Putting together an investment plan

State and local governments have approximately $750 billion in financial assets under their control, not including public employee retirement funds. A comprehensive investment program approved by top elected officials is the key to successful management of these assets.

At a minimum, the program should require a well-defined but flexible investment policy that can be enhanced with accurate cash flow forecasting.

While most local governments have written investment policies, a 1995 survey by the Government Finance Officers Association and MBIA, the Armonk, N.Y.-based bond insurance firm, found that a significant number do not. The most effective policies: * define an investment objective with an acceptable level of risk; * establish benchmarks for measuring not just results and performance, but also whether the portfolio continues to meet the investment policy requirements; * identify permissible investments; * define a diversification policy for investments; and * implement internal control and reporting requirements.

In addition to an investment policy, accurate forecasting of cash flows is vital. Unfortunately, many software packages for cash flow forecasting are expensive and complex, so treasury managers often lack the proper tools to accurately plan cash flows. This results in a tendency to build portfolios that are much shorter in maturity or duration – usually less than 90 days – than is necessary. A portfolio invested in short-term vehicles may provide liquidity, but it reduces the potential return. By matching required cash flows with appropriate durations of investments, overall return can be enhanced and risk contained.

Once an accurate means of forecasting cash flow has been developed, governments can identify two groups of investable cash – primary cash and secondary cash. Primary cash should be invested in the most liquid investments, such as money market vehicles, while secondary cash can be put into investments with long durations and potentially greater returns.

Management of primary cash is crucial to the overall performance of a local government’s portfolio. Well-managed pooled investments provide safety, liquidity and competitive rates of return. Currently, at least 25 states allow local governments to invest in money market funds. Almost as many permit investment in state investment pools. To boost the confidence of local government investors, states are implementing policies that help ensure the safety of assets in investment pools.

For example, the California legislature recently passed a bill that permits investments in money market funds that meet one of the following requirements: 1) the highest ranking or letter from no fewer than two National Recognized Statistical Rating Organizations such as Standard & Poor’s, Fitch’s or Moody’s; 2) an investment advisor registered or exempt from registration with the Securities and Exchange Commission, with not less than five years experience in managing money market funds; or 3) money market fund assets in excess of $500,000 under management. Several other states already have similar policies or are in the process of implementing such policies.

Outsourcing primary cash to investment pools is expected to continue growing in popularity. Legislation for the approval of money market funds is pending in at least one additional state, and more states are likely to follow.

Local governments with a comprehensive investment program that allows for the outsourcing of all or part of investments to pools, could be better served.