United States General Accounting Office

GAO 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

GAO United States

General Accounting Office

Washington, D.C. 20548

Program Evaluation and

Methodology Division

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.

Page 1 GAO/PEMD-95-13 Public Pension Plans
B-254060 

Results in Brief 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

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.

Page 2 GAO/PEMD-95-13 Public Pension Plans
B-254060 

partnerships), this information suffered from several methodological

weaknesses.

Background 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

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.

Page 3 GAO/PEMD-95-13 Public Pension Plans
B-254060 

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.

Fiduciary Rules 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

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.

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.

Page 4 GAO/PEMD-95-13 Public Pension Plans
B-254060 

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.

Definition of ETIs 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.

9

U.S. Department of Labor, Interpretive Bulletin 94-1 on Economically Targeted Investments, bulletin

relating to ERISA, Washington, D.C., June 23, 1994.

10U.S. Department of Labor, Interpretive Bulletin 94-1.

11Based 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).

Page 5 GAO/PEMD-95-13 Public Pension Plans
B-254060 

“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.

Scope and

Methodology

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

12U.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.

13Institute for Fiduciary Education, Economically Targeted Investments: A Reference for Public

Pension Funds (Sacramento, Calif.: June 1993).

14While 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.

Page 6 GAO/PEMD-95-13 Public Pension Plans
B-254060 

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

15For 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).

16U.S. General Accounting Office, Pension Plans: Investments in Affordable Housing Possible With

Government Assistance, GAO/HRD-92-55 (Washington, D.C.: June 1992).

17We 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.

Page 7 GAO/PEMD-95-13 Public Pension Plans
B-254060 

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.

Extent and Nature of

ETIs

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

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

Page 8 GAO/PEMD-95-13 Public Pension Plans
B-254060 

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).

Page 9 GAO/PEMD-95-13 Public Pension Plans
B-254060 

Figure 1: Investments in ETI Programs

by IFE Survey Respondents, by

Program Typea

64.2% • Residential housing: $12,722.8

19.7%•

Other real estate: $3,913.1

0.2%

Small business loans: $41.0

•

3.2%

Venture capital: $638.0

•12.7%

Other ETIs: $2,515.4

Business development ETIs

aDollars 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.

Page 10 GAO/PEMD-95-13 Public Pension Plans
B-254060 

Figure 2: ETI Programs Conducted by

IFE Survey Respondents, by Program

Typea

31.6% • Residential housing: 30

• 10.5%

Other real estate: 10

•

8.4%

Small business loans: 8

25.3%•

Venture capital: 24

•24.2%

Other ETI’s: 23

Business development ETIs

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

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.)

Page 11 GAO/PEMD-95-13 Public Pension Plans
B-254060 

Figure 3: States With ETI Programs

No programs identified 

Nonbusiness development programs 

Business development programs 

Business Development

ETIs by Seven Pension

Plans

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

Page 12 GAO/PEMD-95-13 Public Pension Plans
B-254060 

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

18While the state government has not explicitly guaranteed the bonds, the bonds are backed by the

authority’s general funds and assets.

Page 13 GAO/PEMD-95-13 Public Pension Plans
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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

19One 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.

Page 14 GAO/PEMD-95-13 Public Pension Plans
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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

Type of ETI programa

Pension plan Bond purchase Loan purchase Private placement CD purchase Venture capitalb

Colorado $12.1 • $94.9 • $41.5

Massachusetts • • • • 52.0

Minnesota 14.0 • • $65.6 11.9

New York City • $14.5c • • •

Pennsylvania • • • • 89.6

Wisconsin • • 387.4 34.9 10.7

Wyoming • 15.4 • • •

Total $26.1 $29.9 $482.3 $100.5 $205.7

aDollars are in millions. Amount invested is the origination value.

bAmounts are funds actually invested, not funds committed.

cIncludes two separate loan purchasing programs.

Financial Returns on

Investments

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 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

Page 15 GAO/PEMD-95-13 Public Pension Plans
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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 Investmentsa

aRatings 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

20Except 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.

21Venture Economics, 1993 Investment Benchmarks Report: Venture Capital (Boston, Mass.: 1993).

Page 16 GAO/PEMD-95-13 Public Pension Plans
B-254060 

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.

22The 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.

