O.C. Agencies Weigh Tactics for Investing
Liberty Capital Markets Inc. had a tantalizing offer for the city of Lake Forest: “Conservative Investments, Aggressively Pursued.”
The city, which recently recovered about $7.5 million from the bankrupt Orange County investment pool, has been bombarded with dozens of calls and stacks of glossy brochures from firms like Liberty, all promising savvy money management and sophisticated investment advice.
Liberty touted its Wall Street connections and Orange County commitment. But just months after making its unsuccessful pitch, the Irvine firm went out of business--leaving Lake Forest officials feeling that they had dodged yet another bullet.
The city, armed with new investment guidelines stressing safety and liquidity, decided last week that it will manage its money all by itself--thank you very much.
“It’s better if we just do this ourselves--at least we won’t lose our principal,” said David A. Bass, director of administrative services at Lake Forest.
Badly burned by the interest rate gambles of former Orange County Treasurer-Tax Collector Robert L. Citron, jittery officials for more than 200 agencies are wrestling with how best to manage millions of dollars in investments. The agencies have recovered $5.8 billion of their funds from the collapsed investment pool--about 77% of their total investment before the county’s bankruptcy filing Dec. 6.
It’s an especially vulnerable time for local governments in a county that has spawned such notorious mismanagers of public funds as Citron and Steven D. Wymer, the Newport Beach adviser who siphoned millions from city coffers, including the city of Orange.
Officials of cities and other agencies that routinely turned over big pots of their long-term investment funds to Citron for years are now getting a crash introduction to the complex world of high finance. While most cities and special districts are looking for new options, Orange County schools are still required by law to keep funds in the Orange County pool, at least for now.
For some cities, this is the first time in history that officials have had to handle their own portfolios, which typically include operating funds and proceeds from bond sales.
In the next few weeks, local government officials will be mulling over a wide range of options: managing investment portfolios in-house, hiring a money management firm, putting the funds in a state-run pool, hiring an investment adviser to counsel the city, creating a new pool to replace the failed investment pool run by Citron.
To complicate matters, they are being besieged with offers from investment advisers and money managers big and small who are attempting to win lucrative money-management contracts. Officials from cities such as Data Point have fielded more than 50 applications and phone calls from firms as far away as Boston and New York.
Many reputable firms that handle billions of dollars of investments are vying for business, along with one-person outfits with little experience and little insurance on hand if things go wrong.
“As every city tries to come up with its own investment map, you have all these investment ‘experts’ coming out of the woodwork who want to help. We get faxes from these Johnny-Fly-By-Night firms all the time,” said Anne-Marie Gallant, finance director for the city of Orange, with a $130-million portfolio.
“I’ve been in this business for 17 years, and these are firms I’ve never heard of,” Gallant said.
The task of selecting the best financial adviser and avoiding pitfalls of high finance can be daunting to public officials still bruised from months of court battles to retrieve their money from the Orange County pool.
“It is frightening. When you get burned you say, ‘Who can you trust?’ ” said Larry Hurst, finance director for the city of Brea, which has a portfolio of $45 million.
“Since the Orange County news hit the street, agencies all over the country have looked at their portfolios and wondered if they are doing the right thing,” said Corinne Larson, assistant director for cash management at the Government Finance Officers Assn., a trade group. “You don’t want to make mistakes, especially if you are located in Orange County.”
Last week, officials at the Moulton Niguel Water District in south Orange County struggled with how best to invest $93 million they recently retrieved from the county pool.
The five-member investment subcommittee--including a lawyer, a developer and the water district’s general manager--grappled with issues such as total return versus yield, risk versus return. They even discussed, half-jokingly, how to avoid sleepless nights over their investments.
Newly appointed money manager Kay Chandler tried to guide them through the fiscal wilderness, standing before a huge pink and blue line chart labeled “Longer Duration Portfolios Have Greater Volatility.”
Chandler, who runs Chandler Liquid Asset Management Inc. in San Diego, told the district that for every increase in return, there is an increase in risk. Her 7-year-old firm, which has five employees and about $500 million in public and private investments, will charge the water district about $80,000 a year to manage its money. Chandler, which has a $2-million insurance policy if things go wrong, will receive no commission fees, and has arranged for Bank of America to serve as custodian of the water district’s funds.
