Public Pension Plans: Evaluation of Economically Targeted Investment
Programs (Letter Report, 03/17/95, GAO/PEMD-95-13).
Governments at all levels are increasingly looking to the nearly $4
trillion held as of 1992 by the nation's private and public pension
plans to fund public needs through economically targeted investments
(ETI). In fact, several state and local government employee pension
plans have implemented ETI programs. Critics have raised concerns that
plan participants may lose their retirement savings through economically
dubious but politically expedient investments, requiring increased
taxation and reductions in other needed spending to pay the costs. They
cite widely publicized cases in Alaska, Connecticut, and Kansas, where
public employee pension plans have lost millions of dollars through ETIs
that went bad. This report answers the following three questions: What
has been the extent of ETIs by nonfederal public employee pension plans,
in terms of amounts invested and the types of investments? Did ETI
programs aimed at business development realize competitive returns? What
were the economic effects of business development ETI programs, such as
jobs created?
--------------------------- Indexing Terms -----------------------------
REPORTNUM: PEMD-95-13
TITLE: Public Pension Plans: Evaluation of Economically Targeted
Investment Programs
DATE: 03/17/95
SUBJECT: Pensions
Investments
Investment planning
Small business investment companies
Capital
Trust funds
Employee retirement plans
Pension plan cost control
Economic development
IDENTIFIER: Colorado
Massachusetts
Minnesota
New York
Pennsylvania
Wisconsin
Wyoming
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Cover
================================================================ COVER
Report to the Ranking Minority Member, Subcommittee on Federal
Services, Post Office, and Civil Service, Committee on Governmental
Affairs, U.S. Senate
March 1995
PUBLIC PENSION PLANS - EVALUATION
OF ECONOMICALLY TARGETED
INVESTMENT PROGRAMS
GAO/PEMD-95-13
Public Pension Plans
(973779)
Abbreviations
=============================================================== ABBREV
CD - Certificate of deposit
DOL - Department of Labor
ERISA - Employee Retirement Income Security Act of 1974
ETI - Economically targeted investment
FDIC - Federal Deposit Insurance Corporation
GAO - General Accounting Office
IFE - Institute for Fiduciary Education
IRR - Internal rate of return
IRS - Internal Revenue Service
SBA - Small Business Administration
Letter
=============================================================== LETTER
B-254060
March 17, 1995
The Honorable David Pryor
Ranking Minority Member, Subcommittee on Federal
Services, Post Office, and Civil Service
Committee on Governmental Affairs
United States Senate
Dear Senator Pryor:
Governments at all levels are increasingly looking to the nearly $4
trillion held as of 1992 by our nation's public and private pension
plans to provide funds for meeting public needs through what are
known as economically targeted investments (ETIs). In fact, a number
of state and local government employee pension plans have implemented
ETI programs. Advocates of ETIs have stressed the potential benefits
of investing plan assets not only to help the plan but also to
provide collateral benefits to the economy as a whole. Critics,
however, raise concerns about plan participants' retirement savings
being lost through economically dubious but politically expedient
investments, requiring increased taxation and reductions in other
needed spending to pay the costs. They cite widely publicized cases
in Alaska, Connecticut, and Kansas, where public employee pension
plans have lost millions of dollars through ETIs that went bad.
Given this interest in and controversy over ETIs, we undertook an
evaluation of them and, at your request, are reporting the results to
you. Specifically, we addressed the following three questions:
1. What has been the extent of ETIs by nonfederal public employee
pension plans, in terms of the amounts invested and the types of
investments?
2. Did ETI programs aimed at business development realize
competitive returns (that is, receive rates of return similar to
alternative investments of comparable risk)?
3. What were the economic effects of business development ETI
programs, such as jobs created?
The focus of our study was exclusively on nonfederal public pension
plans, not on private sector plans.
RESULTS IN BRIEF
------------------------------------------------------------ Letter :1
Regarding the extent of ETIs, we found that public pension plans
currently have billions of dollars invested nationwide in ETIs.
However, such investments were limited, accounting for only a small
fraction of plan assets. In a survey of the 139 largest public
pension plans, 50 of the 119 respondents indicated that they had
invested a total of $19.8 billion (or 2.4 percent of all respondents'
assets) in ETIs to promote housing, real estate, or small business
development. Of this amount, about $3.2 billion was invested in ETIs
to promote business development.
We examined the types of ETI investments for promoting business
development by analyzing seven public pension plans that had
considerable experience in conducting apparently successful ETI
programs. These investments included bond purchases, loan purchases,
private placements, certificate of deposit (CD) purchases, and
venture capital investments.
We found that the expected performance of ETI investments other than
venture capital by these seven public pension plans was generally
similar to the returns of benchmark investments.\1 That is, the
performance of these investments was similar to that of comparison
investments at the time of our analysis. However, the performance of
ETI venture capital programs sometimes lagged the comparison
investments, based on industry median returns.
Although these seven plans represent a substantial share of total ETI
investments made by public pension plans nationwide, our findings
cannot be generalized to all public pension plan ETIs. A few public
pension plans are known to have made unsuccessful ETI investments,
and the performance of other plans may or may not match that of these
seven plans, which have a reputation for successful ETIs for business
development.
Concerning the economic effects of ETI programs, we were unable to
reach definitive conclusions because of a lack of data. The
nationwide surveys and studies we reviewed provided little
information regarding the economic effects of ETIs conducted by
public pension plans. Similarly, pension plans in our case studies
had limited data concerning the economic effects of their ETIs. The
plans generally do not gather such data, and although some plans
received information on economic effects from intermediaries (for
example, state agencies, banks, or venture capital partnerships),
this information suffered from several methodological weaknesses.
--------------------
\1 We used expected rather than actual yields (except for venture
capital) because all the investments we examined were still being
held by the public pension plans at the time of our study. Thus,
data on the final actual returns for these investments were not
available.
BACKGROUND
------------------------------------------------------------ Letter :2
As of 1992, nonfederal public pension plans controlled nearly $1
trillion in assets and provided retirement income for millions of
state and local government workers. In several states, pension plan
managers have been encouraged by their state legislatures to invest
some portion of their assets in ways that will affect economic
development, as long as these investments are consistent with sound
investment policy. Similarly, at the federal level, the Commission
to Promote Investment in America's Infrastructure has explored ways
to encourage pension plan investment in infrastructure projects.
Also, on June 23, 1994, the Department of Labor issued guidelines
that could encourage private pension plan investments in affordable
housing, start-up companies, and other programs.\2 Such pension plan
investments, designed to encourage a particular type of economic
activity (for example, community development or infrastructure
investment), are known as economically targeted investments.
Pension plans are established to provide retirement income and other
benefits to a defined group of individuals. State and local
government pension plans, for instance, provide retirement and
disability benefits to state and local government employees, as well
as other benefits to the employees' beneficiaries. In 1991, there
were about 2,360 such public employee pension plans in the United
States, covering about 17.5 million workers and retirees.\3
Public pension plans are maintained in every state, but they differ
from one another in a variety of ways. For example, the retirement
boards governing the plans consist of varying combinations of
elected, appointed, and ex officio members. The plans range greatly
in the size of their membership and professional staff. Small plans
(those with fewer than 1,000 active members) usually have
professional staffs averaging about three full-time equivalent
employees while large plans (those with 100,000 or more active
members) have staffs averaging over 200 employees.\4 The plans also
differ in terms of the size of their administrative budgets, their
level of funding, and their experience with implementing ETI
programs.\5
Pension plans control a significant amount of money. In 1992,
private and public pension plans (excluding those of the federal
government) held $3.9 trillion in assets.\6 Pension plans owned 33.1
percent of all equity holdings in the economy and 17.9 percent of all
taxable bond holdings. Of the $3.9 trillion held by these plans,
$987.8 billion (25 percent) was held by public pension plans.
Generally, public pension plan money (contributed by both employees
and their state and local government employers) is held in trust and
invested by plan administrators, or fiduciaries. Investment returns
on pension plan assets benefit both employees and taxpayers. For
employees, the realized investment income helps ensure that pension
benefits will be paid as they become due. For taxpayers, the
investment income earned on plan assets reduces the ultimate cost to
them of paying these pension benefits.
--------------------
\2 These guidelines were in the form of an interpretative bulletin
that set forth DOL's position that a pension fund fiduciary can
invest in an investment that provides collateral economic benefits
only if the fiduciary is satisfied that the investment is expected to
achieve a competitive, risk-adjusted rate of return and meets ERISA's
other fiduciary standards.
\3 U.S. Department of Commerce, Economics and Statistics
Administration, Bureau of the Census, Finances of Employee Retirement
Systems of State and Local Governments: 1990-1991 (Washington, D.C.:
January 1994). Most of the pension plans covered in the U.S. Bureau
of the Census survey, and reviewed in this report, are actually
pension systems. Pension systems provide retirement and other
benefits to employees of multiple agencies or administer multiple
pension plans. For reasons of simplicity, we refer to the pension
systems as pension plans.
\4 Public Pension Coordinating Council, Survey of State and Local
Government Employee Retirement Systems (Washington, D.C.: June
1994).
\5 U.S. General Accounting Office, Underfunded State and Local
Pension Plans, GAO/HRD-93-9R (Washington, D.C.: December 1992).
\6 Employee Benefit Research Institute, EBRI Quarterly Pension
Investment Report, 8:2 (October 1993), 41.
FIDUCIARY RULES
---------------------------------------------------------- Letter :2.1
In all 50 states, the public pension plan fiduciaries' investment
activities are bound by prudence rules defined in state statutes.\7
Many states use some variation of the prudence rule found in the
Employee Retirement Income Security Act of 1974 (ERISA), a federal
law governing private pension plans that is administered by the
Department of Labor (DOL) and the Department of the Treasury.\8 Under
the prudence rule, plan fiduciaries must seek investments that will
provide market-rate returns. DOL has determined that a private
pension plan can invest in an ETI if the ETI has an expected rate of
return that is commensurate with the expected rates of return on
alternative investments with similar risk characteristics.\9 In
addition, plan fiduciaries may consider collateral benefits in
choosing between investments that have comparable risks and expected
rates of return. However, if fiduciaries violate the prudence rule
by investing in projects that clearly will not yield expected
market-rate returns, they may be held personally liable for the
losses incurred. Such liability will attach to private plan
fiduciaries under ERISA and may attach to public plan fiduciaries,
depending on the regulatory scheme overseeing the plan.
In order to receive the benefits of tax qualification, plans must
also follow the exclusive benefit rule, which, as set forth in
section 401(a)(2) of the Internal Revenue Code and many state
statutes, requires that plans operate with the members of the plan
foremost in mind. For example, plan sponsors cannot forego the
members' benefit to act in their own interest or in the interest of
elected officials. The Internal Revenue Service (IRS) has
interpreted "exclusive" in such a way that a plan may make
investments from which people other than plan members also derive
some benefit, as long as the investments are fairly priced, yield a
market-rate return, are sufficiently liquid, and are otherwise
prudent. However, IRS will disqualify a plan that fails to act for
the exclusive benefit of its members. If a plan were disqualified,
the preferential tax treatment provided to plan sponsors and
participants would be adversely affected or even eliminated.
--------------------
\7 National Council on Teacher Retirement, Protecting Retirees'
Money: Fiduciary Duties and Other Laws Applicable to Public
Retirement Systems, 3rd ed. (Arlington, Va.: 1995).
\8 ERISA establishes minimum standards for private pension plans
concerning reporting and disclosure, participation and vesting,
funding, and fiduciary responsibility. Among DOL's duties under
ERISA, it has the primary responsibility for promulgating and
enforcing fiduciary compliance. The Internal Revenue Service, within
Treasury, oversees plan participation, vesting, and funding and
determines whether plans are qualified under rules set out in the
Internal Revenue Code. (For qualified plans, members can defer taxes
on their plan contributions and imputed earnings until retirement.)
While nonfederal public pension plans are not regulated by DOL, they
must comply with the Internal Revenue Code, as enforced by the
Internal Revenue Service, and state laws. In addition, there are
many instances in which the tax rules that apply to public plans
differ from those that apply to private plans.
\9 U.S. Department of Labor, Interpretive Bulletin 94-1 on
Economically Targeted Investments, bulletin relating to ERISA,
Washington, D.C., June 23, 1994.
DEFINITION OF ETIS
---------------------------------------------------------- Letter :2.2
According to DOL, ETIs are generally defined as investments that are
selected for the economic benefits that they create in addition to
the investment return to the employee benefit plan investor.\10 For
example, some groups define ETIs as investments that are designed to
produce a competitive rate of return commensurate with risk as well
as create some collateral economic benefit for a targeted geographic
area, group of people, or sector of the economy.\11 ETI collateral
benefits may include construction of affordable housing, job creation
or retention, sales and tax revenue generation, and payroll growth.
