1. Utilizing Sector Diversification to Manage Risk and Generate Returns February 22, 2018
Paulina Woo, Director
Luke Schneider, CFA, Director
PFM Asset Management LLC
pfm.com
1820 East Ray Road
Chandler, AZ 85225

2. Where’s the RISK!?!? Which Direction Is the Market Going?
Lesser known markets: Red bull market = marketing rising “with wings”. Panda bear market = most negative pace of growth possible. Hard to tell which way we’re headed.

3. Recent Equity Market Turmoil: Stocks Sell-Off and Volatility Spikes
13.5%
Source: Bloomberg, as of 2/8/2017

4. Stock Market Corrections are Normal and Frequent
Stock Market Returns and Intra-Year Declines
Source: Bloomberg, JP Morgan Guide to the Markets Q As of December Intra year declines refer to the largest market drops from peak to trough during the year. Index Returns are representative of price returns only.

5. Fixed Income Returns Are More Stable
Source: Bloomberg

6. Fixed Income Returns Vary By Sector and Structure
Source: Bloomberg

7. Characteristics of U.S. Treasuries
Issuer: U.S. Government
Credit Quality: “Risk Free”
Liquidity: High (active market)
Custody: Federal Reserve (book entry)
3 months – 30
years
Type
Term to Maturity
Interest
Price Quotes
Bills
1, 3, 6,12 months
Interest at
Maturity
Discount
(Not equal to yield)
Notes 2
10 years
Price per $100
Bonds 10
30 years
Strips
Semi-Annual
Coupon
15th or last day of month
Thursdays

8. Characteristics of Agencies/Government Sponsored Enterprises (GSEs)
Issuer: Federal agencies
Government sponsored enterprises (GSE)
Credit Quality: Most are AA+ (S&P) / Aaa (Moody’s)
Most do not carry explicit U.S. Government guarantee (full faith and credit)
Term of Maturity: 1 day to 30 years
Liquidity: Generally high, but depends on structure
Custody: Federal Reserve (book entry)
Return: Higher than U.S. Treasury obligations
Caution: May have complicated structures
May be callable

9. Characteristics of Asset-Backed Securities
Securities issued by a sponsoring company and backed by pools of assets.
The sponsoring company creates a separate trust to ensure investors have access to the cash flows from the assets held as collateral.
Issuer:
Sponsoring company/trust
Credit:
Varies
Credit enhancements:
Some combination of subordination and credit tranching, over-collateralization, reserve accounts, excess spread, letter of credit, and insurance
Maturity:
Typically up to 10 years
Liquidity:
Moderate
Yield:
Higher than U.S. Treasury/Federal Agency obligations
Caution:
Pre-payment risk
Credit analysis and monitoring required

10. Characteristics of Corporate Notes
Issuer: Publically owned corporations
Credit Quality: Varies
Term of Maturity: 1 – 40+ years
Liquidity: Moderate
Custody: DTC (book entry)
Return: High, depends on credit and structure
Caution: Unsecured promissory note
Credit analysis and monitoring required
Arizona Revised Statutes impose credit and maturity restrictions.

11. Main Types of Fixed Income Investment Risks
Interest Rate: Risk that an investment's value will change due to a change in:
absolute level of interest rates
shape of the yield curve
spread between sectors
Credit: Two main types:
Default: Risk that a bond issuer will be unable to meet its financial obligations.
Market Value Risks:
Credit spread: Risk of financial loss resulting from changes in the level of credit spreads.
Downgrade: Risk that a bond’s price will decline due to a downgrade in its credit rating.
Liquidity: Risk that an asset is unable to be sold or redeemed altogether or at a loss/penalty.
Reinvestment (Optionality): Risk that the proceeds from the payment of principal and interest will have to be reinvested at a lower rate than the original investment.

12. Risk Comparison by Sector
Treasury
Callable Agency
Asset-Backed Security
Corporate/
Commercial Paper
Interest Rate Risk
Reinvestment (Optionality) Risk
Liquidity Risk
Credit Spread Risk
Prepayment Risk
Default Risk

13. General Liquidity Risk Profile by Sector
Money Market Funds
Treasuries
Federal Agency Discount Notes
Federal Agency Notes
Agency Floaters
Commercial Paper
Bankers’ Acceptances
Corporate & Asset-Backed Obligations
Municipal Obligations
Certificates of Deposit (CDs)
Easy to Sell
No Penalties
Low Bid/Ask Spread
Extremely Difficult to Sell
High Bid/Ask Spread
Penalties/Fees
Relative Liquidity 2 4 6 8 10

14. General Risk & Return Comparison by Sector
Other
Multi-asset
Equity
Real Estate
Corporate
ABS
Return
MBS
Muni
Commercial Paper
FDIC CD
Agency
Treasury
Risk
For illustrative purposes only.

15. Risks cannot be eliminated, but they can be prudently managed.
INVESTMENT RULE…
GOLDEN
Risks cannot be eliminated, but they can be prudently managed.

