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Interpreting Weighted Average Maturity (WAM )

To measure risk in a portfolio an investor looks at

• the liquidity available
• the diversification of that portfolio
• the overall length of the portfolio
• the risks represented by different type securities

To measure the length of the portfolio we use the weighted average maturity (WAM) calculation. The WAM measures risk represented by longer maturities.

Many securities have only their stated final maturity date. However, a security whose rate is indexed to another security, or rate, and moves with that index, is known as a floater. Floaters have two dates critical dates each of which must be understood by the investor if true risk is to be assessed:

• the reset date - the date on which the security may change coupon rate
• the stated maturity date - the date on which the security will mature

Most floaters are created by agencies of the US Government and float on recognized rates such as the last auctioned Treasury Bill auction rate. As the index moves, the floater moves with, or inverse to, the rate on a specific set formula. That scheduled point in time is called a reset date. The reset date is dependent upon the type of index as well as the formula. A T-Bill reset might occur once a week when the Bill is auctioned or a prime floater may reset only once a quarter while some floaters reset daily.

Since the floating rate security is actually longer than the reset date implies and since the potential coupon change at reset adds risk, the security often earns additional yield to compensate for those risks. It is for this reason that the Public Funds Investment Act requires all public entities to set a maximum WAM in their written Investment Policy and base that WAM on the "stated maturity date" [PFIA 2256.005 (b)(4)(C)] which implies use of the stated final maturity date and not a reset date. The reporting requirement is clearly made to allow readers of the investment report to judge the risk in the portfolio.

The PFIA also authorizes constant dollar local government investment pools and money market mutual funds (MMMF). Both are based on the SEC's structure for MMMFs. However, the pools are further regulated. Unlike MMMFs, pools

• must be AAA-rated
• must have a maximum 60 day (instead of 90-day) WAM
• must invest only in PFIA authorized securities
• must meet other specific conditions to protect the safety of public funds

A major difference is that SEC registered money market funds are allowed to calculate their WAM based on the reset date.

The PFIA requires the same "stated maturity date" calculation for WAMs in pools (2256.016), but again stipulates "stated" rather than final maturity. Because of this ambiguity the authority to use floaters' reset dates has become an issue for Texas pools. The intent of the PFIA appears to favor the stated final date use for safety and disclosure. Accountants and auditors tend to favor use of the final maturity date to recognize all risks and fully inform the reader of risk. The market favors the reset date methodology to capture all available yield within restrictive policy limitations.

If a pool uses the final maturity for calculating WAM it recognizes the potential liquidity risk in every security as well as the portfolio as a whole. LOGIC's position has always been to provide full disclosure and has used only the final stated maturity date for WAM calculations.

Other pools which are heavily invested in floaters have used the reset date causing them to appear shorter yet higher yielding. In order to give our participants the same competitive yield, LOGIC will adopt the practice of the other pools and use a small percentage of floating rate securities. It will maintain the WAM based on reset date below the 60-day statutory limit. However, LOGIC will also report the WAM based on stated maturity to assure that participants will be fully informed on risk versus return.

LOGIC wants each of its investors to understand and feel comfortable with the information they receive and the service on which they have come to rely.

Patterson & Associates, Austin