23Not 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.

24A 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.

25U.S. General Accounting Office, Pension Plans: Investments in Affordable Housing Possible With

Government Assistance, GAO/HRD-92-55 (Washington, D.C.: June 1992).

Page 17 GAO/PEMD-95-13 Public Pension Plans
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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

purchases

Treasury securities of like maturity

Variable-rate SBA loan

purchases

3-month Treasury bills

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.

26Some 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.

Page 18 GAO/PEMD-95-13 Public Pension Plans
B-254060 

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

Case Study Results 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

27Pension 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.

Page 19 GAO/PEMD-95-13 Public Pension Plans
B-254060 

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

ETI program

Number of

investments

Average spread

to benchmark

(in basis points)

Bond purchases 3 93

Loan purchases

 Fixed rate

 Variable rate

86

62

27a

355

Private placements 34 52

CD programs 

 3- and 6-month

 3-year

3

12

–1

53

Venture capital 16 b

Total 216

aThis 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.

bTen of the 16 ETI venture capital funds had interim internal rates of return that lagged industry

median returns.

28We 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.

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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

29This includes financial returns on both affordable housing and business development ETIs.

30Center 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).

Page 21 GAO/PEMD-95-13 Public Pension Plans
B-254060 

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.

Returns on Other ETIs 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.

31U.S. General Accounting Office, Pension Plans.

32Alicia 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.

Page 22 GAO/PEMD-95-13 Public Pension Plans
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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.

Summary 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

33Center for Policy Alternatives, Economically Targeted Investments.

Page 23 GAO/PEMD-95-13 Public Pension Plans
B-254060 

were a number of technical limitations to our analysis (for example,

transaction costs were not included in our study).

ETIs’ Economic

Effects

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

Page 24 GAO/PEMD-95-13 Public Pension Plans
B-254060 

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.

Economic Effects of ETI

Programs Nationwide

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.

34Lawrence Litvak, Pension Funds and Economic Renewal, Studies in Development Policy

(Washington, D.C.: Council of State Planning Agencies, 1981), vol. 12, p. 13.

35Institute for Fiduciary Education, Economically Targeted Investments.

36Center for Policy Alternatives, Economically Targeted Investments.

37New York State Industrial Cooperation Council, Competitive Plus: Economically Targeted

Investments by Pension Funds (New York: February 1990).

Page 25 GAO/PEMD-95-13 Public Pension Plans
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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.

Economic Effects of Seven

Plans’ ETI Programs

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.

38Advisory 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).

Page 26 GAO/PEMD-95-13 Public Pension Plans
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Table 4: Reported Estimated Effects of ETI Programsa

Estimated direct effect

State ETI program

Jobs created or

retained Payroll Sales revenue Tax revenue

Colorado

Bond purchases 1,241 b b b

Venture capital 4,603 b b b

Private placement 200 b b b

Massachusetts

Venture capital 4,800 $199 b $68

Minnesota

Venture capital 2,115 b $656.6 b

Bond purchases b b b b

CD purchases b b b b

New York City

CPC loan purchase b b b b

SBA loan purchases 550 b b b

Pennsylvania

Venture capital 6,850 $145 b b

Wisconsin

Venture capital b b b b

Private placement b b b b

CD purchases b b b b

Wyoming

Loan purchases b b b b

aDollars in millions.

bNot 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

Page 27 GAO/PEMD-95-13 Public Pension Plans
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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 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

Page 28 GAO/PEMD-95-13 Public Pension Plans
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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

39Statement 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.

Page 29 GAO/PEMD-95-13 Public Pension Plans
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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.

Matter for

Congressional

Consideration

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

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

40Lawrence Litvak, Pension Funds and Economic Renewal, Studies in Development Policy

(Washington, D.C.: Council of State Planning Agencies, 1981), vol. 12, p. 4.

