Texas could be the model for an investor-friendly public funds investment market, with a robust state-sponsored local government investment pool and a number of sizable alternatives that provide public funds investors competitive choices, low fees, risk guardrails and significant disclosure requirements.

• The strength of the industry traces back to a “near-death” run on the state’s pool in 1994 and a resulting state law that provides a comprehensive framework for operations.
• Texas has seven local government investment pools that offer a total of 14 portfolios, including government, prime and fixed rate options.  LGIP assets total about $115 billion.
• The state-sponsored Texpool program sets a high standard, with state oversight, an outside manager who is a major sponsor of money market funds, very low expenses and a high level of disclosure/transparency.  It has nearly $50 billion of assets in a government and a prime portfolio.
• Two other programs have assets of more than $20 billion each, and performance histories that go back to 1987 and 1996. Each is sponsored by one or more statewide associations who receive sponsorship fees.
• While this might seem like a well-served market, Meeder Public Funds, which manages LGIPs in two states with $1.85 billion of assets, has jumped in with a new offering, Texas-Connect. Time will tell whether this new pool will succeed, but it is interesting that a newcomer would venture into this (mature?)  market.

The details. Texas is the second most populous state, and with 5,500 local governments also ranks second in the number of public units. This makes for fertile ground for LGIPs, whose purpose is to pool funds from multiple governments for investment purposes.

Texpool, the state-sponsored LGIP, sets a strong standard. It was organized in 1989 and it was managed by the Texas State Treasury until there was a run on the fund in 1994 precipitated by a sharp rise in short term interest rates and a maturity structure that did not permit it to keep up with short term yields. (Another victim was the Orange County, California investment pool that led to the county declaring bankruptcy.)

Today’s Texpool is quite different than the troubled pool of 1994. It remains under state control, supervised by the State Comptroller of Public Accounts. It offers two stable net asset value portfolios:  One government-oriented and one invested in prime money market securities. It is managed by a well-established outside manager (Federated Hermes) under requirements of a state interlocal government cooperation act that requires a high degree of disclosure, and it charges very low fees (5.5 basis points for the prime portfolio and 4.5 basis points for the government portfolio). 

 This could be a prescription to dominate the market, but in fact competition is strong, with a number of competing pools. Three alternatives, Lonestar, sponsored by the Texas Association of School Boards, Texas CLASS, managed by Public Trust Advisors, and TexSTAR, managed by JP Morgan and marketed by Hilltop Securities have total assets of about $60 billion.

Not all Texas LGIPs publish daily seven-day yields on their websites, but the yields of the Texas LGIPs that are regularly disclosed have all tracked closely to the Public Funds Investment Institute’ s LGIP indices. State law requires that pools maintain the top money find rating and rating agency requirements limit the extent that active management of maturities, security selection and liquidity can affect yields. Thus, it appears that the yield differences among pools are largely explained by differences in expenses charged.

Yet a well-developed market does not seem to have deterred a new entrant. Texas-Connect received a rating from S&P Global in May and is likely to commence operating soon. Whether Texas-Connect can produce a competitive yield will depend importantly on the fees charged. The disclosure document for the pool indicates that fees will be a maximum of 17 basis points. It’s likely that its manager, Meeder, would have to waive a significant portion of fees if it aims to offer a yield in line with Texpool and the other large pools. 

One other interesting aspect of the Texas pools is who has ultimate control over their operations. State law requires that pools have an advisory board but does not specify the powers of the board. Some of the pools are organized in a manner where the advisory board is elected by participants and has oversight and supervisory authority (for example it hires the investment manager, sets the investment policy, etc.). But these specific powers, akin to the powers of the board of trustees of a registered investment company, are not required to be assigned to the advisory board and they could lodge elsewhere.

Texpool is controlled by the Texas Comptroller of Public Accounts. Texas-Connect has both an advisory board and a board of trustees. The board of trustees is responsible for managing and administering the trust. It consists of an officer of Meeder, a retired treasurer of the Columbus Ohio City Schools and the executive director of an Illinois LGIP.

 New Hampshire encourages but does not require that its LGIP invest funds through in-state banks. Earlier this year we reported on efforts by community bankers in New Hampshire to rein in LGIPs in their state. The community banks are squeezed by their super-sized competitors and pressured by high short term interest rates that force them to pay up for deposits. Bankers may see LGIPs as part of the problem because they may invest participant assets directly in the securities issued by large money center banks which tend to pay higher rates than community banks.

Community bankers in New Hampshire mounted an effort to require that the state-sponsored LGIP, the New Hampshire Public Deposit Investment Pool, invest its assets in deposits issued by in-state banks. They argued that this would put public funds to work supporting lending to New Hampshire businesses.

Local government officials countered that such a restriction would reduce their earnings on public funds by limiting the ability of NH PDIP to invest in the national money markets, and that there was no way to account for whether public funds deposits directed into New Hampshire banks actually increased loans to New Hampshire institutions.

The New Hampshire legislature resolved this conflict by directing that NHPDIP’s investment advisor “shall strive to place funds” in bank deposits with state banks so long as the pool “shall achieve and maintain the highest attainable rating for stable value investment pools.” 

 Practically speaking this is unlikely to lead to major changes in the investment strategies of NH PDIP,  Community banks will be able to bid for public funds but will have to structure their investment/deposit offerings so as to meet the AAA rating requirements of the pool, and NH PDIP’s continued access to the national markets should produce a yield that is in line with money fund and LGIP rates nationally.  Las week the NH PDIP yield was 5.34% which compares with the PFII Prime index rate of 5.43%.

Nebraska bankers sought to “Level the playing field.” Nebraska bankers mounted an effort to “level the playing field” between banks and LGIPs, to quote from a statement by the president of the Nebraska Independent Community Bankers Association. Early in the state’s legislative session they supported a bill that would require LGIPs in the state—there are three of them—to disclose risks, including “liquidity risk,” disclose that investments in the LGIPs are not insured by the Federal Deposit insurance Corporation and put guardrails around the use of commercial paper. 

LGIP sponsors wanted legislation to clarify the ability of local government investment pools to invest in commercial paper.

The new law authorizes but limits commercial paper holdings to 50% of a portfolio, requires that the commercial paper be rated in the highest short-term rating by at least two credit rating agencies, and limits holdings to five percent of a portfolio per issuer.

The new law also authorizes investment in government money market funds.

One of the guardrails initially included would have required that marketing representatives of pools be licensed by FINRA. A representative of Public Trust Advisors objected to this specific requirement. In its place the legislation, as finally written, requires that marketing representatives maintain “any license required by federal or state law.”