Committee members quickly confirmed that their top priorities are preserving principal and keeping a significant portion of their money in liquid assets in case of natural disasters, such as earthquakes. Then they debated how much to invest in longer-term government-backed securities that mature within 10 years.
The specter of Citron hovered over the proceedings.
“If we could just watch the Fed and predict a boost in interest rates, then we could adjust our portfolio, right?” district manager John V. Foley asked Chandler, who paused.
“Well, that’s only if you were right and had some inside information for us,” quipped another board member, Larry Lizotte. “Hey, maybe you could ask Bob.”
The participants chuckled.
In the end, water district officials decided to err on the side of caution, investing about 5% of the portfolio with the state of California and up to 30% in securities that mature within 10 years. The rest of the money will be placed in short-term investments.
“You just don’t know who to go to,” Foley said. “It would be terribly embarrassing if something like this happened to us again.”
That’s the fear of all agencies. As they wade through their investment alternatives and interview new money managers, many wonder if the wrong move could push them into bankruptcy.
They’re taking a variety of paths.
Next month, Dana Point will select a firm to help advise the city on how to manage its $15-million portfolio. The six firms under consideration include Vavrinek, Trine, Day & Co., a Rancho Cucamonga accounting firm that specializes in school audits; and Autumn Capital Investment Services, a small Dana Point firm that specializes in advising municipalities on investing bond proceeds.
The Orange County Sanitation Districts, which has a $300-million portfolio, is considering lengthy proposals from various money managers with billions of dollars under management. On Wednesday, the board is expected to hire Pacific Investment Co., a Newport Beach firm that manages $65 billion, officials said. The agency also had considered such firms as Payden & Rygel in Los Angeles, which manages $18 billion, and Chandler and Scudder Stevens & Clark in Boston.
Some smaller agencies that can’t pay hefty fees will be making their own investment decisions, then using local brokers to execute trades, much like Citron did. Brea is managing its portfolio in-house and making trades through a broker at Cruttenden & Co., an investment firm in Irvine.
Several Orange County agencies, including the Capistrano Valley Water District, are still using brokers at Merrill Lynch & Co., the investment firm that the county blames for its collapse. The county has filed a $3-billion lawsuit against the firm. Michael Stamenson, a Merrill Lynch broker, spoke to Citron every day about the contents of the Orange County investment portfolio.
“We got a bid from Merrill on some Treasury notes, but it wasn’t the best bid,” said Jim Widner, finance director for Capistrano, with a $3-million portfolio. “When I sent a letter to them recently, they called us and said, ‘Are you sure you want to send this to us?’ But there is no foundation for us not to do business with them. They have a local office here, so we want to keep things local.” Capistrano selected a local broker with Prudential Securities Inc.
Some investment advisers said municipalities might run into trouble if they rely on brokers, even a pool of brokers who provide competing bids. The advisers argue that brokers got Orange County into trouble in the first place.
Some cities, including Placentia, Lake Forest and Mission Viejo, also are working to create a new Orange County investment pool only for cities, called the Investment Authority of Orange County Cities. The cities hope that by controlling their own investment strategy they can stave off problems of the past.
The pool, which would emphasize investments in short-term securities, would be rated by a major rating agency and be subject to mark-to-market, which means it would be valued daily based on market conditions. Participants also would receive monthly status reports.
Mission Viejo, which had used Citron to manage its funds since it was incorporated as a city almost 20 years ago, is a strong backer of the city pool, said Irwin Bornstein, city treasurer.
“These cities would be in the driver’s seat, and it would be their choice to get burned or not get burned,” said Marty Margolis, a director with Public Financial Management Inc., a Pennsylvania-based firm that gives financial advice to local governments. PFM is helping cities set up the pool and hopes to manage the funds once it is created.
“These cities want to have their hands on the throttle and the brake, they want to be in control. The county clearly has a lot of credibility problems,” Margolis said.
Peggy Eckroth, whose firm, Autumn Capital, is bidding for investment business in Orange County, said she is concerned about a new pool.