"ETIs [can] target the local economy (or the markets upon which
the plan sponsor depends for continuing revenues to fund its
pension obligations). . . . Investments in affordable
housing are expected to strengthen the social fabric of the
region. To the extent that capital markets are judged to be
tradition-bound, rigid, or incapable of funding all `worthy'
investments, making funds available from the pension investment
pool is seen as addressing capital gaps that would otherwise
impede local economic development."\12
Consider a pension plan interested in providing economic benefit to
the citizens of its state in addition to earning a competitive return
for plan members. Rather than simply making traditional stock and
bond investments in national markets, the pension plan might seek
less common mechanisms to direct some portion of plan assets toward
local companies. For example, the plan might purchase stock in local
start-up companies through venture capital funds that target some
portion of their assets to companies located in the pension plan's
state. The intention would be to make equity financing available to
viable in-state companies that might not come to the attention of
out-of-state venture capital partnerships. As another example, the
plan might invest in programs to provide loans to in-state companies
that might not be able to secure debt financing at competitive terms
from traditional lenders.
--------------------
\10 U.S. Department of Labor, Interpretive Bulletin 94-1.
\11 Based on definitions in New York State Industrial Cooperation
Council, Competitive Plus: Economically Targeted Investments by
Pension Funds (New York: February 1990), and Institute for Fiduciary
Education, Economically Targeted Investments: A Reference for Public
Pension Funds (Sacramento, Calif.: June 1993).
\12 U.S. Department of Labor, "Economically Targeted Investments:
An ERISA Policy Review," Report of the Work Group on Pension
Investments, Advisory Council on Pension Welfare and Benefit Plans
(Washington, D.C.: November 1992), pp. 3-4.
SCOPE AND METHODOLOGY
------------------------------------------------------------ Letter :3
To determine the extent and nature of ETIs nationwide, we reviewed
available surveys and literature. We gathered information on the
value, types, and numbers of ETI investments made by nonfederal
public pension plans. A key source we used was a 1992 survey
conducted by the Institute for Fiduciary Education (IFE).\13 This
survey canvassed the 139 largest nonfederal public pension plans
regarding their experience with ETIs; 119 pension plans responded,
for an 86-percent response rate. The respondents accounted for about
85 percent of total nonfederal public pension plan assets in 1992, so
the data are broadly representative.\14
To gain greater insight into the nature of ETI programs, as well as
to obtain and analyze information on the financial returns and
economic effects of these investments, we conducted case studies of
seven pension plans implementing ETI business development
programs.\15 We concentrated the case studies on ETIs designed to
promote business development because we had previously reviewed
public pension plan ETIs in affordable housing.\16 For each case
study in this review, we interviewed plan officials and analyzed data
on the plans' ETI programs. Each of the seven pension plans
conducted one or more ETI programs. These programs, in turn,
consisted of one or more individual investments.
The pension plans in our sample were identified in national surveys
or by industry experts as having considerable experience in
conducting successful ETI programs to promote business development.
We selected these seven plans because, given their experience, they
were likely to have data regarding the financial returns and economic
effects of ETIs. The plans we selected were the Public Employees'
Retirement Association of Colorado, the Massachusetts Pension
Reserves Investment Trust, the Minnesota State Board of Investment,
New York City Pension Systems, the Pennsylvania State Employees'
Retirement System, the State of Wisconsin Investment Board, and the
Wyoming Retirement System.\17
Our sample of plans is small and it was not randomly selected.
Therefore, it is not representative of public pension plans
nationwide. Consequently, the results of our case studies concerning
the financial returns on ETIs as well as their economic effects
cannot be generalized to the universe of public pension plans.
To answer the second question concerning whether business development
ETI financial returns were competitive, we compared the yields on
individual ETIs held by seven public pension plans at the time of our
study to returns of alternative investments with similar risk
characteristics and maturities (or terms). To carry out this
analysis, we collected data on the date of purchase, amount, risk
rating, and expected yield of over 200 individual investments made
through 14 separate ETI programs conducted in 7 states. We then
compared the expected yields on these investments (actual yields in
the cases of venture capital) to the yields on alternative benchmark
investments (that is, other investments with similar risk and
maturity characteristics) whose selection we based on the advice of
experts.
To assess the economic effects of business development ETIs, we
reviewed nationwide studies as well as information provided by the
seven pension plans examined in our case studies. Through the case
studies, we obtained and analyzed available information concerning
job creation, revenue generation, and other potential economic
effects of ETI programs. We did not attempt to independently assess
the economic effects of these investments, nor did we independently
verify the accuracy of the information provided to us.
Throughout our study, we used an advisory panel consisting of experts
from academe, a national association representing administrators of
teacher and other public employee retirement systems, an employee
benefits consulting firm, a venture capital consulting firm, an
investment consulting firm, and a nonprofit group familiar with the
design and implementation of ETI programs. The panel helped us
select case studies and identified relevant literature to be
reviewed. The panel also reviewed our methodology for conducting
case studies and analyzing the data and provided comments on a draft
of our report. We conducted our work between June 1993 and July 1994
in accordance with generally accepted government auditing standards.
--------------------
\13 Institute for Fiduciary Education, Economically Targeted
Investments: A Reference for Public Pension Funds (Sacramento,
Calif.: June 1993).
\14 While the survey did not report the respondents' total assets, we
estimated them by multiplying the average pension plan asset figures
reported in the survey by the number of pension plans responding.
\15 For another example of using case studies to examine ETIs, see
Center for Policy Alternatives, Economically Targeted Investments by
State-wide Public Pension Plans (Washington, D.C.: September 1993).
\16 U.S. General Accounting Office, Pension Plans: Investments in
Affordable Housing Possible With Government Assistance, GAO/HRD-92-55
(Washington, D.C.: June 1992).
\17 We reviewed ETI programs funded by the New York City Police
Pension Fund and the New York City Employees' Retirement System that
were administered by the New York City Comptroller's Office.
EXTENT AND NATURE OF ETIS
------------------------------------------------------------ Letter :4
In this section, we provide data on the value, type, number, and
geographic dispersion of ETIs nationwide. We then provide similar
data for the business development ETI programs conducted by the seven
pension plans we studied.
VALUE, TYPE, AND NUMBER OF
ETI INVESTMENTS
---------------------------------------------------------- Letter :4.1
Public pension plans have invested a significant amount of money in
ETIs nationwide, although these investments constitute a modest
portion of all public pension plan assets. According to the IFE
survey, 50 of the 119 responding plans (42 percent) conducted a total
of 95 ETI programs. Overall, they had invested $19.8 billion of
their assets in ETIs by 1992. This amount is nearly 2.4 percent of
the 119 respondents' 1992 assets.
The IFE survey had several limitations. First, the survey relied on
self-reported data: thus, some investments that would meet the
definition of ETIs might not have been reported by the survey
respondents, while other investments that would not meet this
definition could have been reported by the respondents. Second, the
IFE questionnaire asked respondents to indicate the dollars invested
in ETIs but did not make clear whether this amount should be assessed
at the current market value or the value at origination, so we cannot
know precisely what values are represented by respondents' answers.
Third, the survey asked for ETI investment "to date"; therefore, the
IFE totals include some ETIs that were no longer held by the survey
respondents.
The survey report grouped respondents' ETIs into five major
categories: residential housing, other real estate, small business
loans, venture capital, and other ETIs (private placements, CD
programs, limited partnerships, and other investment vehicles not
appropriately included in the four other areas). Figure 1 shows the
amounts invested in ETI programs for the 50 plans reporting ETIs,
while figure 2 shows the number of ETI programs conducted by the
plans. The bulk of the survey respondents' ETI assets were invested
in residential housing programs, while business development programs
(that is, small business loans, venture capital, and other ETIs)
accounted for only about 16.1 percent of those assets (the shaded
portion of figure 1). Nevertheless, business development programs
did constitute nearly 58 percent of the number of ETI programs
reported (the shaded portion of figure 2).
Figure 1: Investments in ETI
Programs by IFE Survey
Respondents, by Program Type\a
(See figure in printed
edition.)
\a Dollars in millions. Total invested in ETIs = $19.8 billion.
"Other ETIs" includes private placements, CD programs, limited
partnerships, and other investment vehicles not appropriately
included in the four other areas.
Source: Institute for Fiduciary Education, Economically Targeted
Investments: A Reference for Public Pension Funds (Sacramento,
Calif.: June 1993), pp. 14-15.
Figure 2: ETI Programs
Conducted by IFE Survey
Respondents, by Program Type\a
(See figure in printed
edition.)
\a "Other ETIs" includes private placements, CD programs, limited
partnerships, and other investment vehicles not appropriately
included in the four other areas.
Source: Institute for Fiduciary Education, Economically Targeted
Investments: A Reference for Public Pension Funds (Sacramento,
Calif.: June 1993), pp. 14-15.
GEOGRAPHIC DISPERSION OF
ETIS
---------------------------------------------------------- Letter :4.2
ETIs are geographically widespread. We identified 29 states in which
public pension plans were implementing housing, business development,
or some other type of ETI program. Our list may not be complete,
however, given the lack of a nationwide database on ETI activity.
Figure 3 shows (1) the 29 states in which we identified one or more
pension plans having an ETI program and (2) the 24 states in which
plans had business development ETI programs. (See appendix I for the
types of business development ETI programs conducted in each of the
24 states.)
Figure 3: States With ETI
Programs
(See figure in printed
edition.)
BUSINESS DEVELOPMENT ETIS BY
SEVEN PENSION PLANS
---------------------------------------------------------- Letter :4.3
In addition to gathering national data on the amounts and types of
ETIs, we gathered data from seven selected pension plans on ETIs
currently in their portfolio that were intended to promote business
development. As of 1993, these pension plans conducted a total of 14
ETI business development programs: 2 bond purchasing programs, 3
loan purchasing programs, 2 private placement programs, 2 CD
purchasing programs, and 5 venture capital programs. According to
IFE, most bond and loan purchases would fall into the "small business
loan" category shown in figures 1 and 2, while private placement and
CD purchasing programs would fall into the "other ETIs" category.
Bond purchasing programs were conducted in Colorado and Minnesota.
In Colorado, the pension plan purchased Colorado Housing and Finance
Authority bonds backed by U.S. Small Business Administration (SBA)
loans. The loans were made by local banks, and then the loans or
loan participations were purchased and securitized by the authority.
These loans were secured by either unguaranteed first liens
subordinated by an SBA second lien or a federal guarantee. According
to an authority official, the bonds were backed by the general
obligation of the authority.\18 Businesses receiving loans under this
program included a minority-owned day-care facility and a woman-owned
construction firm. In Minnesota, the pension plan purchased bonds
from the Minnesota Small Business Finance Agency. The bonds were
backed by the guaranteed portions of SBA loans. The loans were made
by local banks in Minnesota and then purchased and securitized by the
agency.
Loan purchasing programs were conducted in New York City and Wyoming.
The New York City pension plan conducted two loan purchasing
programs. Under one, the pension plan committed to purchase loans
for 20 stores and offices in low- to moderate-income areas and had
purchased one loan as of November 1, 1994. The loans will be
underwritten by the Community Preservation Corporation and fully
guaranteed by the State of New York Mortgage Authority. Under the
second program, the plan purchased the guaranteed portions of SBA
loans made by local banks. Similarly, in Wyoming the pension plan
worked with the Wyoming Industrial Development Corporation to select
and purchase the guaranteed portions of SBA loans made by Wyoming
banks.
Private placement programs were conducted in Colorado and Wisconsin.
Unlike loan purchasing programs, under which the pension plans
purchased the federally guaranteed portions of loans made by local
banks, the private placement investments were loans made by the
pension plans themselves to in-state companies. For example, in
Wisconsin, a typical transaction is structured for repayment over a
10-to-15-year period, with
the plan charging a fixed interest rate usually 150 to 250 basis
points above Treasury securities of comparable maturity.\19 To avoid
excessive portfolio turnover, borrowers usually cannot prepay a loan
during the first 5 years of its term. The loans were usually with
established companies with strong performance records. The plan
competed, in terms of pricing the loan, with other large public
pension funds, life insurance companies, and commercial banks. No
intermediaries were used in implementing either the Colorado or
Wisconsin private placement programs.
CD purchasing programs were conducted in Minnesota and Wisconsin.
Under these programs, the funds purchased CDs from state banks,
thereby increasing the banks' capital that could be available for
small business lending. In each state, the pension plan set rates at
which it would purchase CDs from state banks and then worked with
large lending institutions to arrange the transactions.
