Leveling the Playing Field: A Review of GIPs (Part II)

In Part I of this article, we reviewed the yield data about state and local government investment pools (GIPs) across the United States. The data show that there was nearly a 100-basis-point difference between what a cash manager in one state makes on simple overnight money versus that of another. For example, TexPool Prime was paying 3.36 percent as of June 30, 2005, whereas another pool serving schools was earning only 2.48 percent!

While the spread between underperforming and outperforming GIPs can be large at any point in time, it is equally important to note that these differences persist over time. For example, on December 31, 2004 when prevailing short-term interest rates were generally lower, the spread between the highest and lowest performing GIPs was 107 basis points.

There are a number of benchmarks available that assist in measuring relative performance. The exhibit below shows several industry benchmarks that a government treasurer could track for this asset class. The benchmarks are comprised of $1 NAV pools and are similar in terms of credit and liquidity risk. The S&P All-Rated Index and TRACS Pool Composite Index show similar yields, since they track a very similar universe of GIPs. The TRACs pool composite is subdivided into rated and non-rated components and they have performed very similarly as of June 30, 2005.

In addition, the firm iMoneyNet tracks the top money market mutual funds (MMMF) available to institutional investors like municipalities, and their performance mirrors the top performing GIPs. The top-performing GIPs in the TRACS index yielded 3.23 percent in the period, only 2 basis above top-performing money market funds. An important difference is that money market funds are available nationally, whereas GIPs typically are available intra-state only.

Exhibit 1: Institutional Benchmarks as of June 30, 2005

Note: Yields are net of fees. Source: TRACS Financial, S&P, and iMoneyNet

Lessons to Learn. What is the data presented in Part I and Part II telling us? In my opinion, we can draw several inferences from the data:

• Competition creates better yields. As we know from Texas, governments can place their liquidity funds in one of several pools. Absent such competition, or in states with below average pool yields (e.g., pool yields below the TRACS Pool Composite Index of 2.93 percent), money market mutual funds could create immediate results. If you are a treasurer in a state with below average GIP yields and can legally invest in money market mutual funds, you may be able to earn better yields on your overnight balances and influence the pools to become more competitive. (Of course, this requires a government to exercise due diligence in a selection of such a fund, focusing on lower-cost MMMFs with appropriate investment policies.) The same money management firms operating GIPs may also offer competitive money market mutual funds products. Shop and compare.
  
• School districts appear to have more of the low-yield pools in the nation. Because of the level of competition in the money market asset class, and because yields are generally low in this asset class, the level of fees has a dramatic impact on income earned by investors (compared to bond funds further out on the yield curve, which have more “room” for fees). Not surprisingly, our firm's research indicates that higher fees correlate with lower yields. Treasurers, particularly school treasurers, need to be cognizant of these costs, including fees that are layered upon ordinary money management fees. These may include fees allocated to a state or local entity that sponsors or endorses the pool and that covers certain services.
  
• State pools have higher yields. As note in part I of this article, state pools nationwide provided about 30 basis points more in yield than local pools as of May 30, 2005. In my view, this can be attributed to the fact that their fees are lower than almost all LGIPs and can exploit economies of scale.

Conclusions. According to the efficient market theory, yields on fixed-NAV pools should all be within a narrow band at any point in time, with narrow spreads between the highest- and lowest-performing pools. However, in this article we have observed significant differences among pools across the United States. If government treasurers are dissatisfied with the pool yields they have realized, they have several options to consider including a) other pools if permissible, b) institutional money market mutual funds, or c) separately managed accounts.

Jeff Flynn is founder of Tracs Financial. For more information regarding GIP research or alternative investments, please contact the author Jeff Flynn at info@tracsfinancial.com or visit the website at www.tracsfinancial.com. For confirmation of firm data or sources regarding pool and fund yields, please refer also to the Web sites of iMoneyNet and S&P.

Panel of Economists

Housing Bubble About to Burst?

Federal Reserve Board Chairman Alan Greenspan has called the housing market “frothy” in particular regions of the United States and some have warned that a bursting of a housing market bubble might have a bigger effect on the economy than the dot.com crash in the equities market that occurred several years ago. To illustrate the level of froth, PMI Mortgage Insurance predicts that six hot real estate markets in Massachusetts, New York, and California will have a greater than 50 percent chance of experiencing a price decline in the next two years.

This month, Public Investor asked its panel of economists if the housing market is indeed about to burst. We also asked what would be the likely impact of a burst (or other likely event) on the economy and interest rates.

Adolfo Laurenti of LaSalle Bank/ABN Amro does not anticipate a “burst” in the housing market. However, he does expect a correction that will probably lead to a slowdown, but not a dramatic downturn, in house prices. He anticipates that private consumption will taper off in 2006, because of less carry-over spending and a reduction in the wealth effects caused by increased housing values. He predicts that interest rates will rise slowly during the second half of this year, but should remain stable during 2006.

John Silvia of Wachovia Securities also does not expect that the housing market will burst. At the same time, he does anticipate a flatter trajectory for home prices.

Solid Growth, Low Inflation…What's Not to Like?

Current economic data suggest that the economy is growing solidly with low inflation. In his most recent testimony before Congress, Fed Chairman Alan Greenspan indicated that the economy has moved through the “soft patch” from last spring and is now on a “firm footing.” Some economists have suggested that the economy is returning to a “Goldilocks” condition in which economic growth and inflation is “not too hot, not too cold.”

A recent survey of economists conducted by the National Association for Business Economics predicts solid growth in the economy with a majority of economists forecasting average GDP growth of 3 to 4 percent for the second half of this year. In addition, the University of Michigan consumer confidence survey rose to the highest level in three years.

Despite solid growth, inflation remains low, and the producer price index (PPI)—a leading indicator of inflation—was unchanged from the previous month. Over the past 12 months, the PPI has risen 3.6 percent.

RGM

“Measured” Fed Rate Hikes Continue Unabated

As widely expected, the Federal Reserve Open Market Committee decided to raise the Fed Funds rate 25 basis points to 3.25 percent at its most recent meeting on June 30. Thus far, the Fed has raised rates nine times since it began tightening last year. The Fed's next meeting is on August 9, where it is also expected to raise rates 25 basis points. The Fed Funds futures market expects that the Fed will continue to raise the Fed Funds rate through the rest of the year and predicts a rate of 3.75 percent by October with a 70 percent probability. The Fed Funds futures market has very accurately predicted the Fed's policy moves over the past two years. Fed watchers disagree on when the Fed will stop raising rates. Some Fed watchers predict that the Fed will stop when it reaches 4.5 percent next year, while others predict that the Fed will stop much sooner, in order to avoid inverting the yield curve and tipping the economy into a recession.

RGM

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