Maximizing revenue and managing risk on municipal “Legal List”

Given today’s fiscal circumstances, municipalities cannot afford to ignore any potential source of revenue – and that includes investment income. While concerns about risk can be a common barrier to being more proactive, there are strategies that can help any municipality maximize returns to help fund longer term capital projects.

Using the Legal List of investments, which is fully compliant with regulations under the Municipal Act, it is important to create a diverse portfolio that includes both fixed income and equities. This is the best way to protect against risk. This combination improves potential returns while limiting the incremental risk associated with equities, says Keith Taylor, Chief Investment Officer for ONE Investment. Taylor points to the market reaction to the pandemic earlier this year as an example.

“Both our bond portfolios and equity portfolios responded to the crisis as expected, with equities experiencing a sharp, short-term sell off and bond portfolios moving to modestly higher prices,” Taylor said. “If it were a boat, bonds reflect the ballast in the boat, providing stability, while equity is more like the sail. The key is to have the right balance between the two.”

Using a balanced approach provides some stability to the portfolio. By combining more conservative bond investments with investments with higher growth potential, such as ONE’s Canadian Equity Fund, you benefit when markets are up and buffer losses when they are down.

How you strike that balance will depend on circumstances. There is no ‘one size fit all’ solution.  Two investors with different circumstances/needs will allocate investments differently.  Also, the appropriate balance is not static.  As the municipality’s circumstances change over time, they may need to revisit their investments to ensure the allocations meet needs. For this reason, a periodic review is recommended. This review will also help you re-balance based on market performance.

Time is everything in this approach. That does not mean timing markets. Rather, it means having a solid understanding of your investment horizons, which will be based on asset management plans and long-term capital plans. This will dictate your investment strategy.

It’s important to know your cash flow, which will be derived from operational needs and asset management planning. Besides having different buckets (such as for the next one to three years, five years plus and 10 years plus), it is also about knowing your revenue flexibility. What are projected trends in tax revenue or other sources, based on demographics and other factors? In terms of expenses, what is predictable and what is beyond your control?

Once you understand how much you have available to invest, the best way to manage risk is to set an investment policy that outlines the balance of fixed income and equities.

Taylor notes that those who were investing over a five or 10-year timeframe didn’t get spooked by the dive in markets this past March. While some municipalities held steady, a lot of Ontario municipalities increased their equity positions to take advantage of low prices as they rebalanced their portfolio.

The most important thing to recognize is the risk of doing nothing, as the purchasing power of money declines over time. Inflation runs about two per cent per year. Using a High Interest Saving Account isn’t an effective solution for long-term infrastructure needs. Money socked away in savings accounts for long periods will lose purchasing power and put more pressure on the tax base. With historically low interest rates expected to hang around for a while, the need to do more with longer term money is even more pressing.

ONE Investment’s advisory team can help. With both investment expertise and municipal finance experience, the team helps municipalities through each step of translating asset management plans into a financial strategy to fund the plan and set up investments.