The objective for both programs was to try to encourage business
lending activity and economic development in small towns by
increasing the capital available for lending in local banks. The
logic was that if small-town banks had more deposits, they would be
more likely to lend money to businesses in their communities.
However, neither of the plans we examined directly linked bank
participation in its CD program to business lending activity, nor did
they systematically monitor business lending by participating banks.
ETI venture capital programs were conducted in Colorado,
Massachusetts, Minnesota, Pennsylvania, and Wisconsin. Under these
programs, the pension plans invested as limited partners in venture
capital funds that were likely to invest a portion of their assets in
the pension plan's state. In Colorado, the plan invested in six
state venture capital funds, all of which in turn invested some
portion of their assets in Colorado. In Massachusetts, according to
a plan official, the state legislature mandated that the plan invest
in a state development corporation that targeted state technology
companies. The pension plan also invested in a separate venture
capital fund that targeted 20 percent of its assets toward
Massachusetts businesses. The Minnesota pension plan invested in two
Minnesota-based venture capital funds, one investing in state
high-tech businesses and the other targeting at least 50 percent of
its assets toward Minnesota businesses. The Pennsylvania pension
plan's venture capital portfolio consisted of 17 venture capital
funds that had a history of investing some of their funds in
Pennsylvania and that were likely to make further in-state
investments. Finally, the Wisconsin plan invested in three state
venture capital funds that, according to fund officials, were likely
to invest some portion of their assets in Wisconsin. For all the
pension plans, the actual venture capital investments were made by
the general partners running the venture capital funds, not pension
plan administrators. Table 1 shows the level of ETI investment, by
program type, for each of the seven pension plans.
Table 1
Amount Invested in ETIs by Seven Pension
Plans as of 1993, by Program Type
Pension Bond Loan Private CD Venture
plan purchase purchase placement purchase capital\b
------- ------------ ------------ --------------- ---------- --------------
Colorad $12.1 -- $94.9 -- $41.5
o
Massach -- -- -- -- 52.0
usetts
Minneso 14.0 -- -- $65.6 11.9
ta
New -- $14.5\c -- -- --
York
City
Pennsyl -- -- -- -- 89.6
vania
Wiscons -- -- 387.4 34.9 10.7
in
Wyoming -- 15.4 -- -- --
================================================================================
Total $26.1 $29.9 $482.3 $100.5 $205.7
--------------------------------------------------------------------------------
\a Dollars are in millions. Amount invested is the origination
value.
\b Amounts are funds actually invested, not funds committed.
\c Includes two separate loan purchasing programs.
--------------------
\18 While the state government has not explicitly guaranteed the
bonds, the bonds are backed by the authority's general funds and
assets.
\19 One hundred basis points equal 1 percentage point. For example,
an expected yield of 8 percent is 100 basis points lower than an
expected yield of 9 percent.
FINANCIAL RETURNS ON
INVESTMENTS
------------------------------------------------------------ Letter :5
To assess the financial returns on ETIs, we collected and analyzed
financial information for our seven case studies and reviewed our
earlier reports and academic articles concerning ETI investment
results. We also contacted public pension plans in Alaska,
Connecticut, and Kansas, for information on specific state
investments that resulted in investment losses. In this section, we
describe our case study methodology and its limitations, summarize
our case study results, and briefly describe the returns on ETIs
conducted by other public pension plans not reviewed in our case
studies.
CASE STUDY METHODOLOGY
---------------------------------------------------------- Letter :5.1
An analysis of the success of any investment requires a consideration
of its yield and risk characteristics. In a competitive,
well-functioning capital market, the expected yield of an investment
is directly related to its risk. Investments with a high risk are
generally expected to yield more than investments with a low risk
because investors demand higher compensation for the additional risk
they incur. (High-risk investments do not necessarily carry high
expected yields, but an investor choosing between two investments
with equal yields but different risk characteristics would want to be
compensated for selecting the higher-risk option.) For example,
Treasury bonds, being fully guaranteed by the U.S. government, have
less credit risk than corporate bonds and consequently provide lower
yields for comparable maturities. Figure 4 illustrates the relative
risk and yield of alternative bond investments, as reflected in bond
ratings by Standard and Poor's.
Figure 4: Relative Risk and
Yield Characteristics of Bond
Investments\a
(See figure in printed
edition.)
\a Ratings are Standard and Poor's.
For our seven case studies, we compared expected yields on ETIs held
by plans at the time of our study to expected returns on alternative
investments, or benchmarks, with similar risk, maturity, and, where
possible, sector characteristics. Specifically, we calculated the
difference, or spread, between ETI and benchmark yields on more than
200 individual ETIs made through 14 ETI programs. Except for venture
capital, data on the benchmarks were drawn from Salomon Brothers'
Analytical Record of Yields and Yield Spreads (July 1994), the Wall
Street Journal, and Data Resources, Inc.--all industry recognized
data bases. For the bond purchasing, loan purchasing, private
placement, and CD purchasing programs, we calculated the average
spread between the ETI expected yields and those benchmarks.\20 We
did not incorporate transaction costs (such as researching candidates
for investment, brokerage fees, and legal fees) in our analysis. The
venture capital benchmarks were drawn from the 1993 Venture Economics
report.\21
We used a different methodology to assess the returns on ETI venture
capital investments. Five of the seven pension plans examined in our
case studies implemented ETI venture capital programs. These five
plans invested in 16 ETI venture capital funds for which we could
obtain information concerning a fund's internal rate of return
(IRR).\22 For these 16 funds, we compared their actual IRRs to the
IRRs as of December 31, 1992, for all venture capital funds formed in
the same year as the ETI venture capital fund.\23 For example, we
compared the IRRs on ETI venture capital funds formed in 1985 to the
IRRs for all venture capital funds formed in 1985. We then
determined whether the ETI fund IRRs fell within the upper, middle,
or lower quartiles of IRRs for all venture capital funds formed in
the same year.\24 This "vintage year" approach was developed by
Venture Economics and is considered by some in the industry as the
best benchmark for analyzing interim venture capital returns.
We took several steps to ensure that the benchmarks we used to
analyze the ETI programs were appropriate. First, we confirmed our
benchmark selection for some of the programs through reviews of prior
studies and discussions with industry officials. For example, for
our analysis of bond purchases, we used corporate bond benchmarks
employed in our 1992 report on ETI bond purchases to promote
affordable housing development.\25 For our analysis of SBA loan
purchases, we used Treasury securities of similar maturity, as
suggested by pension, industry, and SBA officials. To analyze
venture capital investments, we used industry benchmarks identified
through consultation with industry experts. Finally, industry
experts on our advisory panel reviewed all our benchmarks. Table 2
shows the benchmarks we used to analyze the expected yields of each
ETI program.
Table 2
Benchmarks Used to Analyze the Financial
Returns of ETI Programs
ETI program Benchmark
---------------------- ----------------------------------------------
Bond purchases Similarly rated bonds with like maturity and
sector characteristics
Fixed-rate SBA loan Treasury securities of like maturity
purchases
Variable-rate SBA loan 3-month Treasury bills
purchases
Private placements Similarly rated bonds with like maturity and
sector characteristics
CD programs 3-and 6-month secondary market CD rates or 3-
year Treasury securities
Venture capital Vintage year analysis by Venture Economics
----------------------------------------------------------------------
Source: DRI/McGraw-Hill; Salomon Brothers, Inc., Analytical Record
of Yields and Yield Spreads (New York: July 1994); Venture
Economics, 1993 Investment Benchmarks Report: Venture Capital
(Boston, Mass.: 1994); The Wall Street Journal.
Our methodology has three key limitations. First, our benchmarks
were not adjusted to account for all the risk characteristics unique
to each ETI, such as prepayment risk, credit risk, and liquidity
risk. Typically, such adjustments are made by pension plan
investment officials prior to making individual ETI investments. We
did not have the information needed to appropriately adjust our broad
benchmarks to account for the unique risk characteristics of each
ETI.
Second, the benchmarks often did not perfectly match the maturity
characteristics of the individual ETIs. We tried to use benchmarks
with maturities equalling either the maturities or average lives of
the ETIs we examined.\26 However, the Treasury security and corporate
bond benchmarks did not always match the dates of purchase or the
maturities or average lives of the ETI bond purchases, loan
purchases, and private placements in our case studies.
Third, our data, except in the case of venture capital, reflected
expected yields on ETIs rather than actual returns. The ETIs we
examined in our case studies were held by the public pension plans at
the time of our study. Therefore, data on final returns were not
available. In addition, we did not have data on expected and actual
credit losses incurred through ETIs.
These first two limitations may, to some extent, counterbalance each
other. On the one hand, investors would expect to be compensated, in
terms of higher yield, for additional prepayment, credit, or
liquidity risk in an ETI bond purchase, loan purchase, or private
placement. In other words, investors would expect that an ETI SBA
loan purchase, given its prepayment risk, would earn higher yields
than a Treasury security of similar maturity; and they would expect
that an ETI bond purchase or private placement, given their liquidity
risk, would earn higher yields than a similarly rated, long-term
corporate bond. However, we did not adjust our benchmarks upward to
account for these higher expectations of risk and return.
On the other hand, we did not adjust our benchmarks downward when
their maturities were longer than the maturities or average lives of
the ETIs. Assuming that short-term interest rates were lower than
long-term rates at the time an ETI investment was made, our benchmark
yields would be too high when benchmark maturities were longer than
ETI maturities. Benchmark maturities slightly exceeded those of
fixed-rate loan purchases in 58 of 86 cases and they exceeded the
average lives of the private placements in 18 of 34 cases we
analyzed.
Despite these limitations, because of the reasons cited above, we are
confident that comparison of ETI expected yields to broad industry
benchmarks provides a sound basis for determining whether, on the
average, ETI investments are characterized by reasonable expected
yields.\27
--------------------
\20 Except for venture capital, the average spread for each ETI
program was calculated by subtracting the benchmark yield from the
expected yield for each individual ETI in that program, summing the
differences, and then dividing this total by the number of ETIs in
that program.
\21 Venture Economics, 1993 Investment Benchmarks Report: Venture
Capital (Boston, Mass.: 1993).
\22 The IRR is calculated by considering the money paid into the fund
by the limited partners (for example, the pension plan), the money
returned to the limited partners by the venture capital fund, and the
estimated value of the remaining investments held by the fund.
Because the value of the remaining investments is an estimate, the
IRR is merely an approximation of the venture capital fund's
performance. Moreover, all venture capital funds may not calculate
this value the same way.
\23 Not all plans could provide IRR information as of December 31,
1992. The venture capital fund IRRs reported to us were as of June
30, 1992, for one plan; December 31, 1992, for three plans; and June
30, 1993, for the fifth plan.
\24 A quartile is the segment of a sample representing a sequential
quarter (25 percent) of a group. For example, out of 40 funds, the
10 with the highest IRRs would constitute the first quartile.
\25 U.S. General Accounting Office, Pension Plans: Investments in
Affordable Housing Possible With Government Assistance, GAO/HRD-92-55
(Washington, D.C.: June 1992).
\26 Some of the investments we examined were prepaid or were
amortized such that the lives of the investments were shorter than
their terms. The average life of an investment time-weights the
principal payment stream to reflect the early retirement of debt
throughout the life of that investment.
\27 Pension portfolio managers are presumably concerned with the
expected return, relative to risk, of the entire portfolio. Because
ETI returns may be correlated with the returns of other investments
in the portfolio, the risk associated with a given ETI, evaluated in
isolation, is not always a reliable indicator of how the ETI affects
the riskiness of the portfolio. The same can be said of the
alternative investments we analyzed. However, an analysis of how ETI
returns covaried with returns on other investments in the portfolio
would have required a more ambitious data-gathering effort than was
feasible for this study. In addition, because, in the aggregate, the
investments we analyzed are small relative to the size of the pension
plan portfolios, the covariance of ETI returns with other investment
returns is not likely to be an empirically important consideration.
Therefore, we did not undertake such an analysis.
CASE STUDY RESULTS
---------------------------------------------------------- Letter :5.2
We found that the expected performance of ETIs, other than venture
capital, for the seven public pension plans we studied was generally
similar to the returns on benchmark investments. For example, on the
average, expected yields on the ETI bond purchases were somewhat
higher than those on comparably rated bonds with like maturity and
sector characteristics. Similarly, expected yields on federally
guaranteed fixed-rate loans generally approximated those on Treasury
securities of comparable maturity. Expected yields on all federally
guaranteed variable-rate loans well exceeded those on 3-month
Treasury securities, but this might reflect the relatively
conservative benchmark we used for these investments. For the most
part, private placements had expected yields somewhat above those of
similarly rated bonds of like sector and maturity. CD purchases had
expected yields equal to or slightly higher than appropriate
benchmarks, either Federal Reserve Bank of New York secondary CD
rates or 3-year Treasury note rates, depending on the term of the CD.
