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II.
Investments Results & Prospective Strategies -
First Quarter 2006
DIF
- During the first quarter of 2006, the par value of the DIF investment
portfolio increased by $609 million or by 1.36 percent—from $44.904
billion on December 31, 2005, to $45.513 billion on March 31, 2006.
- The DIF
investment portfolio's total return for the first three months
of 2006 was -0.13 percent, approximately 27 basis points
higher than the return of the benchmark, the Merrill Lynch 1-10
Year U.S. Treasury Index (Index), which earned -0.40 percent
during the quarter.
The performance relative to the benchmark can be attributed to
three factors. First, the DIF investment portfolio’s conventional
securities have a slightly lower average duration than those in the
Index, and consequently,
as yields increased over the course of the quarter, the DIF portfolio’s
conventional securities slightly outperformed the Index. Second,
during the quarter, the DIF’s TIPS portfolio slightly outperformed
the Index’s conventional securities. And third, during this quarter,
overnight investment balances typically exceeded 5 percent of the
DIF’s
portfolio. On a total return basis, overnight investments outperformed
the longer-maturity conventional Treasury securities included in
the Index during the quarter.
- During the first quarter of 2006, staff purchased new securities
with a total par value of $3.160 billion, a weighted average maturity
(WAM) of 7.39 years, a weighted average modified duration of 5.84 years,
and a weighted average yield to maturity (YTM) of 4.68 percent. On March
31, 2006, the effective duration of the DIF portfolio was 2.72 years.
The Treasury Market
- Conventional Treasury yields increased dramatically across all
maturity sectors during the first quarter of 2006. The largest increases
were posted by securities near the three-year sector. Three- and six-month
Treasury bill yields were up 53 and 43 basis points, respectively, largely
reflecting increases in the federal funds target rate. The two-year note
yield, which is also sensitive to actual as well as anticipated changes
in the federal funds rate, increased by 42 basis points. Intermediate-
to longer-maturity Treasury security yields also increased over the course
of the first quarter. The yield on both the five-year Treasury note and
the ten-year Treasury note increased by 46 basis points. The Treasury
yield
curve remained very flat during the first quarter; on March 31, 2006,
the ten-year to two-year yield curve spread was only three basis points
(compared
to a negative one basis point spread at the beginning of the quarter).
From a historical perspective, the curve remains significantly flatter;
over
the past five years, this spread has averaged 155 basis points. Overnight
investments and conventional Treasury notes and bonds represent 81.9
percent of DIF’s investment portfolio as of March 31, 2006.
- During
the first quarter, the TIPS real yield curve underwent a dramatic
twist—short-maturity TIPS real yields declined while longer-maturity
TIPS real yields increased. The real yield on the DIF portfolio’s
shortest-maturity TIPS (with a maturity of about two years)
decreased by 19 basis points over the quarter, and the real yield
on the portfolio’s
longest-maturity TIPS (with a maturity of about five years)
increased by 18 basis points. Moreover, the current “on-the-run” 10-year
TIPS maturing on January 15, 2016, increased by 34 basis points
over the course of the quarter. TIPS represent 18.1 percent of DIF’s
investment portfolio as of March 31, 2006.
Prospective Strategies
- The current investment strategies provide the flexibility to purchase
a wide range of different Treasury securities with varying maturities,
depending on Treasury market conditions and developments during the second
quarter of
2006. Similar to the first quarter 2006 investment strategies, if higher
yields become available—either as a result of an upward shift in the
yield curve or because of potential yield volatility—the second quarter
2006 strategies provide the flexibility to purchase comparatively higher-yielding,
longer-maturity Treasury securities.
- The
DIF portfolio’s
primary reserve target floor balance will be reduced to $10
billion in the second
quarter of 2006, from $10.5 billion in the first quarter.
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