Page 30 GAO/PEMD-95-13 Public Pension Plans
B-254060 

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

Page 31 GAO/PEMD-95-13 Public Pension Plans
Contents

Letter 1

Appendix I 

State Business

Development ETI

Programs

34

Appendix II 

Financial Returns of

ETI Programs

Examined in Our Case

Studies

36

Appendix III 

Advisory Panel

53

Appendix IV 

Comments From the

Department of Labor

54

Appendix V 

Major Contributors to

This Report

58

Glossary 59

Bibliography 62

Tables Table 1: Amount Invested in ETIs by Seven Pension Plans as of

1993, by Program Type

15

Table 2: Benchmarks Used to Analyze the Financial Returns of

ETI Programs

18

Table 3: Summary of ETI Expected Yields Relative to

Benchmarks

20

Page 32 GAO/PEMD-95-13 Public Pension Plans
Contents

Table 4: Reported Estimated Effects of ETI Programs 27

Table II.1: Financial Returns of Colorado and Minnesota ETI

Bond Purchases, Compared to Returns on Alternative

Investments

37

Table II.2: Financial Returns of New York City and Wyoming ETI

Fixed-Rate Loan Purchases, Compared to Returns on Alternative

Investments

39

Table II.3: Financial Returns of New York City Variable-Rate Loan

Purchases, Compared to Returns on 3-month Treasury Securities

43

Table II.4: Financial Returns of Colorado and Wisconsin ETI

Private Placements, Compared to Alternative Investments

46

Table II.5: Financial Returns of Minnesota and Wisconsin CD

Purchases, Compared to Alternative Investments

49

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

51

Figures Figure 1: Investments in ETI Programs by IFE Survey

Respondents, by Program Type

10

Figure 2: ETI Programs Conducted by IFE Survey Respondents,

by Program Type

11

Figure 3: States With ETI Programs 12

Figure 4: Relative Risk and Yield Characteristics of Bond

Investments

16

Figure II.1: Spreads to Benchmark on Fixed-Rate Loan Purchases 39

Figure II.2: Spreads to Benchmark on Variable-Rate Purchases 43

Figure II.3: Spreads to Benchmark on Private Placements 46

Figure II.4: ETI Venture Capital Funds 50

Abbreviations

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

Page 33 GAO/PEMD-95-13 Public Pension Plans
Appendix I 

State Business Development ETI Programs

Type of program identified

State Venture capital

Small

businessa

Private

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

Massachusetts x

Michigan x x

Minnesota x x x

Mississippi

Missouri x

Montana

Nebraska

Nevada

New Hampshire x

New Jersey

New Mexico x

New York x x

North Carolina

North Dakota

Ohio x

Oklahoma

(continued)

Page 34 GAO/PEMD-95-13 Public Pension Plans
Appendix I 

State Business Development ETI Programs

Type of program identified

State Venture capital

Small

businessa

Private

placement CD purchasing

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

aIncludes 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.

Page 35 GAO/PEMD-95-13 Public Pension Plans
Appendix II 

Financial Returns of ETI Programs

Examined in Our Case Studies

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.

Page 36 GAO/PEMD-95-13 Public Pension Plans
Appendix II 

Financial Returns of ETI Programs

Examined in Our Case Studies

Table II.1: Financial Returns of Colorado and Minnesota ETI Bond Purchases, Compared to Returns on Alternative

Investments (at Date of Purchase)

Pension system bond purchase

Benchmark

State

Investment

date

Investment

amount

Term

(years) Rating Yield Term Yield

Spread to benchmark

(basis points)

Coloradoa 02/01/93 $ 4,857,000 25.6 A 7.87% b 7.10% 77

03/31/93 7,239,000 20.3 A 8.62 b 6.80 182

Minnesotac 12/12/84 14,000,000 20.0 AA 11.70d e 11.50 20

aData from September 30, 1993.

bBenchmark 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.

cData from July 31, 1993.

dThe 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.

eBenchmark 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.

Page 37 GAO/PEMD-95-13 Public Pension Plans
Appendix II 

Financial Returns of ETI Programs

Examined in Our Case Studies

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.