While the investments above, on the average, had reasonable expected
yields in comparison to broad industry benchmarks, interim financial
returns on the venture capital investments we examined were less
encouraging. Interim returns on 10 of the 16 funds we examined
lagged industry median returns, although the returns of the older
funds more closely mirrored those of the overall market. Of the 10
oldest funds we examined, 5 had returns above the median, and 5 had
returns below the median. As discussed later, the interim returns of
the older funds are a more reliable indicator of future performance
than the interim returns of younger funds. Table 3 summarizes the
average spread to the benchmarks for each of the ETI programs we
examined. A more detailed discussion of the expected yields for each
ETI program is provided in appendix II.\28
Table 3
Summary of ETI Expected Yields Relative
to Benchmarks
Average spread
Number of to benchmark
investment (in basis
ETI program s points)
----------------------------------------- ---------- ---------------
Bond purchases 3 93
Loan purchases
Fixed rate 86 27\a
Variable rate 62 355
Private placements 34 52
CD programs
3-and 6-month 3 -1
3-year 12 53
Venture capital 16 \b
======================================================================
Total 216
----------------------------------------------------------------------
\a This is the average spread to benchmark for all 86 fixed-rate
loans we examined, including 85 federally guaranteed loans and 1 loan
guaranteed by the State of New York Mortgage Authority. The 85
federally guaranteed loans had an average spread of 28 basis points
over Treasuries of like maturity.
\b Ten of the 16 ETI venture capital funds had interim internal rates
of return that lagged industry median returns.
Our case study results suggest cautious optimism concerning the
ability of public pension plans to earn reasonable financial returns
through their ETI programs. They demonstrate that some pension plans
have made investments characterized by reasonable expected yields
through their ETI programs to promote business development.
These results complement those of the IFE survey in which 53 percent
of respondents said that they were either satisfied or very satisfied
with the financial returns of their ETIs, 38 percent were neutral,
and 12 percent were slightly or very dissatisfied with their ETI
financial performance.\29 Regarding the ability of ETIs to realize
benchmark returns, 62 percent of respondents said that the ETI
returns either met or exceeded benchmarks, and 14 percent said they
failed to meet their benchmarks. Other respondents, noting that the
ETIs were long-term investments, said that it was too early to assess
ETI financial results. (Of course, these views were provided by
pension officials who might have an interest in reporting positive
results.)
While encouraging, the case study and IFE survey results do not
suggest that all pension plans can easily construct ETI programs that
will realize returns similar to those of alternative investments with
similar risk characteristics. The pension plans included in our case
studies were chosen, in part, because they had a long history of
making these investments. Some of the programs were cited as
successful in previous studies by the Center for Policy Alternatives
and the State of New York.\30 The plans implementing these programs
often employed an in-house professional staff that made or monitored
these investments. Indeed, in recognition of their experience and
expertise, some officials of these plans had spoken at ETI
conferences or testified before the ETI Work Group of the Department
of Labor's Advisory Council on Employee Welfare and Pension Benefit
Plans or before the Commission to Promote Investment in America's
Infrastructure. Not all plans seeking to implement an ETI program
will have, or will be able to easily acquire, this level of
expertise. For example, according to the IFE survey, the most
commonly cited problem confronted by plans seeking to develop an ETI
program was the procurement of a competent asset manager. About 38
percent of survey respondents noted that the procurement of a
competent asset manager to implement the program was of some or great
difficulty. Therefore, while the plans in our case studies realized
reasonable expected yields from their ETIs, other pension plans may
not easily replicate these financial results.
--------------------
\28 We analyzed only financial returns from the point of view of the
plans. This analysis did not address whether the particular
investments were otherwise desirable from a public policy point of
view.
\29 This includes financial returns on both affordable housing and
business development ETIs.
\30 Center for Policy Alternatives, Economically Targeted Investments
by State-Wide Public Pension Funds (Washington, D.C.: September
1993); New York State Industrial Cooperation Council, Our Money's
Worth: The Report of the Governor's Task Force on Pension Fund
Investment (New York: June 1989).
RETURNS ON OTHER ETIS
---------------------------------------------------------- Letter :5.3
Studies of ETI affordable housing programs and commonly cited
examples of business development programs implemented by other public
pension plans demonstrate that success is not automatic when
implementing an ETI program. For example, two studies on the
financial returns of affordable housing ETIs had differing results,
one positive and one negative. In a prior case study analysis of
public pension fund affordable housing ETIs, we found that all five
of the pension plan investments for which financial return
information was available received rates of return similar to other
investments of comparable risk.\31
In contrast, a nationwide survey of state-administered pension funds
found that many ETI programs to promote affordable housing
development did not realize competitive returns.\32 This study
concluded that, while public pension investments in
government-insured mortgage-backed securities yielded competitive
returns, plans sacrificed returns in an attempt to foster home
ownership when using almost any other targeted mortgage investment
instrument. It should be noted that the study is dated and,
according to one expert on ETIs, does not account for the full
maturing of the mortgage-backed securities market nor for the
recently expanded union pension fund investment in affordable housing
projects.
Similarly, public pension plans may be vulnerable to significant
financial losses through their state investments, as illustrated by
three commonly cited examples in Kansas, Connecticut, and Alaska. In
Kansas, a series of private placement investments made by the Kansas
Public Employees Retirement System had resulted, by 1991, in losses
of about $122 million. The ultimate losses, according to a plan
official, will probably total as much as $200 million, including a
fiscal year 1991 loss of about $65 million invested in a savings and
loan. The Kansas state legislature investigated the losses and
concluded that one of the plan's investment managers violated the
prudence rule in making some of these investments. The legislative
investigation also noted a significant oversight failure on the
plan's part. Subsequently, according to a plan official, the plan
increased its professional staff to improve oversight of plan
investments.
In Connecticut, the State of Connecticut Retirement and Trust Funds
invested $25 million in 1990 to acquire 64.3 percent of Colt's
Manufacturing Company stock, as well as 49.5 percent of the rights to
the Colt name and trademark. The funds had obtained an opinion from
a national investment banking firm that it considered to be well
regarded. This firm stated that the investment was "fair, from a
financial point of view" to the funds. Only after the investment was
made, according to a state official, did it become apparent that Colt
was unable to manufacture firearms on competitive terms because of
problems with management, antiquated manufacturing equipment, and
labor-management relations. In March 1992, Colt declared bankruptcy.
The same official stated that the funds ultimately lost $20.7 million
of their investment.
According to a nationwide study of ETIs, the Alaska Retirement
Systems invested over $250 million during the 1980's in unguaranteed
home mortgages, over one third of which were for property in
Alaska.\33 When oil prices dropped dramatically, according to this
study, the Alaska real estate market crashed. As a result, over a
third of the state loans became delinquent, and the plan lost
millions of dollars. Alaska officials told us that they did not
believe the mortgage investments were ETIs, and they declined to
provide information on the results of these investments.
--------------------
\31 U.S. General Accounting Office, Pension Plans.
\32 Alicia H. Munnell, Lynn E. Blais, and Kristine M. Keefe, "The
Pitfalls of Social Investing: The Case of Public Pensions and
Housing," New England Economic Review, September-October 1983, pp.
20-41.
\33 Center for Policy Alternatives, Economically Targeted
Investments.
SUMMARY
---------------------------------------------------------- Letter :5.4
The expected yields that characterize investments that public pension
plans have made through their business development ETI programs have
been reasonable but should be viewed with caution. The yields on
most fixed-income ETIs we examined in our case studies were generally
similar to those of comparable alternative investments. However,
these programs were implemented by pension plans with extensive
experience with ETIs, and often with in-house staff, so these results
cannot be generalized to the universe of pension plans. Further, the
actual returns on about 62 percent of the venture capital ETIs we
examined lagged industry benchmarks. Also, the successes of these
programs should be balanced against the failures of programs not
included in our case studies. For example, while five housing ETI
programs we examined in 1992 generally received rates of return
similar to other investments of comparable risk, another nationwide
study identified many ETI housing programs that did not yield
competitive returns. Also, while the private placement programs that
we examined evidently achieved competitive returns, the Kansas
experience reminds us that success is not automatic. Finally, as
noted above, there were a number of technical limitations to our
analysis (for example, transaction costs were not included in our
study).
ETIS' ECONOMIC EFFECTS
------------------------------------------------------------ Letter :6
To assess the economic effects of business development ETIs, we
reviewed nationwide studies as well as information provided by the
seven pension plans examined in our case studies. From the pension
plans, we obtained and analyzed available information concerning job
creation, revenue generation, and other potential economic effects of
their ETI programs. We did not attempt to independently assess the
economic effects of these investments, nor did we independently
verify the accuracy of the information provided to us.
An investment can have both direct and indirect economic effects.
Direct effects occur at the business receiving the investment. For
example, for a business receiving investment money, the direct
economic effects could include the number of jobs created or
retained, the payroll created, or the tax or sales revenue generated
as a result of the investment. Indirect, or multiplier, effects are
linked to the direct effects but take place not at the business
receiving the investment but, rather, at related businesses. For
example, if a business is able to expand its manufacturing facility
as a result of a small business loan, a direct effect of the
expansion might include new manufacturing jobs. These new jobs, in
turn, would increase local demand for, and jobs in, restaurants,
health service facilities, retail shops, newspapers, and other
businesses.
Direct and indirect effects in a targeted area can be measured on a
gross or net basis. The gross effects on the economy of an ETI, in
terms of job creation, are the total number of jobs created, both
directly and indirectly. The net effects on the economy are the
gross effects less any jobs lost as a result of the ETI. For
example, jobs could be lost through the ETI that expanded a
manufacturing facility because of either equipment modernization or
job displacement from one area to another. Concerning the latter, an
ETI could have little net effect if the company receiving the ETI
merely displaced another company that, without the ETI, would have
employed the same people, developed the same product, and created the
same level of economic activity. Similarly, an ETI could have little
net effect if it merely displaced capital that would have been
invested anyway by another investor. Litvak noted that "Displacement
will occur when a pension fund targets projects so well served by
capital markets that the fund only competes with private investors
rather than supplying additional capital."\34 For example, a public
pension fund's investment in SBA-guaranteed loans could merely
displace capital that would have been invested by another investor in
SBA-guaranteed loans.
--------------------
\34 Lawrence Litvak, Pension Funds and Economic Renewal, Studies in
Development Policy (Washington, D.C.: Council of State Planning
Agencies, 1981), vol. 12, p. 13.
ECONOMIC EFFECTS OF ETI
PROGRAMS NATIONWIDE
---------------------------------------------------------- Letter :6.1
In our literature search, we found only two national surveys that
addressed the economic effects of public pension plans' ETI programs.
The first, conducted by IFE, reported how pension plans measure the
economic effects of their ETIs (that is, in terms of jobs created or
retained or housing units rehabilitated or constructed).\35 But
specific economic effects, such as the actual number of jobs created,
were not reported.
The second survey, conducted by the Center for Policy Alternatives,
also provided limited information regarding the economic effects of
ETI programs.\36 The survey report described ETI programs conducted
by pension plans nationwide but provided economic effect estimates
for plans in only 6 states. In these states, according to the survey
report, the direct effects of ETI programs included 18,304 jobs
created, 9,953 jobs retained, and 28,396 housing units (including
low-income units) financed. However, according to an author of the
survey report, these estimates did not include indirect effects.
Further, the author did not know if these effects were net effects
over and above what would have occurred if the ETI programs had not
been implemented.
A study of ETIs throughout the country conducted for the governor of
New York cited the need for further information on the economic
effects of ETI programs.\37 The study concluded that despite the
growing interest in ETIs, too little formal evaluation of the
effectiveness of these programs had been conducted. Most ETI
programs did not include an evaluation plan. Such evaluations could
determine whether the economic development objectives of ETI programs
were being achieved, and they could identify how to improve ETI
programs. The study recommended that ETI programs include an
evaluation component examining both the financial performance and
economic effect of these investments.
A Department of Labor study noted that quantifying and documenting
collateral benefits and tracking them back to the plans was a
difficult process that could be beyond the capabilities of small
plans.\38
In August 1993, several experts testified before the ETI Work Group
of DOL's Advisory Council on Employee Welfare and Pension Benefit
Plans about the need for an independent clearinghouse to provide
information on ETI financial performance, benchmarks, and collateral
benefits. According to a DOL official, in April 1994 DOL let a
request for proposals for an information clearinghouse to be funded
through a cost-sharing arrangement involving DOL, the Department of
Housing and Urban Development, and private sources. The contract was
awarded to Hamilton Securities Advisory Services, Inc., in September
1994.