“What happens if everyone gets spooked about something and wants to pull their money out? It could be Citron’s pool all over again,” said Eckroth, whose firm typically invests proceeds from bond issues rather than diverse investment portfolios.
Other local governments are opting for the safe route--putting their money in the state’s Local Agency Investment Pool, known as LAIF, which allows agencies to take out their money at any time, but has lower returns than other types of investments.
“Anyone can sell you things or give you advice, but they may not have your best interests at heart,” said Pat Neal, administrator of the state’s local fund, which has $9.5 billion under management from more than 2,100 cities and special districts in California. “Officials need to beware.”
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Pending Legislation
The Orange County bankruptcy resulted in an array of legislation to prevent future mismanagement of public funds. An overview of bills pending in the capitol:
Sponsored by Sen. William A. Craven (R-Oceanside) and Sen. Lucy Killea (I-San Diego), co-chairs of the Senate Special Committee on Local Government:
SB 861: Clarifies and strengthens existing laws regarding public officials’ responsibility for investment-fund security
SB 863: Places into law qualifications for the office of county treasurer-tax collector and requires continuing education
SB 864: Requires local agencies investing surplus funds to establish oversight committees with 3 to 11 members to review investment policy and assure compliance
SB 866: Declares that proceeds from any borrowing by local agencies may not be invested for a maturity longer than the term of loan
SB 867: Places 20% overall limit on use of reverse repurchase agreements by local agencies and establishes safeguards against misuse
SB 868: Prevents local agencies from investing in any security that could yield no interest at any time during its term.
Sponsored by Sen. Patrick Johnston (D-Stockton):
SB 564: Requires county treasurer to make monthly or quarterly reports on status of investment funds to board of supervisors and all pool participants. Also requires counties to adopt investment policy so all participants know what they are buying and provide yardstick to evaluate quarterly reports.
Sponsored by Sen. Quentin L. Kopp (I-San Francisco):
SB 19XX*: Allows the governor to appoint a trustee when a local agency files Chapter 9 bankruptcy. Governor would specify trustee’s powers and duties. Trustee would report to an advisory authority consisting of the state treasurer, controller and director of State Department of Finance.
Kopp bills approved by the Senate and pending in the Assembly:
SB 13XX*: Requires local agencies to open contracts for financial services to competitive bidding
SB 14XX*: Restricts local agencies’ use of repurchase agreements and reverse repurchase agreements to 10% of portfolio. Expands right of local agencies to rescind transactions after the fact
SB 15XX*: Clarifies fiduciary standards between broker/dealers and local agencies
*XX designates legislation from second extraordinary session
Source: California State Assn. of Counties
Researched by JANICE L. JONES/ Los Angeles Times
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Money Manager Red Flags
Those responsible for investing public funds should beware of money management firms that:
* Are not registered as an investment adviser with both the Securities and Exchange Commission and the California Department of Corporations
* Discourage appointing an independent custodian to protect assets
* Recommend investments with too great a reliance on a single strategy or single type of security
* Fail to disclose who at the firm will manage funds and provide a detailed resume
* Tout investments with a “guaranteed” level of performance
* Commingle investments with those of other clients
* Recommend a compensation arrangement based on transactions
* Impose exit penalties if the relationship is terminated
* Have conflicting interests
Other Controls
Once a money manager has been selected, here are other steps to avoid getting stung:
* Third-party oversight: Investment managers give advice, make investment decisions and execute transactions. They do not have possession of funds or securities. A third-party custodian, usually a bank trust division, should be used to account for all assets, collect interest and provide an independent assessment of the fund’s market value each month. Demand an explanation of any discrepancies between the management firm’s statements and the custodian’s.
* Limit discretion: Require the management firm to consult with the investor before conducting major transactions.
* Confirmations and audits: The management firm should send confirmation reports documenting all transactions to the investor and third-party custodian. Pay attention to these documents and question any discrepancies and unauthorized transactions.
Source: Skip Fish, former chairman of the Municipal Securities Rule-Making Board and chairman of Fish and Lederer Investment Counsel of Orange.