Page 38 GAO/PEMD-95-13 Public Pension Plans
Appendix II 

Financial Returns of ETI Programs

Examined in Our Case Studies

Figure II.1: Spreads to Benchmark on

Fixed-Rate Loan Purchases Number of loan purchases

0

5

10

15

20

25

30

35

40

45

50

100+

basis

points

below

100 to 1

basis

points

below

0 to 100

basis

points

above

100+

basis

points

above

8

15

49

14

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)

Pension system loan purchase

Benchmark

City or state

Investment

date

Investment

amount

Term

(years) Yield Terma Yield

Spread to benchmark

(basis points)

New York Cityb 08/12/92 $1,300,000 18.0 8.22%c d 8.15% 7

10/14/92 120,886 6.8 9.25 7 5.90c 335

12/02/92 135,000 20.0 7.65 20 7.26 39

Wyominge 10/24/78 112,500 15.9 9.50 15 8.54 96

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

(continued)

Page 39 GAO/PEMD-95-13 Public Pension Plans
Appendix II 

Financial Returns of ETI Programs

Examined in Our Case Studies

Pension system loan purchase

Benchmark

City or state

Investment

date

Investment

amount

Term

(years) Yield Terma Yield

Spread to benchmark

(basis points)

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

(continued)

Page 40 GAO/PEMD-95-13 Public Pension Plans
Appendix II 

Financial Returns of ETI Programs

Examined in Our Case Studies

Pension system loan purchase

Benchmark

City or state

Investment

date

Investment

amount

Term

(years) Yield Terma Yield

Spread to benchmark

(basis points)

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

(Table notes on next page)

Page 41 GAO/PEMD-95-13 Public Pension Plans
Appendix II 

Financial Returns of ETI Programs

Examined in Our Case Studies

aTreasuries, in years.

bData for February 15, 1994.

cInvestment guaranteed by the State of New York Mortgage Authority.

dBenchmark was AA-rated long-term (25-30 year) new financial bonds.

eData 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.

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.

Page 42 GAO/PEMD-95-13 Public Pension Plans
Appendix II 

Financial Returns of ETI Programs

Examined in Our Case Studies

Figure II.2: Spreads to Benchmark on

Variable-Rate Purchases Number of loan purchases

0

5

10

15

20

25

30

35

40

45

50

55

60

65

100+

basis

points

below

100 to 1

basis

points

below

0 to 100

basis

points

above

100+

basis

points

above

0 0 0

62

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

Investment date

Investment

amount

Term

(years)

Yield at

purchase

Yield on 3-month

Treasury securities

Spread to Treasuries

(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

(continued)

Page 43 GAO/PEMD-95-13 Public Pension Plans
Appendix II 

Financial Returns of ETI Programs

Examined in Our Case Studies

Investment date

Investment

amount

Term

(years)

Yield at

purchase

Yield on 3-month

Treasury securities

Spread to Treasuries

(basis points)

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

(continued)

Page 44 GAO/PEMD-95-13 Public Pension Plans
Appendix II 

Financial Returns of ETI Programs

Examined in Our Case Studies

Investment date

Investment

amount

Term

(years)

Yield at

purchase

Yield on 3-month

Treasury securities

Spread to Treasuries

(basis points)

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

aData 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

Page 45 GAO/PEMD-95-13 Public Pension Plans
Appendix II 

Financial Returns of ETI Programs

Examined in Our Case Studies

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 Number of private placements

0

5

10

15

20

100+

basis

points

below

100 to 1

basis

points

below

0 to 100

basis

points

above

100+

basis

points

above

0

8

17

9

Table II.4: Financial Returns of Colorado and Wisconsin ETI Private Placements, Compared to Alternative Investments (at

Date of Purchase)

Pension system private placement

State

Investment

date

Investment

amount

Term/average

life (years) Rating Yield

Benchmark

yield

Spread to benchmark

(basis points)

Coloradoa 05/29/73 $4,000,000 30.0/b A 7.60% 7.65%c –5

10/15/79 9,917,000 25.0/b d 10.25 10.14e 11

5/19/82 8,592,000 12.4/b A 15.80 15.75f 5

5/17/84 22,994,000 10.4/b A 13.00 13.63f –63

08/17/87 49,391,000 13.9/b b 9.40 b b

Wisconsing 07/18/73 3,000,000 25.0/18.0 AAA 8.00 b b

11/07/85 3,500,000 13.0/10.0 AAA 11.88 10.30h 158

04/02/66 1,500,000 30.0/23.0 AA 5.45 b b

12/05/85 25,000,000 15.0/7.0 AA 8.18 b b

12/04/91 10,603,000 14.0/6.0 AA 8.21 b b

05/16/73 1,800,000 25.0/16.0 A 8.50 7.65c 85

01/09/86 10,000,000 15.0/9.0 A 10.30 9.70h 60

(continued)