--------------------
\35 Institute for Fiduciary Education, Economically Targeted
Investments.
\36 Center for Policy Alternatives, Economically Targeted
Investments.
\37 New York State Industrial Cooperation Council, Competitive Plus:
Economically Targeted Investments by Pension Funds (New York:
February 1990).
\38 Advisory Council on Pension Welfare and Benefit Plans, U.S.
Department of Labor, "Economically Targeted Investments: An ERISA
Policy Review," Report of the Work Group on Pension Investments
(Washington, D.C.: November 1992).
ECONOMIC EFFECTS OF SEVEN
PLANS' ETI PROGRAMS
---------------------------------------------------------- Letter :6.2
We also examined data on the economic effects of ETIs in the seven
pension plans we reviewed. For each of the 14 ETI programs conducted
by the plans, we examined available data on four types of economic
effects: job creation and retention, payroll, sales revenue, and tax
revenue. Job creation and retention estimates were available for 7
of the 14 business development ETI programs invested in by the
pension plans. Information on other economic effects was more
limited. Estimates of payroll were available for 2 of the 14
programs, and of sales revenue and tax revenue for one program each.
Table 4 shows the estimated direct economic effects of the seven
pension plans' business development ETI programs. In no case could
the pension plans provide us with estimates of indirect effects.
Further, they did not attempt to assess whether the direct effects
above were net of what would have occurred without the pension plan
investments. That is, they did not assess whether their investments
displaced capital that would have been invested by other investors.
Table 4
Reported Estimated Effects of ETI
Programs\a
Jobs created Sales Tax
State ETI program or retained Payroll revenue revenue
------------- ------------- -------------- -------- ------------ ----------
Colorado
Bond 1,241 \b \b \b
purchases
Venture 4,603 \b \b \b
capital
Private 200 \b \b \b
placement
Massachusetts
Venture 4,800 $199 \b $68
capital
Minnesota
Venture 2,115 \b $656.6 \b
capital
Bond \b \b \b \b
purchases
CD purchases \b \b \b \b
New York City
CPC loan \b \b \b \b
purchase
SBA loan 550 \b \b \b
purchases
Pennsylvania
Venture 6,850 $145 \b \b
capital
Wisconsin
Venture \b \b \b \b
capital
Private \b \b \b \b
placement
CD purchases \b \b \b \b
Wyoming
Loan \b \b \b \b
purchases
--------------------------------------------------------------------------------
\a Dollars in millions.
\b Not available.
The table highlights the paucity of information available on economic
effects for most of the plans. Moreover, the estimates of economic
effects for venture capital programs, which accounted for 8 of the 11
estimates contained in the table, were of limited value because they
did not isolate that portion of the effect that resulted from the
pension plan's investment. That is, the estimates did not break out
the effects among all partners that had invested in the venture
capital fund.
All the estimates of economic effects were compiled by intermediaries
involved in the programs. Pension plan personnel did not
independently assess the economic effects of their investments.
Several pension plan officials told us that they saw no need to have
precise information on economic effects because their primary concern
is the financial return on their investments. One pension plan
official added that he did not want economic effect information
because it might inappropriately influence his investment decisions.
That is, the knowledge that one investment would have a lower return
than another but might create more new jobs could result in an
imprudent decision, such as a concessionary investment based on
potential economic effects rather than on financial merit. Moreover,
such information could lead to political pressures to make such
concessionary investments.
In sum, then, we found that the economic effects of ETI programs are,
to a great extent, unknown. The national surveys and studies we
reviewed provided little information regarding the economic effects
of ETIs conducted by public pension plans. Similarly, pension plans
in our case studies had little information on the economic effects of
their ETIs, and the information they did have was of limited value.
Pension plans are not required to gather information on their ETIs'
economic effects. Further, the collection and analysis of these data
could prove difficult and be burdensome to many pension plans.
Mechanisms to collect such data as unobtrusively as possible could be
developed. Such efforts could use third parties, such as financial
analysts, and sampling techniques that minimize the overall burden.
In any case, unless or until such information, derived from
methodologically sound data collection and analyses, can be made
available, pension plan officials and public policy makers will not
know whether ETIs are effective in encouraging local economic
development.
CONCLUSIONS
------------------------------------------------------------ Letter :7
Although no national data base on ETI activity exists, we found from
surveys that many large public employee pension plans across the
nation conduct ETI programs. Currently, however, the overall
percentage of plan assets devoted to such investments is limited.
Thus, overall, the risk posed to public pension plans by ETI
investments is relatively small, although some plans may be exposed
to more risk than others.
We found that certain ETI programs achieved financial returns similar
to benchmark investments. The bond, loan purchasing, private
placement, and CD programs we examined generally were characterized
by expected rates of return that were similar to other investments of
comparable risk. However, these results cannot be generalized to
other pension plans, as demonstrated by the Kansas experience with
state investments. In addition, we found that ETI venture capital
returns sometimes lagged benchmarks. Further, prior studies of ETI
housing programs have identified some housing ETI programs that have
realized competitive returns and other housing ETI programs that have
not.
We were unable to determine the economic effects of pension plan ETI
programs because of a lack of reliable data and methodological
limitations. Pension plan officials usually do not track the
economic effects of their ETIs. Therefore, they may not know whether
their ETIs are an effective means of encouraging economic
development.
Our analysis of ETI programs suggests that pension fund participation
in any ETI program should be voluntary, not mandatory. Although some
pension plans have realized satisfactory returns on their ETIs,
others have not, and some have suffered substantial losses.
Requiring plans to invest in ETIs could lead to more plans
experiencing such undesirable financial results. In some cases, plan
officials could be forced to make bad investments in order to meet a
mandated level of ETI activity. Moreover, pension plans differ in
terms of their level of financial assets, portfolio composition,
numbers of professional staff, and administrative budgets; an ETI
program appropriate for one plan may not be appropriate for another.
Thus, any large-scale program encouraging ETIs would need to be
accompanied by a strong evaluation component to ensure against
undesirable effects on plans.
The tendency of plan administrators to monitor the financial returns
of their ETIs more closely than the economic effects of their
investments establishes an area of tension to be addressed in any
effort to encourage ETIs for economic development purposes at the
national level. That is, from the point of view of plan
administrators,
"Regardless of the merits of the project to the community at
large, the fiduciaries' sole concern is to decide whether the
project would benefit the members of the plan. If it benefits
the members, the fiduciaries may go forward with it. If it does
not, but the fiduciaries proceed in any event, they and the
plan's members face an array of negative consequences."\39
However, unless the social returns on investment, in the form of
economic development, are also taken into account, the goals of an
ETI program may not be met. Rather than fill capital gaps, ETIs
could merely displace otherwise available capital. Thus, according
to one analyst,
"The key to success [in ETIs] is concentrating on sectors and
enterprises that have been underfinanced due to gaps and
inefficiencies in our financial system . . . . Effective yet
financially sound development investing first requires
identifying situations where the unavailability of capital on
competitive terms is impeding development that would otherwise
take place."\40
These conflicting views demonstrate the difficulty that could
confront any effort to enlist public or private employee pension
plans in improving economic development through ETIs. Investments
would have to be justified not only in terms of their financial
returns to the plans but also in terms of their net contribution to
economic development, which plan administrators generally prefer not
to analyze. Moreover, while quantification of these development
benefits is desirable, it is not legally required and is difficult to
achieve.
--------------------
\39 Statement by Cynthia L. Moore, National Council on Teacher
Retirement, before a hearing of the National Conference on State
Legislatures, May 6, 1993. The possible negative consequences
include IRS disqualification of the plan, resulting in the loss of
tax preferential treatment that is afforded to plans satisfying the
requirements under section 401(a) of the Internal Revenue Code. In
addition, according to Moore, the fiduciaries may be sued for breach
of their fiduciary duties.
\40 Lawrence Litvak, Pension Funds and Economic Renewal, Studies in
Development Policy (Washington, D.C.: Council of State Planning
Agencies, 1981), vol. 12, p. 4.
MATTER FOR CONGRESSIONAL
CONSIDERATION
------------------------------------------------------------ Letter :8
If the Congress decides to initiate a program to promote public or
private pension plan investment in ETIs, it should ensure that
participation in the program is voluntary, not mandatory, and that
such efforts are properly evaluated in terms of both their financial
and economic outcomes.
AGENCY COMMENTS AND OUR
RESPONSE
------------------------------------------------------------ Letter :9
DOL provided written comments on a draft of this report. (See
appendix IV.) Most of these comments were technical or editorial in
nature, and we have made changes where we deemed them appropriate.
DOL agreed that any ETI program that the Congress may adopt should be
voluntary.
However, DOL disagreed with our conclusion that other states might
not easily replicate the financial results we found in our seven case
study states. DOL argued that it is possible that other states could
model their ETI programs on those of the states we studied, making
replication easier. Of course, it is possible that other states
could learn from those now conducting ETIs. Our point, however, was
that we selected the seven cases precisely because they were reputed
to be good examples of how ETIs might work. Because they do not
necessarily represent all state and local pension plans, we cannot
generalize our results to other plans, and therefore we caution
against the assumption that similar results could be obtained by
other plans.
We also obtained informal comments from staff of IRS and SBA. These
were technical in nature and are reflected in the text, as
appropriate.
As we agreed with your office, we plan no further distribution of
this report until 30 days from its date of issue, unless you publicly
announce its contents earlier. We will then make copies available to
others who are interested upon request.
If you have any questions or would like additional information,
please call me at (202) 512-5885. Other major contributors are
listed in appendix V.
Sincerely yours,
Robert L. York
Director of Program Evaluation in
Human Services Areas
STATE BUSINESS DEVELOPMENT ETI
PROGRAMS
=========================================================== Appendix I
Venture Small Private
State capital business\a placement CD purchasing
------------ ------------ ------------ ------------ --------------
Alabama x
Alaska
Arizona x
Arkansas x x
California x
Colorado x x x
Connecticut x
Delaware
Florida
Georgia
Hawaii
Idaho x
Illinois
Indiana
Iowa x
Kansas
Kentucky
Louisiana
Maine x
Maryland
Massachusett x
s
Michigan x x
Minnesota x x x
Mississippi
Missouri x
Montana
Nebraska
Nevada
New x
Hampshire
New Jersey
New Mexico x
New York x x
North
Carolina
North Dakota
Ohio x
Oklahoma
Oregon x
Pennsylvania x x
Rhode Island x
South
Carolina
South Dakota
Tennessee
Texas x
Utah
Vermont x
Virginia
Washington
West
Virginia
Wisconsin x x x
Wyoming x
----------------------------------------------------------------------
\a Includes bond purchase and loan purchase programs.
Source: Center for Policy Alternatives, Economically Targeted
Investments by State-wide Public Pension Funds (Washington, D.C.:
September 1993); Institute for Fiduciary Education 1992 survey.
FINANCIAL RETURNS OF ETI PROGRAMS
EXAMINED IN OUR CASE STUDIES
========================================================== Appendix II
This appendix presents the results of the ETI bond purchasing, loan
purchasing, private placement, CD purchasing, and venture capital
programs examined in our seven case studies.
RETURNS ON ETI BOND PURCHASES
Expected yields on the ETI bond purchases we examined were, on the
average, 93 basis points above similarly rated bonds with like
maturity and sector characteristics. For one of Colorado's two ETI
bond purchases, the expected yield was 77 basis points above that of
similarly rated, medium-term (10-year) financial bonds. The expected
yield on the other Colorado bond purchase exceeded this benchmark by
182 basis points. We used 10-year financial bonds as the benchmark
because, although the Colorado Housing and Finance Authority bonds
had terms of from 20 to 25 years, the bonds were expected to be paid
off within 10 years, according to a plan official. Indeed, all six
authority bonds previously purchased by the plan had been paid off in
less than 10 years.
In Minnesota, the expected yield on the pension plan's one ETI bond
purchase was 20 basis points above that of 10-year Treasury
securities. We used 10-year Treasuries as the benchmark because the
Minnesota Small Business Finance Agency bond consisted solely of the
guaranteed portions of SBA loans, and the 10-year Treasury had the
closest maturity to the 12-year expected life of this bond. Given
that all three of the ETI bonds we examined were backed by federally
guaranteed loans or state authority assets, the ETI bond returns seem
reasonable. Table II.1 provides the specific expected yields for
each bond purchase, as well as those for alternative investments on
the date of purchase.
