t add a great deal of value to the reporting process.

The main thing to note is that interest or fair value should be reported in the fund with the investment. In other words, cities can’t take a loss and allocate it to another fund.

Make market-value decline a non-issue
These three practices are key to helping cities ride the waves of the market without becoming swamped. Plus, cities that have these practices in place are in a great position to consider different options for market/investment allocation.
For additional information on this topic, including commonly asked questions from the MNGFOA seminar we presented with Wells Fargo, please give me a call.

Andy Berg, CPA, is AEM’s Government/Nonprofit Segment Leader. When he’s not fishing for ways to help governments boost efficiency, he’s casting lines for whopper muskies. You can reach Andy at 952.715.3003 or at andrew.berg@aemcpas.com.