FC 97/8




FINANCE COMMITTEE



Ninety-seventh Session

Rome, 17 - 22 September 2001

Report on Investments - 20001

Table of Contents

I. Background

1. This document is submitted to the Finance Committee for information, in accordance with the Financial Regulation IX, which provides, in part as follows: "The Director-General may invest monies not needed for immediate requirements seeking, wherever practicable, the advice of the United Nations Investments Committee. The investment of monies standing to the credit of any trust fund, reserve or special account shall be subject to any directives of the appropriate authority. At least once a year, the Director-General shall include in the financial statements submitted to the Finance Committee a statement of the investments currently held." 2

2. The financial assets of the Organization referred to above, for purposes of investment are apportioned to and managed in two separate portfolios: a long-term portfolio managed by Fiduciary Trust Company; and the short-term portfolio managed by The Northern Trust Company.

II. Long-term Investments

3. The long-term investment fund is set up to enable the Organization to meet the long-term liabilities resulting from the Staff Compensation Plan, the Separation Payment Scheme and After Service Medical Liabilities3. The Staff Compensation Plan Reserve Fund and the Separation Payment Scheme Fund accounts were combined in May 2000 into the FAO long-term investment account in order to take advantage of economies in terms of investment commissions and fees. The monies are invested in internationally diversified equities, fixed income instruments and venture capital, with the dual objectives of preservation of capital and capital growth. The benchmark for this portfolio is:

as approved by the FAO Investments Committee and endorsed by the Advisory Committee on Investments.

4. The benchmark combination provides a means of comparison of the returns of the portfolio in terms of both growth and income with indices whose components fairly represent the geographical and sector allocation of the portfolio. It was reviewed with the Advisory Committee in May 2001, along with all other benchmarks and investment guidelines and is currently under further reviewed with Cambridge Associates, the Organization's financial consulting firm.

Long-term Portfolio Activity and Performance for 2000, 2001

5. The balance in the long-term portfolio amounted to:

 

as of 31 December 2000

as of 30 June 2001

1. Cost basis

US$ 183,147,589

US$ 179,302,804

2. Market value

US$ 216,906,998

US$ 189,700,962

3. Unrealized gain

US$ 33,759,409

US$ 10,398,158

6. The investment guidelines to the asset manager (Fiduciary Trust Company International - FTCI) for the year 2001 have been to trade, buy, sell or otherwise acquire and/or hold, the following combination of instruments: 65% equity and/or equity related securities, 35% fixed income instruments under a balanced mandate as reflected in the selected benchmarks.

7. At the end of 2000 the long-term portfolio held equities and fixed income of 62 and 26 percent respectively (excluding venture capital comprised of both investment categories) which compares with 56 and 33 percent respectively on a cost basis. As of June 30, 2001 the asset allocation was 58 percent equities and 29 percent fixed income (excluding venture capital comprised of both investment categories) which compares with 56 and 34 percent respectively on a cost basis.

8. As of December 31, 2000, the FAO one year benchmark return was -8.61% while the FAO long-term portfolio one-year return was -10.71%. As of June 30, 2001, the FAO one year benchmark return was -14.68% while the FAO long-term portfolio one-year return was -21.09%. The tables attached as Annex A show the breakdown of the one-, three- and five-year returns as of 31 December 2000 and as of 30 June 2001.

9. The FAO long-term returns of 2000 reflect the decline in the world economy and in the financial markets where rising oil prices, tightening interest rates and slower GDP growth rates toward the end of the year all worked to depress market prices. These factors and the collapse of the NASDAQ bubble created an extremely difficult year for equities. Higher interest rates were felt also in bond markets which weakened bond prices. Thus, the FAO long-term portfolio was subject to strong pressure in both its areas of asset allocation during 2000. Although the fixed income portion of the long-term portfolio managed to outperform the benchmark, weakness in equity growth issues contributed to the performance for the Organization. In terms of currency allocation, the portfolio was gradually more heavily weighted toward the Euro which was thought to be undervalued, under weighted in the Yen while neutral toward the U.S. Dollar by the end of the year. This proved to have a positive impact on the portfolio. While the results of 2000 were not as good as expected, the 3 and 5 year results show a high performance relative to the benchmark, that is, an average return of just over 12% for the past three years versus a benchmark for the same period of 7.8%. If one looks back over the past five years the average yearly return was again just over 12% on a slightly higher benchmark of 8.9%. The Committee should also note that the negative performance in 2000 does not mean an accounting loss to FAO as most of the securities are still held. If one compares the cost to the market value of securities held at 31 December 2000, we show a gain on the investment of US$11 million (realized) and US$34 million (unrealized) over the period we have held the securities.

