Austin, Texas - When it comes to running the state's $5.2 billion investment pool for local government, one expense that Texas Treasurer Kay Bailey Hutchison does not have to pay is advertising.
"We don't market the program," she said of the state's massive Tex-Pool program, which has grown sixfold since she took office in January 1991. "It's word of mouth among the participants."
Like many of the nation's 26 local investment pools run by state treasurers' offices, Texas has been the beneficiary of a flood of new cash that local agencies are pulling out of banks and other private sector funds in search of security, liquidity, and better yields.
By many estimates, the state-run funds have investments totaling $30 billion. For now, it appears that the search for yield has as much to do with the influx of capital that has caused the Texas fund to swell from $800 million to $5.2 billion last month. Other states surveyed reported up to 30% increases in the growth of local participation over the past year.
Whether the state-run funds will sustain that growth is uncertain. Private firms, which control much of the estimated $800 billion to $1 trillion in cash invested by local governments, say they, too, are seeing a surge, but say history shows that it is not likely to last.
"The yields. are a very important factor," said Gerard Miller, senior vice president at Fidelity Investment, the Boston-based investment giant. "We've seen an increase of $2 billion or more in the governmental use of mutual funds."
He said that after the stock and bonds markets were rattled in 1987, there was a similar flow of money from individual investment strategies into huge pools. But Mr. Miller believes it may be much longer before local governments redirect their funds again.
"They will leave," he said. "There will come a point in the business cycle when the lag effect goes the other way. Right now that could be a couple of years away.
Localities' Stubborness
While not everyone believes that growing investments in state-run pools will be reversed, many agree that treasurers now have the opportunity to show local officials the benefits of letting them manage their millions by pointing out the lower cost and their better-safe-than-sorry. strategies.
For instance, cities or towns that individually invest with private funds or banks could pay fees of up to 50 basis points - though major localities could get institutional rates of under 20 basis points. Meanwhile, state-run funds generally offer their investment help for three to five basis points.
Still, many local governments are stubborn about change.
"Usually we see [localities] putting a toe in the water just to see if it works," said Linda Patterson, the deputy state treasurer who runs TexPool and the state's own investments. "We've heard of some who have put $10 million in one day and taken it out the next day just to see if we were liquid.
Others say that local governments may view switching investment strategies as a betrayal of their hometown bank.
"You have some counties or cities out there who still believe there is some benefit to leaving their money in the local bank to earn 2 or 3%," said one state investment officer, who asked not to be identified. "They believe that if they take the money out of the bank, local loans won't be made."
Abilene, Tex., used to be one of those localities. Today, the city of 106,000 invests $25 million in the state fund and puts other cash in federal government agencies.
"Before TexPool, we were buying government securities and bank certificates of deposit," said David Wright, finance director for the city. "But CDs are a thing of the past."
Not surprisingly, banks are often the largest competitors for local funds. In New Jersey, the banking lobby has fought attempts to broaden investment options for local governments.
The Competence issue
Ironically, one state official believes it was the specter of bank failures in the Northeast that has caused another $1 billion now into his $3.1 billion State of New Jersey Cash Management Program over the past year.
"I think the problem with the banks have changed some thinking," said Roland Machold, director of the division of investment in the New Jersey treasurer's office. "Some people saw that and got worried."
The New Jersey fund was created in 1977 after a state grand jury investigated local investment policies two years earlier. "They didn't find anything criminal," Mr. Machold said. "What they found was a level of incompetence when it came to investing local money."
With the recent highly publicized losses that some local governments suffered a year ago, the issue of competence has become as important as yield. History shows that cities, counties, school districts, and others are not too forgiving when they lose money - especially when it is in a state-run pool.
In 1987, the West Virginia treasurer's office sustained investment losses of $279 million even while investing in relatively safe Treasuries and government agency issues. Ultimately, no local government suffered a hit, but none appears to have forgiven the state.
Now the West Virginia Board of Investments runs the pool. Craig Slaughter, the board's executive director, said local investments that once reached nearly $500 million today total $23 million, making it one of the smallest state-run funds in the nation.
"There's still a lot of fear over what happened before," he said.
But pooling money is not for everyone.
In Seattle, the city invests up to $250 million of its own money in a fund with an average life of two years - considerably longer than the money market strategy many state-run funds use.
Rod Rich, the city's director of investments for the past 12 years, said the do-it-yourself approach has resulted in an annualized return of 8.4% this year through last month.
"I think it is the smaller jurisdictions that make greater use of these pools," he said. "If you are looking at doing a repo, the ability to do that is lost with size."
It was the needs of small local governments that prompted late California Treasurer Jesse Unruh to establish a local investment pool in 1977. Today, the pool is the nation's largest publicly managed fund, with $8.8 billion from nearly 2,000 localities. It has grown nearly $1 billion over the past year.
"We had cities that complained that no one would deal with their small investments." said Pat Beal, director of the California fund. "This was started for that reason."
Today, the fund limits to $15 million the amount that any local government may invest, largely because some cities a decade ago were using the fund for weekend safekeeping and then pulling their money out the rest of the time.
"We don't really compete with private funds," Ms. Beal said. "Many put the maximum here and then go to private firms to invest the rest."
Fidelity's Mr. Miller said, "We are obviously two different kinds of animals that fulfill different needs."
More recently, local governments have lost funds in pools. One of the most notable cases involved Californian Steven Wymer, who has been charged with fraud for his handling of government accounts that lost millions last year.
Underlying situations like the Wymer case is a general lack of sophistication.
"You've got people out there investing money that don't really know a tea bag from a T-bill," said a former state investment officer who now works for a private firm that invests government money. "For every one person who knows what they are doing, there are a probably a dozen who have no idea of what is going on."
States generally invest in only the safest short-term securities - Tresuries, government agencies, reverse repurchase agreements, and commercial paper - with strict guidelines designed to avoid getting caught in market plays.
Even though the Texas Treasury has adopted this conservative approach, its performance over the last two years has matched and often beaten the national average of all money market funds. For instance, when IBC/Donoghue reported the average monthly yield at 3.24% in July, the treasurer's office returned 4.02% to its investors.
That difference is even more meaningful to small local governments that get an even larger return because of the market muscle TexPool offers. The higher yield is significant because the average yield on money market funds is now less than half the 6.89% it was when Mrs. Hutchison took office.
Since TexPool was created in December 1989, the fund has paid out $318.4 million to the state's local governments.
The key, Mrs. Hutchison said, has been an aggressive but focused strategy.
"We consider this a service for our local governments," she said. "Many government agencies buy and hold, and we have traded and traded and traded."
Working from a fifth-floor trading desk that was built in her garage, Ms. Patterson says her approach to investing has saved her from ever suffering a loss.
"I set price points on everything I buy. When it gets there, I trade it and take my profit," said the former treasurer of Fort Worth. "You cannot get greedy."