16. Manage Risk Through Diversification
Issuer
Asset Class
Sector
Maturity
Security Structure

17. Yield Environment as of January 30, 2018
Maturity
Treasury
Federal Agency
Callable Agency
Asset-Backed Securities
A Corporate
3-Month
1.45%
1.44%
n/a
1.65%
1.72%
6-Month
1.54%
1.91%
1-Year
1.89%
1.74%
2.12%
2.16%
2-Year
2.15%
2.32%
(2 NC 6-mo)
2.40%
2.45%
3-Year
2.31%
2.34%
2.57%
(3 NC 1-yr)
2.61%
2.66%
5-Year
2.51%
2.58%
2.95%
(5 NC 1-yr)
2.83%
2.96%
10-Year
2.73%
2.84%
3.45%
(10 NC 1-yr)
3.51%
Source: Bloomberg BVAL yield curves for Treasury and Corporate yields, TradeWeb for Federal Agency yields, JP Morgan for Callable Agency yields, JP Morgan and PFMAM estimates for ABS yields. 3 and 6 month corporate yields rated A-1 from commercial paper. Yields are for indicative purposes only; actual yields may vary by issue.

18. 2018 Rate Hike Expectations
Fed expects 3 rate hikes in 2018
Market expects only 2 rate hikes
Source: Federal Reserve, Bloomberg. Market expectations as measured by Fed Funds futures.

19. Corporates Can Provide a Buffer Against Rising Rates
Source: Bank of America Merrill Lynch Indices from Bloomberg.

20. Annual Returns of Callable vs. Non-Callable Instrumentalities
Fluctuating Value of Callable Sector
Annual Returns of Callable vs. Non-Callable Instrumentalities
Callables
Bullets
Difference
2007
6.00%
7.81%
+1.81%
2008
4.84%
8.63%
+3.79%
2009
2.14%
2.53%
+0.39%
2010
1.24%
3.54%
+2.30%
2011
1.67%
2.62%
+0.95%
2012
0.85%
1.52%
+0.68%
2013
-0.01%
0.03%
+0.04%
2014
1.38%
1.29%
-0.09%
2015
1.28%
0.90%
-0.38%
2016
0.81%
1.19%
+0.38%
2017
0.99%
0.82%
-0.17%
2.44%
3.35%
+0.91%
Small Outperformance
Big Underperformance
Shifting from callable bonds to non-callable bonds would have added nearly 1% annually to return over the past 10 years
Source: BofA Merrill Lynch 1-5 Year Callable Instrumentality Index compared to the BofA Merrill Lynch 1-5 Year Bullet Instrumentality Index, as of 12/31/2017.

21. Long-Term Performance Correlations
Correlation Matrix
Column1
Treasury
Agency
Corp
AAA-A
MBS
Municipal
ABS
BBB
1.00
0.94
0.59
0.79
0.62
0.56
0.32
0.70
0.87
0.68
0.44
Corporate AAA-A
0.66
0.76
0.84
0.63
0.48
0.75
Corporate BBB
Correlations of sector indices from Sep – Sep

22. Shifting Sector Returns
Index / Ending Duration
2013
2014
2015
2016
2017
U.S. Treasury / 2.60 Years
2.39%
3.90%
1.54%
4.22%
3.21%
Bullet Agencies / 2.15 Years
1.29%
2.19%
1.51%
2.29%
2.35%
Callable Agencies / 2.11 Years
1.24%
2.18%
1.45%
1.93%
Corp AAA / 2.62 Years
0.70%
2.06%
1.28%
1.32%
1.62%
Corp AA / 2.48 Years
0.41%
1.92%
1.22%
1.26%
1.50%
Corp A / 2.68 Years
0.03%
1.38%
1.20%
1.19%
1.45
Corp BBB / 2.77 Years
0.00%
1.30%
0.98%
1.08%
0.99%
MBS / 3.22 Years
-0.01%
0.90%
0.81%
0.82%
Municipals / Years
-0.19%
0.85%
0.16%
0.64%
5-year returns
BBB: 3.50%
UST: 0.80%
Bullet Agencies: 0.99%
Callable Agencies: 0.86%
Source: BofA Merrill Lynch 1-5 Year Bond Indices, as of 12/31/2017.

23. Historical Benefits of Diversification
Sample portfolio returns are based on the ICE BofAML 1-5 Year indices for all the sectors shown. Source: ICE BofAML Indices

24. Diversification Manages Risk and Generates Return
Evaluate risk tolerances.
Diversify to strategically allocate the sources and types of risk in a portfolio.
Diversified portfolios balance risk and return.
Diversification can take advantage of opportunities in the market.
Diversification is a major component of Safety.

26. Disclosures
Any investment advice in this document is provided solely by PFM Asset Management LLC. PFM Asset Management LLC (“PFM”) is an investment advisor registered under the Investment Advisers Act of PFM Advisors is a division of PFM Asset Management LLC. Public Financial Management Inc. is not providing and is not responsible for any investment advice herein. This material is based on information obtained from sources generally believed to be reliable and available to the public; however, PFM Asset Management LLC cannot guarantee its accuracy, completeness, or suitability. This material is for general information purposes only and is not intended to provide specific advice or a specific recommendation. All statements as to what will or may happen under certain circumstances are based on assumptions, some but not all of which are noted in the presentation. Assumptions may or may not be proven correct as actual events occur, and results may depend on events outside of your or our control. Changes in assumptions may have a material effect on results. Past performance does not necessarily reflect and is not a guarantee of future results. The information contained in this presentation is not an offer to purchase or sell any securities.