10. The long-term one year returns as of June 30, 2001 still show the impact of the decline of market indices during 2000, a troublesome year for equities, and the continuing uncertainty in the major economies, specifically, the United States, Europe and Japan in 2001. Better equity performance in 2001 is reflected in the markedly improved second quarter returns for the FAO portfolio. US equities in general have been aided by the Federal Reserve's moves to avoid recession and the FAO portfolio therefore benefited from security selection in North American equities and bonds. The fixed income portion of the long-term portfolio remains slightly underweighted as the benefit derived from rate easing has already been absorbed. In terms of currency allocation, the portfolio was impacted negatively due to previous overweighting of the Euro. The Yen has been neutrally weighted due to the weakness and uncertainty in the Japanese economy while the US dollar is currently above a neutral weighting. While the partial results of 2001 still reflect the underperformance of equity markets in 2000 as well as the world economic conditions of 2001, the 3 and 5 year results still indicate good performance relative to the benchmark.

11. The structure of the long-term portfolio was reviewed in late May with the Investment Committee and the Advisory Committee on Investments with a view to diversification of the long-term portfolio with up to three separate managers selected through a competitive process:

    1. A fixed income manager to manage the bond component of the portfolio;
    2. An equity growth stock manager; and
    3. An equity value stock manager.

12. The Committee reinforced the decision to diversify the long-term assets at the May meeting, however concluded that any changes to the current management should not be undertaken until FAO has proper monitoring operations in place in order to effectively control placement of assets.

III. Short-term Investments

13. The short-term investment account consists largely of Trust Fund deposits held pending disbursements on project implementation. These funds are currently invested by the Northern Trust Company (the custodian for FAO) in accordance with the recommendation of the FAO Advisory Committee on Investments at its Twenty-fourth Session (18 May 1998).

14. The benchmark used to measure performance on the short-term fixed income portfolio is the Northern Trust Government Select Portfolio which invests primarily in U.S. Government and Government Agency Securities with the objectives of capital protection, income and liquidity. The return, which closely follows the returns of the short-term US interest rates, hovered at 6.32% during 2000 versus a benchmark of 6.78% . The return measured at 2.51% during the first six months of 2001 versus a benchmark of 5.02% as shown in Annex B attached. The balance in this portfolio at 30 June 2001 amounted to US$228,768,928, which mostly represented Trust Fund money in trust to FAO.

15. As part of the decision to externalize the management of the short-term portfolio, the Advisory Committee on Investments meeting on 26 May, 2000 endorsed the proposal to change the current short term portfolio to a proactive approach using specialized asset managers. It was concluded that the approach should be to place the short-term assets with low risk of loss. Given this objective, a new benchmark of the three-month LIBOR rate plus 25 basis points net of fees and a minimum of 80% return of the three-month U.S. Treasury Bill rate was also proposed and agreed by the Advisory Committee on Investments.

16. The decision to hire specialized asset managers for the short-term portfolio was implemented through the selection of two fixed income managers: Wellington Management Company and Western Asset Management. Each firm is to be given up to a maximum of US Dollars 100 million in trust fund assets. The investment performance will be measured against the benchmark noted above and the funds will be managed under the following investment guidelines:

  1. The primary objective of the Organization is preservation of capital and the earning of income on a calendar year basis of at least 80 percent of the ninety-day US Treasury Bill rate and the three month US Dollar LIBOR rate plus 25 basis points, net of cost.
  2. The base currency shall be the United States Dollar. Any non-US Dollar securities must be fully hedged back to the US Dollar.
  3. Time deposits, certificates of deposit, bankers acceptances and commercial paper (when issued by a bank) shall be placed only in banks at the following major money market centres: Belgium, Canada, France, Germany, Italy, Japan, Netherlands, Sweden, Switzerland, United Kingdom and the United States and the off-shore centres of Ireland, Nassau and the Cayman Islands.
  4. The Manager shall have the authority to trade, buy, sell or otherwise acquire, hold or dispose of the following securities and instruments in the following categories:
    1. time deposits;
    2. certificates of deposit;
    3. bankers acceptances;
    4. commercial paper;
    5. treasury bills and notes;
    6. corporate notes and bonds, including floating rate notes;
    7. Mortgage-backed securities (MBS) including floating rate notes, collateralized mortgages (CMO's) and commercial mortgage-backed securities (CMBS);
    8. asset-backed securities including floating rate notes;
    9. spot and forward contracts for the purchase and sale of currencies with approved counterparties;
    10. exchange-traded futures and options contracts for currencies and fixed income instruments on the approved exchanges*;
    11. repurchase agreements;
    12. government agency and instrumentality issues;
    13. Custodian's short-term investment fund.

