Pension plan sponsors have increased attention to risks related to derivatives and leverage in the wake of the huge losses taken by Orange County, Calif., consultants and money managers say.
Sponsors want to know what derivatives are in their portfolios and how they are being used, they say. The message being returned to clients is that derivatives have their place in investment portfolios, although understanding and controls regarding their use are essential.
Securities-lending operations are also receiving scrutiny, given their likeness to reverse repurchase agreements. Reverse repos were one transaction former Orange County Treasurer Robert Citron used to boost returns in the county's portfolio.
Edgar Barksdale, president of RCB International, a manager-of-managers firm in Stamford, Conn., said "virtually every client is doing a due diligence check" for their portfolios.
"The message is not to stop using derivatives," Mr. Barksdale said, only that investors "should understand very carefully what (they're) doing with them."
Used properly, derivatives pose no threats, he said.
RCB uses derivatives for hedging and equitizing cash, he said.
Stephen Nesbitt, senior vice president for consultant Wilshire Associates Inc., Santa Monica, Calif., said Wilshire also is focusing on securities lending because of its likeness to reverse repos.
Based on press accounts, Mr. Nesbitt said Orange County's strategy is effectively the same as a securities lenders: borrowing short and investing long.
"Essentially, securities lending is a reverse repo," referring to the borrowing of cash against securities owned, he said.
The losses at Orange County, coupled with disclosed losses in securities lending at Mellon Trust and Harris Bank, have sponsors questioning whether the risks of securities lending are worth the income, Mr. Nesbitt said.
While there won't be a full-scale retreat from securities lending, sponsors might become more selective in what types of securities they will lend if profits aren't sufficient, Mr. Nesbitt said.
But Michael O'Leary, executive vice president in the Denver office of consultant Callan Associates Inc., said he hasn't seen a "huge groundswell" of concern from clients following Orange County's bankruptcy. He did say sponsors are more willing to focus on derivatives and leverage once the subject is raised.
Clients of Miller, Anderson & Sherrerd, West Conshohocken, Pa., are showing a real interest in derivatives education following the Orange County disaster, said Kathryn J. Engebretson, who works in client servicing for the firm. Hence, Ms. Engebretson and another MAS employee produced a 28-page report on the firm's use of derivatives. The report details some of the highly publicized derivatives blow-ups that took place in 1994, and includes descriptions of many different types of derivatives.
The report also includes explanations of how MAS uses derivatives, but highlights the importance of following the word and the spirit of investment guidelines.
Similarly, investment firm Mississippi Valley Advisors, St. Louis, is getting regular questions on use of derivatives. "It's probably the No. 1 question coming up," said John H. Blixen, president. "People are extremely leery" of getting into a similar situation.
At the government level, the Orange County debacle has served as a wakeup call that appropriate investment guidelines should be in place.
Mark W. Bloss, a senior vice president for Federated Investors, Pittsburgh, said most governmental units he has come across either didn't have investment guidelines in place or have guidelines that are outdated.
"Back when these policies were invented, they didn't anticipate inverse floaters," he said referring to fixed-income securities that pay a smaller coupon as interest rates rise. Many of them were mainly limited to investing in government securities, which isn't sufficient, he said.
He said most guidelines he has seen couldn't have protected the government units from an Orange County-type of loss. "A lot of municipalities missed the bullet," but are now trying to prevent future losses, he added.