STATE OF WEST VIRGINIA
UPDATE OF
PRELIMINARY PERFORMANCE
REVIEW OF THE
BOARD OF INVESTMENTS
OFFICE OF LEGISLATIVE AUDITOR

Major Issues of the Review Were Addressed Through Legislation

Five Recommendations are
in Compliance

Performance Evaluation and Research Division
Building 1, Room W-314
State Capitol Complex
CHARLESTON, WEST VIRGINIA 25305
(304) 347-4890

ISSUE AREA 1: Excessive Liquidity Has Resulted in the State Receiving Lower Earnings Over the Past Two Years


Recommendation 1

The BOI should work with the Legislative Auditor's Budget and Fiscal Affairs Division to develop annual projections of daily cash flow for the General Revenue Fund for the upcoming fiscal year. Thereafter, the BOI will develop these projections on its own. These 12 month projections should then be made available to advisors every month.

Level of Compliance: Planned Compliance

In the February compliance review, BOI officials indicated that they would develop a system to provide annual projections of daily cash flow without assistance from the Legislative Auditor's Budget and Fiscal Affairs Division. At that time, BOI acknowledged the need for better cash flow data. The Treasurer's Office will be responsible for providing the Investment Management Board (IMB) with cash flow data.

The Treasurer's Office intends to develop daily cash flow projections through computer software called Crystal which is being implemented by the Department of Administration. Crystal is a reporting tool that will allow State agencies to have customized reports generated from data contained in the State's automated financial system (WVFIMS). However, the use of this system has been delayed according to a written statement from the Treasurer's Office. The following is an excerpt from that statement:

However the ability of using Crystal to project future financial obligations has been delayed. The Crystal system doesn't currently provide a daily update. Therefore, we can't utilize this system to provide daily information concerning future financial obligations or information concerning daily receipt of revenue from all sources.

Officials with the Department of Administration indicated that Crystal requires additional programming which will allow it to provide daily updates of disbursements and receipts. The programming is scheduled to be complete in October 1997. The Treasurer's Office indicated that "Once the Crystal system is developed to provide our office with daily updates of revenue, we can then provide the IMB with better cash flow projections."

Recommendation 2

The BOI should consider giving advisors more specific guidelines that reflect the BOI's objectives for the Consolidated Operating Fund overall. The BOI should provide advisors specific information on what levels of liquidity the BOI desires, how much of a liquidity cushion is needed, and specific ranges of average maturities within the pool's structure, instead of giving only the top maturity limit. The performance measures may need to be adjusted periodically if specific guidelines preclude the possibility of the advisor meeting the performance measures.

Level of Compliance: In Compliance

During the February compliance review, BOI minutes showed evidence of BOI taking a more active role in providing more specific guidelines to advisors concerning the Board's investment objectives. BOI encouraged one advisor to invest more in commercial paper because too much was being invested in overnight repurchase agreements resulting in a lower rate of return than another advisor. The advisor invested in commercial paper, resulting in a higher average maturity that compares well with the other advisor of the Cash Liquidity Fund. It is too early to tell if IMB will continue this approach with the investment advisors. However, IMB's financial statements for June 30, 1997 on the Cash Liquidity Fund indicated that the repurchase agreement balance as a percent of the Cash Liquidity pool was at 34%. This is down from 56% at the time of the Legislative Auditor's initial review. The average maturity of the Cash Liquidity Fund was 67 days, up from 39 days at the time of the preliminary audit. This will generally provide a higher rate of return.

Recommendation 3

The BOI should consider rule changes that allow the Consolidated Operating Fund to be invested between the guidelines of a money market structure and a mutual fund structure.

Level of Compliance: Partial Compliance

In the February compliance review, the Executive Director of the BOI responded to this recommendation as follows:

"To the extent that the BOI can obtain better cash flows based on many of the above points (referring to response to Recommendation 2), we will be able to increase the amount of state dollars invested in longer term, higher yield investments. However, a large portion of this fund is comprised of participants who do not want the risk of a mutual fund structure."