Table II.1
Financial Returns of Colorado and
Minnesota ETI Bond Purchases, Compared
to Returns on Alternative Investments
(at Date of Purchase)
Term Spread to
Investmen Investmen (years Ratin Yiel benchmark (basis
State t date t amount ) g Yield Term d points)
----- --------- --------- ------ ----- ------ ---- ---- ----------------
Color 02/01/93 $ 25.6 A 7.87% \b 7.10 77
ado\a 4,857,000 %
03/31/93 7,239,000 20.3 A 8.62 \b 6.80 182
Minne 12/12/84 14,000,00 20.0 AA 11.70\ \e 11.5 20
sota 0 d 0
\c
--------------------------------------------------------------------------------
\a Data from September 30, 1993.
\b Benchmark was yield on A-rated medium-term (10-year) financial
bonds, as the Colorado Housing and Finance Authority bond was
A-rated, and it had an expected life of about 10 years.
\c Data from July 31, 1993.
\d The yield calculation does not include a commitment fee received
by the Minnesota State Board of Investment that was equal to 0.5
percent of the aggregate principal amount of the bonds.
\e Benchmark was the 10-year Treasury bond as the Minnesota Small
Business Finance Agency bond consisted solely of the guaranteed
portions of SBA loans, and the bond had an expected maturity of 12
years.
Source: Pension system information was obtained from the Colorado
Public Employees' Retirement Association and the Minnesota State
Board of Investment. The benchmark data were obtained from Salomon
Brothers, Analytical Record of Yields and Yield Spreads (New York:
July 1994). Although the information contained in the Salomon
Brothers report was obtained from sources that Salomon Brothers
believed to be reliable, Salomon Brothers does not guarantee the
accuracy of the information. The information may be incomplete or
condensed. All opinions and estimates included in the Salomon
Brothers report constituted its judgment as of July 1994 and are
subject to change without notice.
RETURNS ON ETI SBA LOAN PURCHASES
The expected yields on the loan purchasing programs approximated
those of alternative investments. All but one of the 86 fixed-rate
loan purchases that we examined were purchases of the federally
guaranteed portions of SBA loans. On the average, the expected
yields on these 85 guaranteed loan portions were 28 basis points
above Treasury securities of similar maturity. The expected yields
on 77 of the 85 guaranteed loans approximated or exceeded the
Treasury benchmarks, with 14 of these loans exceeding the benchmark
by more than 100 basis points. Expected yields on the remaining 8
guaranteed loans lagged those of Treasuries of similar maturity by
more than 100 basis points. These 8 loans were purchased by the
Wyoming pension plan in the early to mid-1980's. A Wyoming pension
investment officer could not explain why these investments lagged the
benchmark.
The average spread seems reasonable given that the guaranteed
portions of the SBA loans and Treasury securities have similar risk
characteristics. Concerning liquidity risk, according to SBA
documents, there is an active secondary market for the portions of
small business loans guaranteed by SBA. Concerning the credit risk
of SBA loans, if the SBA loans become 60 days delinquent, SBA
guarantees to purchase from the registered holder the guaranteed
portion of the loan as well as accrued interest due. SBA's guarantee
is unconditional and is backed by the full faith and credit of the
United States.
The remaining loan purchase that we examined, which was purchased by
the New York City pension plan under its Community Preservation
Corporation program, was unrated but was backed by a state guarantee.
The expected yield on this investment exceeded by 7 basis points that
for long-term, AA-rated new financial bonds.
Figure II.1 shows, for the 86 fixed-rate loan purchases, how the
expected yields compared to those of alternative investments of
similar maturity. Table II.2 provides the specific expected yields
for each New York City and Wyoming pension plan fixed-rate loan
purchase as well as those for alternative investments on the date of
purchase.
Figure II.1: Spreads to
Benchmark on Fixed-Rate Loan
Purchases
(See figure in printed
edition.)
Table II.2
Financial Returns of New York City and
Wyoming ETI Fixed-Rate Loan Purchases,
Compared to Returns on Alternative
Investments (at Date of Purchase)
Term Spread to
City or Investmen Investmen (years benchmark (basis
state t date t amount ) Yield Term\a Yield points)
-------- --------- --------- ------ ------ ------ ------ ----------------
New York 08/12/92 $1,300,00 18.0 8.22%\ \d 8.15% 7
City\b 0 c
10/14/92 120,886 6.8 9.25 7 5.90\c 335
12/02/92 135,000 20.0 7.65 20 7.26 39
Wyoming\ 10/24/78 112,500 15.9 9.50 15 8.54 96
e
04/07/82 188,988 14.9 9.25 15 13.83 -458
03/09/83 421,200 14.3 10.25 15 10.52 -27
04/28/83 60,000 16.4 11.00 15 10.77 23
06/22/83 379,274 14.9 9.50 15 11.04 -154
08/25/83 60,000 19.9 7.75 20 11.98 -423
11/21/83 495,000 19.8 8.25 20 11.92 -367
08/09/84 486,690 18.2 9.00 20 12.89 -389
12/05/84 163,595 20.0 8.50 20 11.68 -318
02/25/85 502,818 19.0 7.88 20 11.30 -342
07/31/85 107,000 20.0 11.00 20 10.55 45
01/31/86 105,186 13.5 8.75 15 9.24 -49
02/07/86 $275,106 9.6 8.00% 10 9.04% -104
01/30/87 80,000 20.0 7.75 20 7.86 -11
01/30/87 81,000 20.0 7.75 20 7.86 -11
01/30/87 148,750 20.0 7.75 20 7.86 -11
02/19/87 216,750 14.6 8.00 15 7.68 32
02/19/87 296,639 17.6 7.88 15 7.68 20
04/30/87 47,293 19.8 8.25 20 8.02 23
04/30/87 72,000 19.8 8.25 20 8.02 23
04/30/87 216,911 19.8 8.25 20 8.02 23
09/15/87 111,531 15.1 9.75 15 9.17 58
09/15/87 226,800 15.1 9.75 15 9.17 58
10/30/87 172,217 23.6 10.50 20 9.86 64
11/09/88 260,800 24.7 10.13 20 8.77 136
01/30/90 366,489 14.8 8.38 15 8.00 38
04/24/90 161,140 9.8 8.38 10 8.64 -26
04/24/90 212,500 14.8 8.38 15 8.70 -32
04/24/90 240,093 14.7 8.38 15 8.70 -32
06/29/90 34,740 14.8 8.38 15 8.65 -27
06/29/90 47,563 14.0 8.38 15 8.65 -27
06/29/90 64,800 13.4 8.50 15 8.65 -15
06/29/90 162,000 14.9 8.38 15 8.65 -27
06/29/90 179,350 14.6 8.38 15 8.65 -27
06/29/90 414,400 19.8 8.38 20 8.70 -32
08/22/90 49,255 14.7 8.88 15 8.41 47
12/27/90 61,200 19.9 9.00 20 8.40 60
01/31/91 26,981 9.4 9.00 10 8.07 93
01/31/91 123,033 12.6 9.00 15 8.16 84
01/31/91 124,390 14.7 9.00 15 8.16 84
06/12/91 680,000 15.0 8.63 15 8.16 47
06/26/91 76,610 14.7 8.63 15 8.16 47
06/26/91 107,451 14.7 8.63 15 8.16 47
06/26/91 135,000 14.9 8.63 15 8.16 47
07/25/91 711,257 19.5 8.00 20 8.38 -38
10/17/91 215,759 14.8 8.50 15 7.57 93
03/19/92 30,614 10.1 7.75 10 7.26 49
03/19/92 37,241 10.1 8.00 10 7.26 74
03/19/92 64,050 15.1 8.00 15 7.40 60
03/19/92 $64,694 15.1 8.63% 15 7.40% 123
04/23/92 25,319 4.5 7.88 5 6.93 95
04/29/92 205,970 6.7 7.75 7 7.22 53
06/11/92 184,151 13.8 7.75 15 7.45 30
08/11/92 76,987 14.3 7.75 15 6.90 85
08/11/92 180,000 19.6 7.75 20 7.08 67
09/03/92 86,360 15.0 7.50 15 6.81 69
09/03/92 107,100 14.3 7.75 15 6.81 94
09/03/92 153,000 19.6 7.75 20 7.01 74
09/03/92 270,000 19.5 7.75 20 7.01 74
01/14/93 40,694 15.9 7.50 15 6.87 63
01/14/93 505,270 14.8 7.50 15 6.87 63
04/01/93 45,000 29.8 7.25 30 6.93 32
04/01/93 72,938 14.7 7.25 15 6.26 99
04/01/93 146,872 18.7 7.25 20 6.48 77
04/01/93 239,418 29.2 7.25 30 6.93 32
04/01/93 480,000 19.9 7.25 20 6.48 77
04/01/93 527,547 19.8 7.25 20 6.48 77
04/15/93 41,577 9.6 7.25 10 6.03 122
04/15/93 69,715 4.5 7.25 5 5.24 201
04/15/93 179,775 6.7 7.25 7 5.69 156
04/15/93 192,000 14.6 7.25 15 6.26 99
04/15/93 255,000 19.3 7.25 20 6.48 77
05/06/93 78,449 15.0 7.50 15 6.25 125
05/06/93 176,187 15.6 7.68 15 6.25 143
07/29/93 45,000 13.3 7.00 15 6.01 99
07/29/93 68,200 11.8 6.75 10 5.78 97
07/29/93 203,639 19.8 6.75 20 6.23 52
08/26/93 134,400 10.0 7.25 10 5.81 144
08/26/93 166,868 14.1 7.25 15 6.00 125
08/26/93 245,650 15.0 7.25 15 6.00 125
09/30/93 257,070 2.2 7.25 2 3.87 338
01/20/94 89,713 14.6 7.25 15 5.94 131
01/20/94 131,747 14.7 7.25 15 5.94 131
--------------------------------------------------------------------------------
\a Treasuries, in years.
\b Data for February 15, 1994.
\c Investment guaranteed by the State of New York Mortgage Authority.
\d Benchmark was AA-rated long-term (25-30 year) new financial bonds.
\e Data from March 17, 1994.
Source: Pension system information was obtained from the New York
City Comptroller's Office and the Wyoming Retirement System. The
benchmark data were obtained from Salomon Brothers, Analytical Record
of Yields and Yield Spreads (New York: July 1994). Although the
information contained in the Salomon Brothers report was obtained
from sources that Salomon Brothers believed to be reliable, Salomon
Brothers does not guarantee the accuracy of the information. The
information may be incomplete or condensed. All opinions and
estimates included in the Salomon Brothers report constituted its
judgment as of July 1994 and are subject to change without notice.
All 62 variable-rate loan purchases we examined had expected yields
greater than those of 3-month Treasury securities. On the average,
expected yields on these purchases exceeded those of 3-month Treasury
securities by 355 basis points. Because almost all these SBA loans
are adjusted quarterly, both pension fund and SBA officials stated
that 3-month Treasury securities are an appropriate benchmark for
analyzing variable-rate SBA loan purchases. The variable-rate loans
we examined are set to fluctuate with the prime rate, at a fixed
spread ranging from 26.5 basis points below the prime to 162.5 basis
points above. Because the prime rates far exceeded the 3-month
Treasury rates when the loans were purchased, the expected yields on
the ETI loan purchases also exceeded this benchmark.\1 All ETI
expected yields exceeded those on 3-month Treasury securities by more
than 100 basis points, and often they exceeded this benchmark by from
300 to 400 basis points. According to a plan official, the plan
requires this large spread because, although the plan purchases all
the loans at a premium, SBA would reimburse the plan only the par
value of the loans, were the loans to default. Figure II.2 shows,
for the 62 variable-rate loan purchases, how the expected yields
compared to those of 3-month Treasury securities. Table II.3
provides the specific expected yields for each pension plan
investment, as well as those for 3-month Treasury securities on the
date of purchase.
Figure II.2: Spreads to
Benchmark on Variable-Rate
Purchases
(See figure in printed
edition.)
