Most state-run local government investment pools eschew the use of derivatives and shun extensive leverage, according to a survey by The Bond Buyer.
Leverage and the heavy use of risky derivatives led to massive losses in an investment pool run by Orange County, Calif.
Only 12 state-run investment pools -- in Arizona, Connecticut, Florida, Idaho, Kansas, Massachusetts, New Hampshire, Oregon, Texas, Utah, Washington, and West Virginia -- are authorized to use derivatives. And eight of those states -- Arizona, Connecticut, Florida, Kansas, Massachusetts, Texas, Utah, and West Virginia -- currently avoid the instruments.
In Florida, for example, the state-run Florida Local Government Surplus Trust Fund has approximately 641 participants and about $6.5 billion of assets. Although Florida statutes allow the pool to use derivatives and leverage, separate investment guidelines governing the fund prohibit them, said Barbara Jarriel, chief investment officer in fixed-income securities for the Florida State Board of Administration, which administers the fund.
Such prudent policies helped the fund avoid withdrawals in the wake of the Orange County crisis, Jarriel said.
"We did not see a flood of withdrawals," she said. Instead, investors called to query fund managers about the pool's investment policies. And the fund gained cash from seasonal inflows of tax receipts, she said.
Derivatives accounted for about 2% of the portfolio of the Texas state-run TexPool. But following the Orange County fiasco, news of the investments caused a run on TexPool and the derivatives were sold.
"By and large, states take a very conservative view" of investments, said Milton Wells, director of federal relations for the National Association of State Treasurers. "The risks outweigh the rewards."
Wells said he was "stunned" by the Orange County situation. "I think where [states] use derivatives and leverage, it's probably only a small percentage. In Texas, it was 2% and they didn't use leverage," Wells added.
The state treasurers group and the Municipal Treasurers Association are each formulating policy statements on investment practices, which are expected to be released in early 1995, executives for both agencies said.
Both groups are also involved in meetings with Treasury officials and the President's Working Group on Financial Markets to examine and possibly refine existing investment policies.
The state treasurers group already compiles information on local government investment pools, including their size, operation, number of participants, and how frequently assets are valued. In 1989, the association issued a policy statement favoring full disclosure for local government investment pools. The Municipal Treasurers Association critiques and certifies municipalities' investment policies.
Orange County's investment losses aren't the first to involve the use of speculative investment practices.
In 1987, West Virginia's consolidated investment pool lost approximately $271 million. The losses involved the use of reverse repurchase agreements and unauthorized futures investments. Fallout from the debacle caused the state treasurer to resign and prompted the separation of the state board of investments from the treasurer's office.