Page 46 GAO/PEMD-95-13 Public Pension Plans
Appendix II 

Financial Returns of ETI Programs

Examined in Our Case Studies

Pension system private placement

State

Investment

date

Investment

amount

Term/average

life (years) Rating Yield

Benchmark

yield

Spread to benchmark

(basis points)

03/05/87 $15,000,000 12.0/9.0 A 8.63% 8.00%h 63

05/06/87 3,000,000 10.0/6.0 A 9.75 8.88i 87

04/06/88 10,000,000 15.0/8.5 A 10.10 9.50f 60

06/02/88 5,000,000 15.0/9.0 A 10.80 10.10f 70

05/30/90 3,000,000 10.0/6.0 A 10.50 9.85i 65

09/05/91 10,000,000 15.0/10.0 A 9.05 8.85f 20

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 11.50f –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 8.95c 180

11/08/85 1,419,000 15.0/10.0 BBB 12.25 11.00h 125

11/08/85 1,150,000 15.0/10.0 BBB 12.25 11.00h 125

01/08/87 9,000,000 15.0/9.0 BBB 9.25 8.75h 50

08/06/87 4,000,000 15.0/9.0 BBB 10.70 9.80h 90

09/03/87 9,000,000 15.0/9.5 BBB 10.90 10.15h 75

10/08/87 17,000,000 20.0/12.0 BBB 10.90 10.85h 5

11/10/87 20,000,000 15.0/8.0 BBB 10.90 10.38h 52

03/03/88 35,000,000 15.0/8.5 BBB 10.50 9.30h 120

06/02/88 5,000,000 10.0/6.5 BBB 11.25 10.25h 100

08/04/88 4,000,000 15.0/10.0 BBB 11.25 10.15h 110

10/06/88 7,500,000 15.0/9.0 BBB 11.00 9.88h 112

01/04/90 12,500,000 15.0/10.0 BBB 9.75 9.45h 30

05/30/90 5,600,000 15.0/8.5 BBB 9.88 10.55h –67

07/11/90 10,000,000 15.0/12.0 BBB 9.85 9.90h –5

10/22/90 12,000,000 11.5/8.0 BBB 10.03 10.80h –77

10/22/90 14,000,000 18.5/15.0 BBB 10.65 10.80h –15

11/05/90 10,000,000 10.0/7.5 BBB 10.15 10.40h –25

09/05/91 20,000,000 10.0/7.0 BBB 9.49 9.00h 49

03/03/92 11,756,000 18.5/12.5 BBB 9.84 8.30h 154

09/05/85 7,500,000 10.0/6.0 BB 12.50 b b

12/03/87 20,000,000 15.0/8.0 BB 9.80 b b

08/04/88 5,000,000 15.0/10.0 BB 11.82 b b

08/04/88 10,000,000 10.0/7.0 BB 10.97 b b

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

(continued)

Page 47 GAO/PEMD-95-13 Public Pension Plans
Appendix II 

Financial Returns of ETI Programs

Examined in Our Case Studies

Pension system private placement

State

Investment

date

Investment

amount

Term/average

life (years) Rating Yield

Benchmark

yield

Spread to benchmark

(basis points)

12/07/89 $3,600,000 16.0/10.0 BB 10.85% b b

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

aData from September 30, 1993.

bNot available.

cBenchmark was yield on similarly rated long-term (25-30 year) new utility and industrial bonds.

dThis 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.

eBenchmark 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.

gData from August 6, 1992.

hBenchmark 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

Page 48 GAO/PEMD-95-13 Public Pension Plans
Appendix II 

Financial Returns of ETI Programs

Examined in Our Case Studies

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)