Table II.3
Financial Returns of New York City
Variable-Rate Loan Purchases, Compared
to Returns on 3-month Treasury
Securities (at Date of Purchase)\a
Yield on 3-
Term Yield month Spread to
Investmen (years at Treasury Treasuries
Investment date t amount ) purchase securities (basis points)
---------------- --------- ------ -------- --------------- ----------------
12/14/90 $22,500 6.9 10.85% 6.81% 404
12/14/90 66,300 9.6 10.93 6.81 412
12/14/90 111,081 9.7 10.92 6.81 411
12/14/90 117,727 5.8 10.56 6.81 375
12/14/90 131,958 6.7 10.86 6.81 405
12/14/90 133,298 9.7 10.92 6.81 411
12/14/90 135,000 7.0 10.83 6.81 402
12/14/90 163,556 6.5 10.89 6.81 408
12/14/90 271,501 19.8 11.15 6.81 434
12/28/90 31,500 7.1 10.83 6.52 431
12/28/90 157,857 6.4 10.47 6.52 395
12/28/90 168,000 4.6 10.25 6.52 373
02/28/91 54,000 5.9 9.67 5.98 369
04/22/91 368,750 4.9 10.00 5.64 436
07/19/91 80,028 4.5 8.95 5.58 337
07/19/91 342,358 9.7 8.86 5.58 328
07/31/91 $284,750 5.0 9.02% 5.59% 343
07/31/91 425,000 10.0 9.37 5.59 378
10/01/91 255,000 5.0 8.48 5.14 334
10/01/91 425,000 11.9 8.77 5.14 363
11/12/91 98,720 5.3 8.23 4.68 355
03/13/92 208,958 4.9 6.82 4.06 276
04/29/92 27,000 7.0 6.97 3.70 327
04/29/92 63,750 5.0 6.99 3.70 329
04/29/92 64,286 6.6 6.99 3.70 329
04/29/92 112,375 6.6 6.99 3.70 329
04/29/92 552,500 7.0 6.83 3.70 313
07/16/92 108,800 7.0 6.71 3.19 352
09/08/92 625,500 10.1 6.83 2.90 393
10/14/92 65,000 5.3 6.71 2.91 380
10/14/92 81,021 6.0 6.78 2.91 387
10/14/92 102,428 5.8 6.75 2.91 384
12/16/92 255,000 15.0 6.92 3.20 372
12/17/92 90,000 5.0 6.30 3.20 310
01/07/93 46,750 8.0 6.86 3.10 376
01/07/93 135,000 10.0 6.78 3.10 368
01/07/93 660,000 15.0 6.92 3.10 382
02/01/93 84,075 5.0 6.38 2.97 341
02/01/93 375,000 7.0 6.64 2.97 367
02/08/93 106,773 5.6 6.03 2.95 308
02/08/93 133,393 7.5 6.29 2.95 334
03/04/93 69,700 10.0 6.77 2.98 379
03/30/93 722,500 10.0 6.74 2.95 379
04/15/93 135,000 7.1 6.61 2.85 376
07/13/93 276,250 15.0 6.26 3.03 323
07/23/93 184,000 20.1 7.00 3.08 392
07/29/93 62,400 4.4 6.71 3.10 361
07/29/93 88,717 6.0 6.51 3.10 341
07/29/93 103,125 2.9 6.95 3.10 385
09/03/93 126,000 20.0 5.52 2.98 254
09/03/93 311,100 10.0 7.18 2.98 420
09/29/93 416,146 11.7 6.43 2.93 350
10/15/93 397,375 25.0 5.98 3.05 293
11/08/93 315,000 12.4 6.27 3.11 316
11/22/93 $368,100 10.1 6.30% 3.13% 317
12/03/93 87,000 10.0 6.22 3.11 311
12/10/93 572,000 25.0 6.67 3.08 359
12/15/93 224,000 10.0 6.22 3.06 316
01/10/94 184,000 7.1 5.83 3.05 278
01/10/94 216,000 20.1 5.28 3.05 223
01/13/94 85,000 10.1 6.12 2.99 313
01/13/94 212,500 15.1 5.67 2.99 268
--------------------------------------------------------------------------------
\a Data from February 15, 1994.
Source: Pension system information from the New York City
Comptroller's Office; benchmarks from Data Resources, Inc.
RETURNS ON ETI PRIVATE PLACEMENTS
The expected yields on most state private placements appear to be
competitive. We did not analyze the returns on 19 of 53 private
placements because we did not have adequate information on either the
rating of the placements or appropriate benchmarks. However, the
expected yields on the remaining 34 private placements we examined
were, on the average, 52 basis points above yields on similarly rated
bonds with maturities approximating the average lives of the ETIs.
(When possible, we also tried to use benchmarks of the same sector as
the private placements we examined.) The expected yields on nine
private placements exceeded the benchmarks by more than 100 basis
points.
A previous analysis by State of Wisconsin Investment Board staff also
determined that their state private placements realized competitive
returns. The staff compared the spread of each individual placement
at the time of origination with the spread over 10-year Treasuries
for BBB-rated bonds available in the new issue market at
approximately the same time. While the spreads of two AA-rated
Wisconsin private placements lagged the BBB market spreads, all the
other placements (including the AAA- and A-rated placements) had
spreads exceeding the BBB market spreads. Many of the BBB-rated
placements had spreads nearly twice that of the BBB market spread.
Spreads on the BB- and B-rated investments were often twice or three
times as great as the BBB market spread.
Figure II.3 shows, for the 34 private placements, how the expected
yields compared to those of corporate bonds of similar risk and
maturity. Table II.4 provides the specific expected yields for each
investment, as well as those for alternative investments on the date
of purchase.
Figure II.3: Spreads to
Benchmark on Private Placements
(See figure in printed
edition.)
Table II.4
Financial Returns of Colorado and
Wisconsin ETI Private Placements,
Compared to Alternative Investments (at
Date of Purchase)
Term/
St average Spread to
at Investmen Investmen life Ratin Benchmark benchmark
e t date t amount (years) g Yield yield (basis points)
-- --------- --------- ---------- ----- ----- ---------- ----------------
Co 05/29/73 $4,000,00 30.0/\b A 7.60% 7.65%\c -5
l 0
o
r
a
d
o
\
a
10/15/79 9,917,000 25.0/\b \d 10.25 10.14\e 11
5/19/82 8,592,000 12.4/\b A 15.80 15.75\f 5
5/17/84 22,994,00 10.4/\b A 13.00 13.63\f -63
0
08/17/87 49,391,00 13.9/\b \b 9.40 \b \b
0
Wi 07/18/73 3,000,000 25.0/18.0 AAA 8.00 \b \b
s
c
o
n
s
i
n
\
g
11/07/85 3,500,000 13.0/10.0 AAA 11.88 10.30\h 158
04/02/66 1,500,000 30.0/23.0 AA 5.45 \b \b
12/05/85 25,000,00 15.0/7.0 AA 8.18 \b \b
0
12/04/91 10,603,00 14.0/6.0 AA 8.21 \b \b
0
05/16/73 1,800,000 25.0/16.0 A 8.50 7.65\c 85
01/09/86 10,000,00 15.0/9.0 A 10.30 9.70\h 60
0
03/05/87 $15,000,0 12.0/9.0 A 8.63% 8.00%\h 63
00
05/06/87 3,000,000 10.0/6.0 A 9.75 8.88\i 87
04/06/88 10,000,00 15.0/8.5 A 10.10 9.50\f 60
0
06/02/88 5,000,000 15.0/9.0 A 10.80 10.10\f 70
05/30/90 3,000,000 10.0/6.0 A 10.50 9.85\i 65
09/05/91 10,000,00 15.0/10.0 A 9.05 8.85\f 20
0
07/17/67 700,000 25.0/13.0 BBB 6.00 \b \b
07/02/75 1,500,000 20.0/14.0 BBB 11.00 11.50\f -50
11/01/76 1,000,000 20.0/13.0 BBB 9.00 \b \b
11/01/76 3,000,000 20.0/13.0 BBB 8.40 \b \b
04/03/77 3,000,000 20.0/14.0 BBB 10.75 8.95\c 180
11/08/85 1,419,000 15.0/10.0 BBB 12.25 11.00\h 125
11/08/85 1,150,000 15.0/10.0 BBB 12.25 11.00\h 125
01/08/87 9,000,000 15.0/9.0 BBB 9.25 8.75\h 50
08/06/87 4,000,000 15.0/9.0 BBB 10.70 9.80\h 90
09/03/87 9,000,000 15.0/9.5 BBB 10.90 10.15\h 75
10/08/87 17,000,00 20.0/12.0 BBB 10.90 10.85\h 5
0
11/10/87 20,000,00 15.0/8.0 BBB 10.90 10.38\h 52
0
03/03/88 35,000,00 15.0/8.5 BBB 10.50 9.30\h 120
0
06/02/88 5,000,000 10.0/6.5 BBB 11.25 10.25\h 100
08/04/88 4,000,000 15.0/10.0 BBB 11.25 10.15\h 110
10/06/88 7,500,000 15.0/9.0 BBB 11.00 9.88\h 112
01/04/90 12,500,00 15.0/10.0 BBB 9.75 9.45\h 30
0
05/30/90 5,600,000 15.0/8.5 BBB 9.88 10.55\h -67
07/11/90 10,000,00 15.0/12.0 BBB 9.85 9.90\h -5
0
10/22/90 12,000,00 11.5/8.0 BBB 10.03 10.80\h -77
0
10/22/90 14,000,00 18.5/15.0 BBB 10.65 10.80\h -15
0
11/05/90 10,000,00 10.0/7.5 BBB 10.15 10.40\h -25
0
09/05/91 20,000,00 10.0/7.0 BBB 9.49 9.00\h 49
0
03/03/92 11,756,00 18.5/12.5 BBB 9.84 8.30\h 154
0
09/05/85 7,500,000 10.0/6.0 BB 12.50 \b \b
12/03/87 20,000,00 15.0/8.0 BB 9.80 \b \b
0
08/04/88 5,000,000 15.0/10.0 BB 11.82 \b \b
08/04/88 10,000,00 10.0/7.0 BB 10.97 \b \b
0
12/08/88 1,000,000 10.0/6.0 BB 11.50 \b \b
12/08/88 3,000,000 10.0/6.0 BB 12.00 \b \b
02/02/89 8,500,000 15.0/9.0 BB 12.13 \b \b
12/07/89 $3,600,00 16.0/10.0 BB 10.85 \b \b
0 %
11/05/90 775,000 7.0/5.0 B 14.00 \b \b
11/05/90 7,000,000 10.0/7.0 B 10.85 \b \b
10/05/91 1,530,000 10.0/7.0 B 7.00 \b \b
--------------------------------------------------------------------------------
\a Data from September 30, 1993.
\b Not available.
\c Benchmark was yield on similarly rated long-term (25-30 year) new
utility and industrial bonds.
\d This investment had no rating. The private placement was backed
by certified Government National Mortgage Association, Federal
Housing Administration, and Department of Veterans Affairs mortgages.
Consequently, the risk characteristics of the investment are similar
to those of agency securities.
\e Benchmark was yield on 20-year U.S. agency bonds, published by
Data Resources, Inc.
\f Benchmark was yield on similarly rated medium-term (10-year) new
financial bonds.
\g Data from August 6, 1992.
\h Benchmark was yield on similarly rated medium-term (10-year) new
industrial bonds.
\i Benchmark was yield on similarly rated medium-term (7-year) new
utility bonds.
Source: Pension system information was obtained from the Colorado
Public Employees' Retirement Association and the State of Wisconsin
Investment Board. Unless otherwise noted, benchmarks were obtained
from Salomon Brothers, Analytical Record of Yields and Yield Spreads
(New York: July 1994). Although the information contained in the
Salomon Brothers report was obtained from sources that Salomon
Brothers believed to be reliable, Salomon Brothers does not guarantee
the accuracy of the information. The information may be incomplete
or condensed. All opinions and estimates included in the Salomon
Brothers report constituted its judgment as of July 1994 and are
subject to change without notice.
RETURNS ON ETI CD PURCHASES
The expected yields on the CD purchasing programs approximated those
of secondary CD rates or Treasury securities of similar maturity. In
Minnesota, the CD purchases were insured by the Federal Deposit
Insurance Corporation (FDIC), and the plan received, on the average,
an expected yield on its 3- and 6-month CD purchases 1 basis point
below the average secondary CD rates quoted by the Federal Reserve
Bank of New York. In Wisconsin, however, the CD purchases were not
insured by FDIC. Thus, the CDs' spreads above the Treasury rates
were needed to compensate the plan for the higher credit risk of
these uninsured CDs. According to plan officials, the plan limits
its credit risk by conducting internal evaluations of the
creditworthiness of banks interested in participating in its CD
program. The plan does not purchase CDs from banks it does not
consider creditworthy. In addition, CDs are relatively illiquid
investments. According to pension plan officials, expected yields on
CD purchases were usually set about 55 basis points above the 3-year
Treasury rate to take account of this lack of liquidity. The
expected yields on the 12 Wisconsin 3-year CD purchases we examined,
on the average, exceeded those on 3-year Treasury securities by 53
basis points. Table II.5 provides the specific expected yields for
each CD purchase, as well as those for alternative investments on the
date of purchase.
