State investment officers searching for balance

Keeping state coffers stocked and liquid requires a delicate mix of analysis, hedging and listening, with an emphasis on remaining nimble over the coming months.

“Over the last eighteen months, the Fed’s told you what the answer is, and the market has continually bet against them,” said Thomas Waters, chief investment officer, Pennsylvania Treasury.

 “They’ve said they’re going to raise rates, they said they’re going to maintain higher rates. Chairman Powell is talking about a cut that may become two by the end of the year. But that’s certainly less than what’s in the market assumptions.”

The comments came during the National Association of State Treasurers, legislative conference happening this week in Washington DC.  The relative health of state treasuries remains an area of interest and speculation in the realm of public finance because of its direct impact on credit ratings and the states’ ability to issue debt. 

According to the National Association of State Budget Officers, most states ended fiscal year 2023 with budget surpluses and overflowing rainy day funds, which has resulted in nearly forty states cutting taxes. Recent numbers indicate the surplus may be temporary. 

“State tax (revenues) have really come down,” said Michael Brakebill, chief investment officer, Tennessee Department of Treasury.  “A few years ago, they were growing at eight, nine, ten percent per year. That’s basically gone flat.” 

The investment experts agreed with the notion of remaining nimble in a financial climate affected by geopolitical volatility and upcoming elections. 

“We want to keep a very liquid portfolio that’s balanced,” said Ted Wright, chief investment officer, Connecticut Retirement Plans and Trust Funds. “We have more variably-liquid public equities in our portfolio.  On the bond side, we have longer duration, variable liquid high-rated securities providing somewhat of a balance.” 

The preferred liquidity ratio is a moving target. Wright pegged Connecticut at 60% liquid, Brakebill has Tennessee at 60%-65%, Waters described Pennsylvania as “highly liquid,” and Joe Aguilar, chief investment officer for Illinois, indicated the state is nearly 90% liquid.        

 All the CIOs seem cautiously optimistic about placing future bets on private equity investments which falls under the alternative asset category.

Alternative assets also include real estate, private debt, and hedge funds. Some taxation pundits question the valuation risk associated with alternatives as they are sometimes based on fair price estimates  as compared to actual market prices.   

“If you look at the returns of markets for the past several years, what you see is these huge swings back and forth with public and private markets,” said Brakebill. “This past year was a huge year for public markets, and in some portfolios private assets kind of lagged. The prior year, public markets got creamed and private markets did really well.”  

The CIOS are hearing a lot of pitches about the high returns offered by emerging markets but when they compare the numbers against U.S. equity sources, domestic capitalism usually comes out ahead in the long term.

Treasury bonds still hold an appeal but come standard with a cost. “The one thing you want to earn on is long-term treasury bonds,” said Brakebill. “That is the number one asset that protects you in a big downturn. The sad thing is it’s very costly to own those in the long term, because they don’t have a high rate of return, but it’s still a significant piece of our portfolio, 18% or so.” 

The fact that cash is currently paying 5% is not lost on the financial experts, but they are the first to admit that predicting that markets is not a science. “Someone asked me what’s my forecasting skills,” said Wright. “I said I just go to the pet store get a chimpanzee and tell him to throw a dart against the wall, and he’s usually better than I am.”