Magazine article Journal of Property Management

Alternative Investment Opportunities for Condominium Reserve Funds

Magazine article Journal of Property Management

Alternative Investment Opportunities for Condominium Reserve Funds

Article excerpt

[ILLUSTRATION OMITTED]

While the 2013 cost of living rate went up about 1.5 percent, the rate on money market funds and certificates of deposit have maintained rates between 0 and 1.0 percent per year. Arguably, while condominium associations appropriately fund their reserve for capital improvements, the value of the reserve is decreasing versus inflation. Condominium associations have traditionally deposited reserve funds in money market funds and certificates of deposits as their only means of investment for decades. It is believed that this method is the most conservative manner to maintain the reserve capital. Except for longer-term CDs, this approach is guaranteed to lose value if inflation is taken into consideration. Other alternatives are available that are conservative in nature and offer higher returns to the associations.

MONEY MARKET FUNDS AND CERTIFICATES OF DEPOSITS

Unless money market funds are with banks, they are not guaranteed at all. One should look at the fund prospectus quarterly and review the investments of the fund portfolio. Bank money market funds and CDs are guaranteed up to $250,000 in total. Therefore, should the association have reserves in money market funds and CDs beyond $250,000 at one bank, they are not insured. Should the FDIC take over a bank with a CD, they have the right to change the interest rate on the certificate. Finally, CDs must be held to maturity or penalties are incurred. There is no secondary market. If interest rates were to go up, the value of the CD, if it could be sold, would be valued at a discount (capital loss).

I advocate a condominium reserve allocation that includes mutual funds that include short-term federal or treasury investments and short-term investment grade corporate debt. They can be bought and sold on a daily basis and many financial institutions that have their own MMFs and CDs can purchase these funds for the association. Before discussing the efficacy of these alternatives, a few definitions need to be understood. For purposes of expediency, the Vanguard Funds were chosen both for low management fees and acknowledgement of their broad appeal. The funds being considered are the Short-Term Federal Admiral, Short-Term Treasury Admiral and the Short-Term Investment Grade Funds. Important terms to acknowledge include:

Average annual total return-- Fund performance after taxes on distributions and sale of fund shares.

Distribution yield--The interest paid versus the price of the fund.

SEC yield--The interest rate of all the investments in the portfolio if held to maturity.

Duration--The average maturity of securities in the portfolio. For this group of funds the average duration of the portfolios is between 2.2 and 2.3 years.

Of primary concern to the association treasurer and Board of Directors is the variance in the fund price. Safety of capital is the primary concern. For the three-, five- and ten-year period, the Federal and Treasury funds have been very stable. The same is true for the Investment Grade fund except for a one year period from mid '08-'09. Regarding the Federal fund, the value is within 0.8 percent of the current value over a three year period; 6 percent over five years and 4.5 percent over ten years. The Treasury fund is within its current price by 0.15 percent over three years; 5.5 percent over five years and within 3 percent over ten years. The Investment Grade fund is within 10 percent of its current value over three years; 1 percent over 5 years and 1.5 percent over ten years.

We discount the value of the SEC yield because very few of the securities in the fund will be held to maturity. However, if this yield is above or below the distribution yield, it is a good indicator of whether the future dividends will have a higher or lower interest rate to the price of the fund.

The distribution yield is the interest rate current owners of the fund would derive if the value of the fund remains the same. …

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