Pension system CD purchase

State

Investment

date

Investment

amount Term

Number

of banks Yield

Yield on

alternative

investments

Spread to benchmark

(basis points)a

Minnesotab 01/18/94 $22,850,000 6 months 57 3.36% 3.34% 2

04/18/94 13,200,000 3 months 34 4.00 3.98 2

04/18/94 29,500,000 6 months 69 4.32 4.39 –7

Wisconsinc 9/9/92 5,000,000 3 years 1 5.10 4.34 76

5/6/93 3,000,000 3 years 1 4.70 4.24 46

5/18/93 3,000,000 3 years 1 4.85 4.49 36

7/1/93 1,000,000 3 years 1 5.00 4.37 63

7/15/93 500,000 3 years 1 4.90 4.34 56

9/3/93 500,000 3 years 1 4.95 4.04 91

9/22/93 8,000,000 3 years 1 4.60 4.22 38

10/8/93 500,000 3 years 1 4.80 4.09 71

10/21/93 5,000,000 3 years 1 4.65 4.19 46

11/5/93 4,500,000 3 years 1 4.66 4.53 13

2/28/94 2,000,000 3 years 1 5.50 5.04 46

3/18/94 1,900,000 3 years 1 5.90 5.42 48

aBenchmarks 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.

bData from April 22, 1994.

cData 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.

Page 49 GAO/PEMD-95-13 Public Pension Plans
Appendix II 

Financial Returns of ETI Programs

Examined in Our Case Studies

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

Number of funds

0

1

2

3

4

5

6

7

Fourth Third Second First

Venture Economics quartile

6

4

5

1

Page 50 GAO/PEMD-95-13 Public Pension Plans
Appendix II 

Financial Returns of ETI Programs

Examined in Our Case Studies

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

Pension system venture capital investment

State Fund

Total

committed

Total

invested

Initial

funding year

Internal rate of

returna

Quartile for

funding year

Coloradob A $ 5,000,000 $ 5,000,000 1982 8.3% 1

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

Massachusettsb A 2,000,000 2,000,000 1988 –9.7 4

B 50,000,000 50,000,000 1990 6.8 e

Minnesotab A 6,600,000 6,300,000 1986 4.3 2

A 10,000,000 5,600,000 1990 3.9 e

Pennsylvaniaf A 10,000,000 10,000,000 1985 –1.7 4

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

Wisconsing A 5,000,000 3,400,000 1984 c d

B 10,000,000 7,000,000 1987 c d

C 3,000,000 300,000 1991 c e

(Table notes on next page)

Page 51 GAO/PEMD-95-13 Public Pension Plans
Appendix II 

Financial Returns of ETI Programs

Examined in Our Case Studies

aAs reported by the pension funds.

bData from December 31, 1992.

cNo IRR was calculated.

dNot available.

eNo quartile analysis was available for the 1989, 1990, and 1991 funds.

f

Data from June 30, 1993.

gData 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.

Page 52 GAO/PEMD-95-13 Public Pension Plans
Appendix III 

Advisory Panel

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

Page 53 GAO/PEMD-95-13 Public Pension Plans
Appendix IV 

Comments From the Department of Labor

Page 54 GAO/PEMD-95-13 Public Pension Plans
Appendix IV 

Comments From the Department of Labor

Now p. 2.

Now p. 3.

Now p. 5.

Now p. 22.

Page 55 GAO/PEMD-95-13 Public Pension Plans
Appendix IV 

Comments From the Department of Labor

Now p. 23.

Now p. 26.

Now p. 29.

Now pp. 29 and 30.

Page 56 GAO/PEMD-95-13 Public Pension Plans
Appendix IV 

Comments From the Department of Labor

Now p. 30.

Now pp. 36 and 45.

Now p. 20.

Page 57 GAO/PEMD-95-13 Public Pension Plans
Appendix V 

Major Contributors to This Report

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

Page 58 GAO/PEMD-95-13 Public Pension Plans
Glossary1

Bond “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 “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 “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 “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 “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 “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.”

 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.

Page 59 GAO/PEMD-95-13 Public Pension Plans
Glossary1

Risk “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 “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 “The possibility that a fixed-rate debt instrument will decline in value as a

result of a rise in interest rates.

Liquidity Risk “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 “[The chance that] a debt obligation [will be prepaid] before it becomes

due.

Repayment (Credit) Risk “The chance that a borrower or trade debtor will not repay an obligation

as promised.

Risk of Principal “The chance that invested capital will drop in value.”

Venture Capital “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

“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

Page 60 GAO/PEMD-95-13 Public Pension Plans
Glossary1

partners’ profits could be realized from the sale of formerly private stock

to the public.”

Yield “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 “The difference in yield between various issues of securities.”

Page 61 GAO/PEMD-95-13 Public Pension Plans
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