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II.
Investments Results & Prospective Strategies -
Fourth Quarter 2005
BIF
- During 2005, the book value of the BIF investment portfolio increased
by $1.177 billion or by 3.5 percent—from $33.231 billion on December
31, 2004, to $34.408 billion on December 31, 2005.
- The BIF investment portfolio's
total return for 2005 was 2.04 percent, approximately 46 basis points
higher than the return of the
benchmark, the Merrill Lynch 1 - 10 Year U.S. Treasury Index (Index),
which earned 1.58 percent during 2005. The strong performance relative
to the benchmark can be attributed to two factors. First, the BIF
investment portfolio’s conventional securities have a slightly lower average
duration than those in the Index, and consequently, as yields generally
increased over the course of the year, the BIF portfolio’s conventional
securities outperformed the Index. Second, during this period,
about 5 percent of the portfolio was invested in overnight investments.
Although
overnight investments might not yield as much as longer-term securities,
in a rising yield environment, longer-term securities experience
price declines. Accordingly, on a total return basis, overnight investments
outperformed the longer-maturity conventional Treasury securities
included
in the Index during 2005.
- During the fourth quarter of 2005, staff purchased new securities
with a total par value of $1.205 billion, a weighted average maturity
(WAM) of 9.73 years, a weighted average modified duration of 6.63
years, and a weighted average yield to maturity (YTM) of 4.66 percent.
On December
31, 2005, the effective duration of the BIF portfolio was 2.53
years.
SAIF
- During 2005, the
book value of the SAIF investment portfolio increased by $668 million
or by 5.6 percent—from $11.962 billion
on December 31, 2004, to $12.630 billion on December 31, 2005.
- The SAIF
investment portfolio's return for 2005 was 1.92 percent, approximately
34 basis points higher than the return of the benchmark, the
aforementioned Index, which earned 1.58 percent during same period.
As with BIF, the
SAIF investment portfolio’s strong performance relative to the
benchmark can be attributed to the same two factors, the portfolio’s
better performing conventional securities and its relatively large
amounts of overnight investments, both of which on a total return basis
outperformed the longer-maturity conventional Treasury securities included
in the Index.
- During the fourth quarter of 2005, staff purchased new securities
for the SAIF portfolio with a total par value of $325 million,
a WAM of 9.70 years, a weighted average modified duration of 6.61 years,
and a weighted average YTM of 4.66 percent. At the end of the
quarter,
the effective duration of the SAIF portfolio was 2.55 years.
The Treasury Market
- Conventional Treasury yields increased dramatically across all
maturity sectors during the fourth quarter of 2005 (except for the 30-year
maturity sector). The largest increases were posted by short-maturity
Treasury bills; moreover, real yields on Treasury Inflation-Protected
Securities (TIPS) also increased significantly, particularly on shorter-maturity
TIPS.
Three- and six-month Treasury bill yields were up 54 and 45 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 23 basis points. Intermediate-
to longer-maturity Treasury security yields also increased over the course
of the fourth quarter, although yield movements were fairly volatile,
reflecting a number of technical and fundamental factors. The five-year
Treasury note’s
yield increased by 16 basis points, while the ten-year Treasury’s
yield was up a more modest seven basis points. The Treasury yield curve
continued to flatten during the fourth quarter, and on December 31, 2005,
was slightly inverted: the spread between the two-year and ten-year maturity
sectors was negative one basis point. This contrasts with the modest 15
basis point positive spread at the end of the third quarter of 2005. From
a historical perspective, the curve remains significantly flatter; over
the past five years, the spread has averaged 157 basis points.
- Interestingly,
during the fourth quarter, real yields on TIPS increased rather
dramatically, supporting the contention that both shorter-term and
longer-term
inflation expectations declined during the fourth quarter.
For instance, the real yield on the BIF and SAIF’s portfolios’ TIPS
with about two years to maturity increased by 125 basis points, while
the real yield on the portfolios’ longest-maturity TIPS (with
a maturity of about five years) increased by 57 basis points. Moreover,
the real yield of the “on-the-run” (that is, the most
recently auctioned) ten-year TIPS increased by 29 basis points.
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 first
quarter of
2006. Similar to the fourth quarter 2005 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 first quarter
2006 strategies provide the flexibility to purchase comparatively higher-yielding,
longer-maturity Treasury securities.
- During
the first quarter of 2006, the BIF portfolio primary reserve
target floor remains at $8 billion; for the SAIF portfolio,
the respective amount is $2.5 billion.
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