Table II.5
Financial Returns of Minnesota and
Wisconsin CD Purchases, Compared to
Alternative Investments (at Date of
Purchase)
Yield on
alternativ
Number e Spread to
Stat Investmen Investmen of investment benchmark
e t date t amount Term banks Yield s (basis points)\a
---- --------- --------- ------ ------ ------ ---------- ----------------
Minn 01/18/94 $22,850,0 6 57 3.36% 3.34% 2
eso 00 months
ta\
b
04/18/94 13,200,00 3 34 4.00 3.98 2
0 months
04/18/94 29,500,00 6 69 4.32 4.39 -7
0 months
Wisc 9/9/92 5,000,000 3 1 5.10 4.34 76
ons years
in\
c
5/6/93 3,000,000 3 1 4.70 4.24 46
years
5/18/93 3,000,000 3 1 4.85 4.49 36
years
7/1/93 1,000,000 3 1 5.00 4.37 63
years
7/15/93 500,000 3 1 4.90 4.34 56
years
9/3/93 500,000 3 1 4.95 4.04 91
years
9/22/93 8,000,000 3 1 4.60 4.22 38
years
10/8/93 500,000 3 1 4.80 4.09 71
years
10/21/93 5,000,000 3 1 4.65 4.19 46
years
11/5/93 4,500,000 3 1 4.66 4.53 13
years
2/28/94 2,000,000 3 1 5.50 5.04 46
years
3/18/94 1,900,000 3 1 5.90 5.42 48
years
--------------------------------------------------------------------------------
\a Benchmarks were 3- and 6-month secondary CD rates for 3- and
6-month CD purchases, respectively, and 3-year Treasuries for 3-year
CD purchases. Our benchmark yields differed slightly from those used
by the Minnesota State Board of Investment, apparently reflecting the
use of different data bases to generate the benchmarks.
\b Data from April 22, 1994.
\c Data from April 21, 1994.
Source: Pension information from the Minnesota State Board of
Investment and the State of Wisconsin Investment Board; benchmarks
from Data Resources, Inc.
RETURNS ON ETI VENTURE CAPITAL
INVESTMENTS
The interim financial returns on 10 of the 16 ETI venture capital
investments we reviewed lagged the median returns for the industry.
As shown in figure II.4, 10 of the funds had an IRR that would fall
within the lower two quartiles of IRRs for venture capital funds
formed in the same year. Only 1 fund had an IRR in the upper
quartile. In addition, many venture capital investors look to
realize at least 13 to 15 percent average annualized internal rates
of return on their venture capital investments. However, only 1 of
the 16 funds examined in our quartile analysis had realized returns
greater than 13 percent. Table II.6 provides the interim return for
each ETI venture capital fund examined in our case studies, as well
as the quartile placement for the 16 funds for which both financial
return and benchmark information was available.
Figure II.4: ETI Venture
Capital Funds
(See figure in printed
edition.)
Table II.6
Financial Returns of ETI Venture Capital
Investments, and Quartile Ranking, When
Compared to Average Returns for Funds
Formed in the Same Year
Initial Internal
Total Total funding rate of Quartile for
State Fund committed invested year return\a funding year
------- ------- ---------- ---------- ----------- ----------- ------------
Colorad A $ $ 1982 8.3% 1
o\b 5,000,000 5,000,000
B 5,000,000 5,000,000 1984 5.4 2
C 2,000,000 2,000,000 1985 1.1 3
D 25,000,000 25,000,000 1987 -2.8 4
E 5,000,000 3,000,000 1988 \c \d
F 1,500,000 1,500,000 1989 \c \d
Massach A 2,000,000 2,000,000 1988 -9.7 4
usetts
\b
B 50,000,000 50,000,000 1990 6.8 \e
Minneso A 6,600,000 6,300,000 1986 4.3 2
ta\b
A 10,000,000 5,600,000 1990 3.9 \e
Pennsyl A 10,000,000 10,000,000 1985 -1.7 4
vania\f
B 10,000,000 10,000,000 1985 14.3 2
C 2,000,000 2,000,000 1985 8.6 2
D 5,000,000 5,000,000 1985 5.1 3
E 9,000,000 9,000,000 1985 8.3 3
F 2,000,000 2,000,000 1986 -13.0 4
G 20,000,000 20,000,000 1987 5.9 2
H 1,000,000 1,000,000 1987 0.5 3
I 2,000,000 2,000,000 1987 -17.4 4
J 2,000,000 2,000,000 1987 -5.8 4
K 7,500,000 7,000,000 1989 -4.2 \e
L 7,500,000 6,300,000 1989 -1.1 \e
M 3,000,000 2,500,000 1990 8.2 \e
N 1,000,000 800,000 1990 -8.5 \e
O 15,000,000 6,700,000 1992 24.2 \d
P 7,500,000 1,500,000 1992 -38.4 \d
Q 30,000,000 1,800,000 1993 \c \d
Wiscons A 5,000,000 3,400,000 1984 \c \d
in\g
B 10,000,000 7,000,000 1987 \c \d
C 3,000,000 300,000 1991 \c \e
--------------------------------------------------------------------------------
\a As reported by the pension funds.
\b Data from December 31, 1992.
\c No IRR was calculated.
\d Not available.
\e No quartile analysis was available for the 1989, 1990, and 1991
funds.
\f Data from June 30, 1993.
\g Data from June 30, 1992.
Source: Pension system information was obtained from the Colorado
Public Employees' Retirement Association, Massachusetts Pension
Reserves Investment Management Board, Minnesota State Board of
Investment, Pennsylvania State Employees' Retirement System, and the
State of Wisconsin Investment Board; benchmarks were obtained from
Venture Economics, Inc., as of December 31, 1992.
Because the methods for calculating venture capital returns are
imprecise, limited conclusions can be drawn from the information
above. Even the best-performing funds go through periods of high and
low (even negative) valuations in their life cycles; this is the
nature of venture capital investments. As a result, each fund's
current position below (or above) the median for its vintage year
does not mean that it will ultimately yield below-average or
above-average returns once all its holdings are liquidated.
According to Venture Economics, 40 percent of venture capital funds
in the first quartile in year 4 of their partnerships will not be in
the first quartile in year 10. Because the predictive ability of
IRRs strengthens over the life cycle of a venture capital fund, the
degree of confidence in the IRR calculation improves as funds mature.
For example, the estimates of IRRs for funds formed in 1982 are more
likely to reflect the fund's ultimate returns than are estimates for
those funds formed in later years. For the 10 oldest ETI venture
capital funds examined in our quartile analysis, formed between 1982
and 1986, the IRR was above the median in 5 cases and below in the
other 5.
--------------------
\1 Since expected yields are affected by changes in the spread
between the prime rate and the T-bill rate, future yields could
differ significantly from those reported here.
ADVISORY PANEL
========================================================= Appendix III
Tina Brownlee
Prudential Private Placement Investors
Newark, New Jersey
Cathie G. Eitelberg
Government Finance Officers Association
Washington, D.C.
Richard Ferlauto
Center for Policy Alternatives
Washington, D.C.
Lawrence Litvak
Working Assets
San Francisco, California
Frank B. McArdle
Hewitt Associates LLC
Washington, D.C.
Leith Mace
Prudential Private Placement Investors
Newark, New Jersey
Cynthia L. Moore
National Council on Teacher Retirement
Washington, D.C.
Jane Morris
Jane Morris and Associates
Natick, Massachusetts
D. Jeanne Patterson
Indiana University
Bloomington, Indiana
(See figure in printed edition.)Appendix IV
COMMENTS FROM THE DEPARTMENT OF
LABOR
========================================================= Appendix III
(See figure in printed edition.)
(See figure in printed edition.)
(See figure in printed edition.)
MAJOR CONTRIBUTORS TO THIS REPORT
=========================================================== Appendix V
PROGRAM EVALUATION AND METHODOLOGY
DIVISION
Patrick G. Grasso, Project Director
Penny Pickett, Communications Analyst
DENVER REGIONAL OFFICE
Glenn D. Slocum, Project Manager
Stephen P. Gaty, Evaluator
Terry J. Hanford, Adviser
Pamela K. Tumler, Communications Analyst
GLOSSARY
=========================================================== Appendix 0
--------------------
\ From Dictionary of Finance and Investment Terms, 3rd edition by
John Downes and Jordan Elliot Goodman. Copyright (c) 1991, 1987,
1985 by Barron's Educational Series, Inc. Reprinted by arrangement
with Barron's Educational Series, Inc., Hauppauge, New York.
BOND
------------------------------------------------------- Appendix 0:0.1
"Any interest bearing or discounted government or corporate security
that obligates the issuer to pay the bond holder a specified sum of
money, usually at specific intervals, and to repay the principal
amount of the loan at maturity. Bondholders have an IOU from the
issuer, but no corporate ownership privileges, as stockholders do."
CERTIFICATE OF DEPOSIT
------------------------------------------------------- Appendix 0:0.2
"A debt instrument, [which usually pays interest, that is issued by a
bank]. Maturities can range from a few weeks to several years.
Interest rates are set by competitive forces in the market place."
CREDIT RATING
------------------------------------------------------- Appendix 0:0.3
"A formal evaluation of an individual's or company's credit history
and capability of repaying obligations. The bond ratings assigned by
Standard and Poor's and Moody's are a form of credit rating. Most
large companies and lending institutions assign credit ratings to
existing and potential customers."
MATURITY DATE
------------------------------------------------------- Appendix 0:0.4
"The date on which the principal amount of a note, draft, acceptance,
bond, or other debt instrument becomes due and payable. Also, the
termination or due date on which an installment loan must be paid in
full."
PREMIUM
------------------------------------------------------- Appendix 0:0.5
"The amount by which a bond [or loan] sells above its face value.
For instance, a bond with a face value of $1,000 would sell for a
$100 premium when it cost $1,100."
PRIVATE PLACEMENT
------------------------------------------------------- Appendix 0:0.6
"The sale of securities or other investments directly to a limited
number of investors. For example, a new issue of stocks or bonds may
be privately placed with an institutional investor such as a pension
plan."
RISK
------------------------------------------------------- Appendix 0:0.7
"The measurable possibility [that the ex post total return on an
investment will deviate from the ex ante expected total return].
Among the commonly encountered types of risk are:
INFLATION RISK
----------------------------------------------------- Appendix 0:0.7.1
"The chance that the value of assets or of income will be eroded as
inflation shrinks the value of a country's currency.
INTEREST RATE RISK
----------------------------------------------------- Appendix 0:0.7.2
"The possibility that a fixed-rate debt instrument will decline in
value as a result of a rise in interest rates.
LIQUIDITY RISK
----------------------------------------------------- Appendix 0:0.7.3
"The possibility that an investor will not be able to buy or sell a
commodity or security quickly enough or in sufficient quantities
because buying or selling opportunities are limited.
PREPAYMENT RISK
----------------------------------------------------- Appendix 0:0.7.4
"[The chance that] a debt obligation [will be prepaid] before it
becomes due.
REPAYMENT (CREDIT) RISK
----------------------------------------------------- Appendix 0:0.7.5
"The chance that a borrower or trade debtor will not repay an
obligation as promised.
RISK OF PRINCIPAL
----------------------------------------------------- Appendix 0:0.7.6
"The chance that invested capital will drop in value."
VENTURE CAPITAL
------------------------------------------------------- Appendix 0:0.8
"An important source of financing for start-up companies or others
embarking on new or turnaround ventures that entail some investment
risk but offer the potential for above average future profits.
Sources of venture capital are [venture capital funds, also known as]
venture capital limited partnerships. Venture capital financing
supplements other personal or external funds that an entrepreneur is
able to tap, or takes the place of loans or other funds that
conventional financial institutions are unable or unwilling to risk.
In return for taking an investment risk, venture capitalists are
usually rewarded with some combination of profits, preferred stock,
royalties on sales, and capital appreciation of common stock."
VENTURE CAPITAL LIMITED
PARTNERSHIP
------------------------------------------------------- Appendix 0:0.9
"An investment vehicle organized by a brokerage firm or
entrepreneurial company to raise capital for start-up companies or
those in the early processes of developing products and services.
The partnership will usually take shares of stock in the company [it
invests in,] in return for the capital supplied. Limited partners
receive income from profits the company may earn. If the company is
successful and goes public, limited partners' profits could be
realized from the sale of formerly private stock to the public."
YIELD
------------------------------------------------------ Appendix 0:0.10
"In general, the return on an investor's capital investment. The
current yield is the coupon rate of interest [on a bond or loan,]
divided by the purchase price. For example, a bond selling for
$1,000 with a 10-percent coupon offers a 10-percent current yield.
If that same bond were selling for $500, however, it would offer a
20-percent yield to an investor who bought it for $500. (As a bond's
price falls, its yield rises and vice versa.)
"[The yield can also be the] rate of return on a bond [or loan,]
taking into account the total of annual interest payments, the
purchase price, the redemption value, and the amount of time
remaining until maturity."
YIELD SPREAD
------------------------------------------------------ Appendix 0:0.11
"The difference in yield between various issues of securities."
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