      14. * Approved counterparties and exchanges detailed in short-term investment objectives.

  5. The average quality of eligible instruments will be AA- (Standard & Poor's) or Aa3 (Moody's) with a minimum quality of A- or A3 for those ratings firms respectively.
  6. The average duration of the asset portfolio must not exceed two years. The duration of any single issue must not exceed 5 years.
  7. Other provisions:
    1. A maximum of 25% of the portfolio or equivalent in face value of forward foreign exchange contracts and investments may be placed in any one bank in instruments with a rating of either A1 or P1, (S & P and Moody's respectively). There is no limit on placements with the Custodian.
    2. A maximum of 10% of the portfolio or equivalent in foreign exchange and investments may be placed in any one bank or in instruments with a rating of either A2 or P2 (S & P and Moody's respectively).
    3. No more than 5% of the market value of the portfolio may be invested in securities of any one issuing entity at the time of purchase with the exception of US Government issues.
    4. Derivative instruments, such as forward contracts and options, shall be used only for purposes of hedging back to the US Dollar or managing interest rate risk. They may not be used for speculative purposes.
    5. Investments in mortgage-backed securities should be limited to low volatility issues. Securities with imbedded leverage or substantial asymmetric risk such as Interest-only, Principal-only, bonds or inverse floaters are not permitted.
  8. Portfolio Allocation:
    1. US Issues:
      1. Treasuries 0-100%
      2. Agencies 0-50%
      3. Corporates 0-50%
      4. MBS (including CMOs, CMBs) 0-50%
      5. Asset-backed securities 0-50%
      6. Repurchase Agreements 0-50%
    2. Non-US Dollar government issues are limited to issues of sovereigns, government agencies and supranational agencies and shall at no time exceed 40% of the value of the portfolio.

17. The investment managers for the short-term portfolio were selected by FAO using the following due diligence procedures:



1 As this paper was not discussed at the May meeting, the secretariat has supplemented basic figures for the year 2000 with figures on the January to June 2001 performance.


2 In 1998 the UN Investments Committee informed FAO that it could no longer advise FAO on investment practices. In consequence, a reorganization of the three committees which dealt with investment activities of the Organization took place; the Credit Committee was integrated into the Investment Committee which was then assigned responsibility for management of the short-term and long-term assets. In addition, the Advisory Committee on Investments has as its purpose to provide the Director-General an independent view on the policies, plans, operations and performance of the various FAO investment portfolios and on any other aspect of FAO financial management on which the Director-General seeks the Committee's advice. The Advisory Committee on Investments will review the annual report prepared by Treasury for the Investment Committee and make recommendations to the Director-General.


3 The Staff Compensation Plan, introduced on 1 January 1956, provides compensation benefits to staff members (and/or their dependants) in case of injury, illness, or death, attributable to the performance of official duties. The Organization's liability under the Plan is funded currently at 0.129% of payroll for the Regular Programme and other Headquarters Staff and 0,266% for Field Staff. These rates were confirmed by the Finance Committee at its Seventy-seventh Session (21-30 September 1993).

The Separation Payment Scheme, approved by the Council at its Sixty-sixth Session (June 1975) as part of the pay package of Rome General Service Staff with effect 1 January 1975, provides for payments upon separation at the rate of the one month's pay for each year of service computed on the basis of the rate of pay of the month of termination of contract. The Council also decided that the Organization's liability should be funded and an actuarial review of the Fund was last made at 31 December 1997 and subsequently updated as of 31 December 1999. As a result of the review, the amount of $64,838,000 was accrued in the financial statement 1998-1999 for the Separation Payment Scheme.

The After Service Medical Plan provides for worldwide coverage for necessary medical expenses of eligible former staff members and their dependants. The Plan is subject to actuarial review to ascertain the related liabilities and rates of contribution. Conference Resolution 10/99 approved, inter alia, the practice of earmarking excess investment income generated through the Separation Payments Scheme and Staff Compensation Plan investments for the After Service Medical Plan liability. The amount of the investment income designated for the After Service Medical Plan amounted to $42.8 million based on an actuarial review at 31 December 1999.