Increasing Pressure Comes To Bear On State School-Fund 'Nest Eggs'

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Texas lawmakers could scarcely have imagined the rich harvests they would reap from the $2 million they set aside in 1854 to support public schools.

Nurtured over the years by the proceeds from 46.5 million acres of land--much of it covering oil--the fund grew wildly. Mineral royalties, leases, and investments have boosted the value of the 142-year-old fund to $13 billion, and last year it generated $1.4 billion for textbooks and state school aid.

But Texas and some two dozen other states with "permanent school funds"--money or land set aside to generate interest for public schools--are experiencing growing pains. Under pressure to maximize revenues, policymakers are weighing the risks of more aggressive investments. And people are even asking who should manage the billion-dollar nest eggs--in-house staff members or private brokers.

"The founding fathers had the vision to put aside public land for education," Adrian Gentry, the fund's senior portfolio manager, said recently. "And it was lucky enough to be valuable from a mineral standpoint."

The robust funds are a tempting target for politicians who have gobbled up their revenues in lean times.

"We have to work with legislators," said Rene Nunez, the chairman of the Texas state school board's school fund subcommittee. "We must convince them of better ways to do things."

Different Strokes

Most permanent school funds began with federal land grants or cash endowments before or around the turn of the century. The funds' principals, as well as their school beneficiaries, are constitutionally protected. State treasurers are usually designated as the custodians.

That is where most similarities end, however, as the states use their funds in strikingly different ways.

  • The Texas Permanent School Fund guarantees local school bonds. Participating districts get AAA ratings and, in turn, enjoy lower finance charges. The fund has backed $10.4 billion in bonds in 951 districts since voters approved the practice in 1983.
  • Louisiana's Education Quality Trust Fund, worth about $700 million, splits revenue between K-12 schools and state colleges. Each group will get $29 million this year. The K-12 funds, awarded by competitive and block grants, pay for innovative local programs, a priority that gets no other state funding, according to Leilani Urbatsch, the program director.
  • Created in 1810, the Virginia Literary Fund has a principal of $338 million. It provides low-interest loans for facility improvements. Loans range from $50,000 to $5 million. Interest rates range from 2 percent to 6 percent, depending on district wealth. Last year, $49 million in loans were awarded.

The money in Virginia's fund comes from criminal fines, property forfeitures, unclaimed lottery winnings, investments, and loan repayments.

"Where else can you get 2 percent interest rates?" said Kathryn Kitchen, the chief of the Virginia education department's budget division.

And some states simply use the annual interest payments to help provide general state aid.

For example, Arizona's rapidly growing State Land Trust, expected to be worth $1 billion by 2000, generated $63 million last year for school aid. Minnesota's $418 million permanent fund earned $31 million for schools.

Pressure To Grow

But steady and sizable returns are not always enough, and there can be a political price to pay when income from the funds drops.

Texas' fund has earned an impressive 12.9 percent average annual yield over the past 10 years. But with oil revenue sagging, state school board members last year hired three private money managers to invest $3.5 billion of the fund's assets. The private firms were allowed to invest in international markets.

State officials argued that more heavily staffed and diversified private firms could get better returns on the state's money.

So far this year, the stock investments made by the in-house managers had grown by 14.3 percent while the private brokers had seen a 14.9 percent return, according to a recent state report.

Before handing part of its assets to brokers, the fund had been managed entirely by an 11-person staff at the state education agency.

"We just didn't have the personnel, expertise, or research it takes," Mr. Nunez said. "We were missing great possibilities to provide students of Texas with greater opportunities."

Texas officials say it is too early to decide whether $3.5 billion is better off in the hands of a private broker than state-employed money managers. But Mr. Nunez is keeping an eye on the bottom line.

"Regardless of cost, if they result in higher yield, then it's worth it," he said. The three firms, based in Boston and Los Angeles, receive a fee plus a portion of their earnings.

But looking for private managers does not guarantee increased revenues, warned John Petersen, the president of Government Finance Group Inc., a financial consulting firm in Arlington, Va. And private brokers are not always sensitive to political concerns when they are looking for a profitable investment.

"The question is, when you go out into the private sector, what are the guidelines?" Mr. Petersen said. "A lot depends on how structured you are for risks."

Watch Out for Tobacco

In managing state school funds, risks can include public relations problems, as Texas found out when two of the private firms invested $9 million from the fund in tobacco companies. Faced with public criticism, the companies dropped the stocks this fall.

"You can't try to teach children the evils of tobacco and make money off their stocks," state school board Chairman Jack Christie told reporters at the time.

Louisiana's school fund became a hot political issue in this fall's race to replace retiring U.S. Sen. L. Bennett Johnston, a Democrat.

Republican Woody Jenkins accused Democratic nominee Mary Landrieu of losing $52 million from the education trust through bad investments toward the end of her eight years as state treasurer.

The losses came in spite of a 1994 constitutional amendment allowing the treasurer to invest up to 35 percent of the fund in stocks in order to boost its income.

"You don't want someone who lost $52 million for our college students and schoolchildren getting her hands on your Social Security money," Mr. Jenkins said.

Ms. Landrieu, who won the election, countered that the fund actually grew 8.3 percent overall during her tenure.

Legislative Auditor Daniel G. Kyle reported recently that a weak bond market caused losses in Ms. Landrieu's last year in office. He added that the fund would have made $1.7 million more if certain investments had not been sold.

In Virginia, the overseers of the Literary Fund attempted to increase their profits by folding the principal into the state's $2.3 billion general-investment fund.

The effort was seen as a sound strategy, said State Treasurer Susan F. Dewey. In the year since the change, the fund's return has increased.

"It was more a question of economies of scale," she said. "The fund generates greater return as part of a larger investment package."

Meanwhile, states like Arizona, Minnesota, and Nevada are sticking to more conservative routes, investing little or none of their school funds in stocks. State constitutional requirements often force them to favor fixed-income options.

"It's a strategy designed in 1912 or 1914," Richard Petrenka, the deputy state treasurer of Arizona, said. His state's fund yielded an 8.7 percent return last year. "A balanced strategy with more in equities would be more in line with a modern portfolio structure."

Raiding Funds

Regardless of their rates of growth, these pots of money do not go unnoticed.

Arizona school officials have zeroed in on the state-land trust fund as a way to pay for leaky roofs, new books, and education for disabled students.

"We have low wealth, fairly high growth, and an inability to pay for facilities," said Jose Leyba, the superintendent of the 7,800-student Isaac school system in Phoenix.

Arizona legislators control the fund and see little wrong with the current system of converting fund profits directly to state aid.

"The legislature wants a surplus for rainy days," Mr. Leyba said.

And state school officials, while interested in looking at new uses for the fund, are not fighting to change the current system.

"From what we've seen, there's nothing remiss with the beneficiaries involved," said Jennifer Mabry, the director of fiscal policy for the education department.

But in Minnesota, Phillip Kapler, the executive budget officer of the state finance department, is pushing for a new approach to the school fund.

"It's generally agreed that our $450 million is not leveraging much for education," he said.

Mr. Kapler suggests looking at loan programs or one-time expenditures on long-term projects such as building maintenance.

But, as the name "permanent fund" makes clear, the funds were created not to bend to yearly whims but to be preserved as perpetual resources--an idea that many taxpayers still see as sound.

"Anytime you do anything to change this," Mr. Kapler said, "it requires a constitutional amendment, and people get skittish."

Vol. 16, Issue 12

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