Beyond the headlines: the reality of public investing.
Officials from more than 1,300 governmental units across the United States and Canada responded to the early 1995 survey sponsored by the Government Finance Officers Association and MBIA Insurance Corporation. The distribution of survey respondents by type and government is shown in Exhibit 1. This survey comes at a critical time, as investment practices of state and local government have been under intense scrutiny following highly publicized losses in a few large investment portfolios - losses resulting from government managers attempting to achieve higher yields through the use of risky investment practices such as leveraging and/or investing in volatile derivative instruments.
The GFOA/MBIA survey findings cover investment of all kinds of governmental funds except pension funds. More than one-half of the respondents manage investment portfolios of less than $25 million (excluding pension funds). The data show that most investment officials follow a conservative approach and do not support the use of derivatives or leveraging for the investment of public funds. A summary of the survey's findings is presented below.
Prudent, Conservative Practices
Despite the headlines of investment losses, the vast majority of government investment managers are prudent in their choice of investment instruments. Exhibit 2 indicates substantial diversification of assets over a range of conservative investments, including U.S. Treasury securities, certificates of deposit, and state-run pools. Typically any one class of investment does not constitute more than 30 percent of the portfolio. Furthermore, although a small number of respondents concentrate more than 70 percent of their assets in a single investment class, the class is typically a conservative vehicle such as certificates of deposit or state-run pools.
Many governments participate in investment pools, with state-run pools being the most commonly used: 56 percent of the respondents place some of their funds in state investment pools, 12 percent place some funds in pools run by other local governments, and 14 percent place some funds in pools run by private entities. Of the governments that invest in state-run pools, 9 percent have all of their funds in state pools, with the majority coming from governments with portfolios of less than $25 million. On a regional basis, state-run pools are most often used in the West, followed by the South and Midwest, as shown by Exhibit 3.
Most governments do not invest in exotic instruments. Less than 5 percent have any investments in inverse floaters, reverse repurchase agreements, or flexible repurchase agreements. Less than 10 percent have any investments in step-up securities, collateralized mortgage obligations such as mortgage-backed securities, or interest- and principal-only strips.
Governments also tend to keep their maturities short. About one-half of those responding invest only in short-term securities and have maximum investment horizons under 12 months. Nineteen percent had maximum investment horizons of one to two years, while only 9 percent had maximum investment horizons over five years.
A large majority of governments have adopted written investment policies and generally did not find the need to modify their investment practices following Orange County since they were not engaged in risky investing techniques before the Orange County bankruptcy. A significant proportion, although not a majority, of the respondents have reviewed or revised their investment policies since the Orange County bankruptcy filing. When asked if the events in Orange County have affected their investment practices, most governments reported that they have not modified their investment practices. Twenty-five percent have reviewed their investment policies since the Orange County bankruptcy, 7 percent have modified their policies, and 4 percent have adopted a written investment policy. In addition, 4 percent withdrew funds from external pools, 3 percent have ceased purchasing derivatives, and 1 percent have sold their derivative holdings. Exhibit 4 illustrates the responses to this question on a regional basis. As expected, the West reported more incidences of reviewing, modifying, and/or adopting investment policies.
While most jurisdictions have adopted a written investment policy, a significant minority report that they still do not have such a document. Of those governments having written investment policies, the majority are reviewed by the jurisdiction's governing body or investment board or committee.
In most governments, the investment function is the responsibility of an appointed official, not an elected official. Eighty-one percent indicate that ultimate responsibility for investment management lies with an appointed official. Ninety percent indicate that day-to-day management of investments is handled by internal staff rather than external managers.
Use of Derivatives and Leverage
The survey showed that most public investors. do not invest in derivatives and generally believe that derivatives are not appropriate investments for public funds. Almost one-half of the respondents believe that derivatives should never be used, while 24 percent believe they should be permitted sparingly to hedge against risk, and 9 percent believe they should be permitted to maximize investment return, where appropriate. Exhibit 5 shows that, on a regional basis, the West reported holding a slightly more favorable opinion of derivatives than the other regions, although the responses were fairly consistent across the country.
When asked if their investment policies addressed the use of derivatives, 43 percent reported that their investment policies prohibit any investments in derivatives, 5 percent reported that their investment policies permit limited investments in derivatives, and 1 percent reported that their policies do not restrict investments in derivatives. Thirty-nine percent of the respondents have policies that are silent on the issue of derivatives. Exhibit 6 shows the distribution of respondents by their jurisdiction's policies regarding derivative use.
The majority of governments surveyed do not leverage funds for investment purposes and are opposed to doing so. Specifically, 78 percent do not leverage for investment purposes, and 63 percent believe funds should never be leveraged. Of those respondents who feel that there are some uses for leverage, 10 percent believe leveraging is appropriate for meeting unexpected cash-flow needs, while a scant 3 percent believe leveraging should be permitted to maximize investment returns. A small minority of government investors engage in leveraging through the use of reverse repurchase agreements.
Safety and Liquidity First
The limited use of derivatives reported by survey respondents combined with generally short investment horizons indicate that public investors tend to place the safety and liquidity of their investments above yield. These factors contribute to the survey's findings that government investors in general act prudently and professionally despite some highly publicized lapses reported by the media.
This summary of the GFOA/MBIA investment practices survey was prepared by CORINNE LARSON and PAUL ZORN, assistant director and manager, respectively; of the the GFOA's Government Finance Research Center.
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|Publication:||Government Finance Review|
|Date:||Oct 1, 1995|
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|Acknowledging a select few who represent the work of many.|
|BTH reborn (Behind the Headlines).|