Recent events in Orange County, Calif., have not deterred the New Jersey Senate from approving legislation that could allow state pension funds to include derivatives in their investment mix.

Senate Bill 712 would amend current state law to allow state pensionfund managers the leeway to put money in investments that produce higher rates of return.

These investments include venture capital, junk bonds, and possibly risky investment products commonly known as derivatives, Roland Machold, the director of the state's division of investment, said this week.

"The law would allow venture capital and junk bonds if it was prudent. And it's conceivable that if you could do venture capital, you could also do derivatives," Machold said.

The legislation comes as Orange County, Calif., is taking steps to recover from investment losses of about $2 billion, resulting in part from its investments in several derivative products.

At the moment, the state's investment council does not permit investments in derivatives or leveraging, an investment technique also used by Orange County to increase the size of its troubled investment pool.

Machold said if the bill becomes law, the council will scrutinize managers' use of derivatives. Leveraging would still be illegal under the amended law.

"I can't imagine the council allowing higher-risk investments in the cash management fund," he said.

The New Jersey bill passed the Senate last Thursday by 21 to 12. The Assembly version of the bill has been approved by two committees, but an Assembly spokesman could not be reached to comment on the matter.

A spokesman for Gov. Christine Todd Whitman did not return a telephone call.

Proponents said the bill, while allowing for riskier investments, would not put New Jersey pension funds in jeopardy.

"Orange County [leveraged] its money two and three times, but this is not a leveraging bill. This is a prudent bill," said state Sen. Robert Singer, R-Ocean and Burlington counties.

Singer, who co-wrote the legislation along with state Sen. James Mc-Greevey, D-Middlesex County, said the amendments conform to investment standards set forth in the federal Employee Retirement Income Security Act. These rules are designed to limit the risk associated with investing in derivatives, he said.

Machold of the investment division said the amended law uses "whole plan principles," meaning that the state's investment funds would be able to balance their high-risk and low-risk investments.

The investment division has responsibility for 121 funds, including seven pension and annuity funds, with a fiscal 1995 book value of $43 bilion.

In Senate hearings on the amendments, Singer acknowledged, representatives for funds such as the teachers pension and annuity fund expressed concerns about the use of derivatives in the wake of the Orange County crisis.

At the same time, Singer said, "I consider this [amended bill] a major success for business. Bankers as well as lawyers approached me to get other things in the legislation. They had concerns that this bill didn't go far enough."

Many of New Jersey's investment laws were created following the Great Depression, when 44 New Jersey municipalities "went belly up" and declared bankruptcy, said Robert Friant, spokesman for the state Department of Community Affairs. These laws set stiff guidelines for fund managers, and do not permit the use of many risky investment.

For example, counties and municipalities can invest in certificates of deposit and government-backed securities such as Treasury bills. "Some would even say it's boring, but it has served us well in New Jersey," Friant said. "We don't anticipate having any Orange County situations here."

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