The Legislative Auditor acknowledges that the strict sense of the recommendation has not been complied with because participants are reluctant to completely invest in a mutual fund structure. However, the restructuring of the Enhanced Yield Pool (recommendation 4) complies with some of the intent of the recommendation. The Enhanced Yield Pool was structured as a mutual fund during the preliminary audit, however, it did not provide much of an enhanced yield. The basic contention of the audit was that most of the Consolidated Operating Fund was under a money market structure with no option for investing longer term except for the Enhanced Yield Pool, which was not a significant improvement over the money market structure. The restructure of the Enhanced Yield Pool, in compliance with recommendation 4, doubled the average maturity restrictions. Agencies have been offered the flexibility of investing shorter term or longer term depending on each agency's liquidity needs. A sizable amount of funds has been added to the Enhanced Yield Pool as indicated in recommendation 4. The PERD recommends that State agencies be kept informed of their investment options and strive for better cash flow management in order to avoid excessive liquidity.

Recommendation 4

The BOI should consider restructuring the Enhanced Yield Pool to achieve a higher enhanced yield. The BOI should also consider increasing the amount within the Enhanced Yield Pool from the current level of $25 million.

Level of Compliance: In Compliance

In response to recommendation 4, BOI established new investment policy guidelines. The new guidelines restructured the Enhanced Yield Pool to allow a longer average maturity. The average maturity restriction was doubled from one to two years. According to IMB's June 30, 1997 financial statements, the new guidelines remain in effect for the Enhanced Yield Pool. Also, the amount in the Enhanced Yield Pool is $231,223,210 as of June 30, 1997. This is in contrast to the $25 million the pool contained during the preliminary audit.

Recommendation 5

The Legislature should consider amending WVC §5-10D-4 to require the actuary for the pension funds to provide the BOI with monthly projections of withdrawals and contributions for the fiscal year for each pension plan. In addition, the amendment should include the requirement that the projections be updated each quarter or more frequently if necessary. The actuary currently projects annual contributions and benefit payments for the pension funds.

Level of Compliance: Requires Legislation

Recommendation 6

The Legislature should consider amending WVC §5A-2-11 to require the Department of Administration to provide the BOI with its monthly revenue projections. The Legislature should also consider requiring the Department of Administration to project daily revenue flows for the General Revenue Fund.

Level of Compliance: In Compliance

This recommendation was resolved by the passage of Enrolled HB 4866 in 1996. This bill amended WVC §5A-2-11 as recommended. The Department of Administration is providing the monthly and daily revenue projections to the Treasurer's Office as required by HB 4866. Also, despite the repeal of BOI, §5A-2-11 still makes reference to BOI. The statute needs to be amended to have the projections submitted to the Treasurer's Office.

ISSUE AREA 2: The BOI Should Use Greater Diligence in Carrying Out Its Investment Responsibilities.

Recommendation 7

The Legislature should consider amending WVC 12-6-5(9) to require that the BOI use Delivery-versus-Payment or Tri-Party arrangements in conducting repurchase agreements.

Level of Compliance: In Compliance

The Legislature implemented this recommendation by passage of Enrolled HB 4866 in 1996. Passage of SB 563 in 1997 did not affect the language with respect to this recommendation. Under current law, IMB is required to take physical possession of securities involved in its repurchase agreements, or enter into a tri-party arrangement. IMB has made the following statement:

Currently, the WVIMB utilizes a tri-party arrangement for repurchase agreements on the Consolidated Pension Fund. Collateral for the Consolidated Fund repurchase agreements is currently done through physical possession. We are currently working on obtaining a tri-party contract for the Consolidated Fund.

ISSUE AREA 3: Management Fees Do Not Reflect Actual Costs of Managing Funds


Recommendation 8

The Legislature should consider amending §12-6-6a to allow the BOI to calculate the management service fee using an actual cost allocation formula. An alternative amendment would be to have the fee based on net assets. Net earnings are volatile and do not reflect the actual cost of investing the funds. The service fee should pay for the BOI's actual expenses, not its appropriated budget.

Level of Compliance: In Compliance

Senate Bill 563 amended the language requiring the charge of management fees for investment services. The current language requires IMB to charge management fees as a percentage of assets, which is consistent with recommendation 8. IMB has indicated that it is charging fees consistent with the statute.

Recommendation 9

If the Legislature decides to amend §12-6-6a to base the service fee on net assets, PERD recommends that the language allow the BOI to transfer to the Consolidated Pension Fund and local governments, any excess service fees charged, rather than have any overcharge diverted to the General Revenue Fund.

Level of Compliance: Requires Legislation