The Risk of Living in Investment’s Fast Lane : Orange County pool suffers a $1.5-billion paper loss
For years Orange County Treasurer-Tax Collector Robert L. Citron commendably earned comparatively high rates of return for the 180 agencies that had joined the investment pool he runs. The pool seeks returns of 7% to 9% through investments that are mostly in bonds. Although it doesn’t aim for returns of 15% or 20% by buying wildly speculative stocks, there is risk--and that became gut-wrenchingly clear this week when it was disclosed that the pool had suffered a paper loss of nearly $1.5 billon since January.
Those who played certainly knew the danger, that the greater the potential reward the greater the risk. The investment pool had been in place a long time and was very well known. None of the Orange County public agencies that participated can claim to have been caught by surprise. Nobody complained when the pool was reaping attractive returns.
EFFECT IS UNCERTAIN: It is still not clear what the overall financial impact of Citron’s strategy will be for the long term. But the disclosure certainly should reinforce the message for investors of public funds everywhere that caution should be exercised before committing money to risky financial strategies.
Wisely, the cities, school districts, transit authorities and other agencies involved in the Orange County pool have not run for the exits in a panic. The county has made a smart move in seeking independent review of the portfolio, to study the potential damage and to recommend changes, if needed.
Part of the reason for the loss appeared to be Citron’s investments in derivatives, which are financial contracts that derive their value from another asset, such as stocks, bonds or commodities. They have been used for years but have become more common recently. They are very volatile: In the age of computer investing, they can soar or plunge quickly.
Public agencies have special responsibilities when they handle the public’s money. One is not to gamble foolishly; another is to earn the highest return prudently possible. If they err, it should be on the side of caution.
Late last year, many investment advisers were warning of likely increases in the interest rate by the Federal Reserve Board and counseling clients to take their money out of bond mutual funds. If Citron had concerns, the agencies that were his clients said, he did not announce them. The Federal Reserve began raising rates in February, sending bond prices down. Yet in May and June, before his reelection over an opponent who challenged the county’s investment strategy, Citron insisted he was confident about the investments. One question that must be answered is whether he should have switched the portfolio mix and, if so, when.
SOME SAID NO, THANKS: Last April Citron released more than 700 pages of investment data, so the agencies entrusting their money to him were able to see where their investments had gone. After looking at the data, the treasurer and the City Council of San Juan Capistrano, not a member of the pool, decided the county investments were too speculative for their taste. So did Garden Grove.
Some cities and agencies did diversify. The City of Orange reduced its investment in the pool this year to about 20% of its assets. The Sanitation District of Orange County said it had about two-thirds of its investment portfolio in the Citron-managed pool. That would seem to be a gamble, even though the pool itself is diversified.
Orange County’s loss, even though only on paper--at least at this point--should warn other public agencies of the dangers of taking on too much risk. Until everyone understands derivatives better, and they are better regulated, public agencies should approach such investments with extreme caution.
