Public pension funds can play a role not only in ensuring retirees’ economic security, but also in promoting local economic-development goals. That’s why increasing numbers of elected officials and trustees are investigating “economically targeted investment.”Pensions ; Investments ; Community development

Doug Hoffer

English

Research Papers in Economics

Fall  2006 12
Public Pensions: 
The
Pension funds can play an
important role not only in
ensuring the economic security
of a state’s retirees, but also in
promoting local economic-
development goals. Historically,
public pension funds’ invest-
ment policies were narrowly
construed, weighing only the
rate of return for potential
investments. Today, however,
many elected officials and
trustees recognize that consider-
ing secondary effects like local
economic growth fulfills both 
a social responsibility and a 
fiduciary one. 
Effect
by 
Doug
Hoffer
Multiplier
Public Pensions: 
by 
Doug
Hoffer& Banking Communities 13
That is why more trustees are 
investigating opportunities for “eco-
nomically targeted investment” (ETI).
As financial markets and economic
conditions have changed and gaps in
traditional sources of credit have
appeared, barriers to government goals
such as small business development
and affordable housing have increased.
Officials around the country are learn-
ing that pension fund investments,
when done properly, can boost eco-
nomic development without under-
mining fiduciary responsibility.
What and Why?
California Public Employees’
Retirement System defines economically
targeted investments as risk-adjusted
market rate investments with collater-
al intent to improve “the economic
well-being of the [state], its localities,
and residents. Economic stimulation
includes job creation, development,
and savings; business creation; increas-
es or improvement in the stock of
affordable housing; and improvement
of the infrastructure.”1
ETIs are not a separate asset class but
a perspective that gauges secondary effects
as well as good financial returns: 
• Market rate returns. “ETIs are 
distinguished from ‘benevolent’ 
or ‘social’ investments. Social 
investments are made by founda-
tions, government agencies, non
profits,and individuals whose 
primary purpose is to accomplish 
some social goal. In contrast, ETIs 
must be organized to yield a 
market rate of return commensu-
rate with risk, liquidity, and 
transactional costs.”2
• Collateral benefits. Although 
most investments yield a return to 
society, ETIs are distinct because 
they provide money to under- 
financed sectors of the economy 
and fill “capital gaps.”
The societal return from most
corporate stocks and bonds is diffuse
and may not provide direct social ben-
efit to the state from which the invest-
ment originated. ETIs, however, direct
both the investment and the social
benefit to a defined geographic area. If
Vermont pension funds, for example,
target investments to Vermont, they
can get a good return, help the
Vermont  economy, and boost the tax
base (thereby supporting the security
of the state employees they serve).
Because capital markets do not
invest equally in all worthy investment
vehicles, more pension funds are look-
ing at ways to invest in the local econ-
omy without risking a poor return.3
Win-Win
Nonfederal public pension plan
fiduciaries are bound by rules defined
in state statutes, usually a variation of
those found in the Employee
Retirement Income Security Act
(ERISA), the 1974 federal law govern-
ing private pension plans. These
include cautions about prudence,
diversification, and exclusive purpose
(fiduciaries must discharge their duties
for the exclusive purpose of providing
benefits to participants and their ben-
eficiaries and defraying reasonable
administrative expenses). 
The U.S. Department of Labor’s
most recent interpretive bulletin, July
2002, reiterates that the same fiduci-
ary standards apply to ETIs as to other
plan investments, so fund administra-
tors are free to pursue them. 
State and local pension plans offer
potential for win-win investing. With
trillions in assets, they can designate at
least a portion to local economic
development. The most recent com-
prehensive survey of public pension
plans found at least 29 states have
public pension plans with some form
of ETI program.4 Assets invested in
ETI programs were estimated at about
$55 billion, with residential housing
and venture capital the most common
ETI programs.5
Because mortgage-backed securities
are safe and easily traded, public 
pension funds have made housing an
important part of their ETI programs.
According to the U.S. General
Accounting Office (GAO), almost
one-third of those programs are
focused on residential housing, with
investments in mortgage-backed 
securities, housing finance agency
bonds, investment trusts (for example,
AFL-CIO Housing Investment 
Trust), project financing, and 
direct financing. 
Some pension funds stimulate local
development through guaranteed
Small Business Administration (SBA)
loans, linked certificates of deposit,
private placement, and targeted 
venture capital. 
How Are They Doing?
According to the fiduciary stan-
dards, it is not enough to have a posi-
tive return: a market rate of return for
comparable types of investments is
required. In 1995, the GAO devel-
oped benchmarks for each type of ETI
program. Then it surveyed U.S. public
pension funds and found that most
ETI programs were  outperforming
the benchmarks.
Today the numbers of ETI programs
are growing. California’s CalPERS and
CalSTRS have large ones.6 Together
they have:  
• committed $830 million for 
private equity investment in 
businesses in underserved areas;
• committed more than $4.3 
billion to urban, in-fill real estate 
ventures, including $695 million 
for affordable housing;
• purchased $90 million in 
California home mortgages; Fall  2006 14
• purchased $260 million in 
California SBA loans; and 
• vastly increased deposits in 
community lending institutions 
and credit unions.
In Massachusetts as of March 31,
2006, the market value of the
Alternative Investment Portfolio,
which includes venture capital and spe-
cial equity partnerships, was $2.64 bil-
lion. The portfolio comprised 6.3 per-
cent of the state’s public pension trust
funds, although the asset allocation
allows up to 10 percent.7
As of December 31, 2005, the 
aggregate investments for all New York
City ETI programs since inception
amounted to more than $1 billion.
The investments went toward renova-
tion, new construction, or financing of
more than 30,000 units of affordable
housing and many small retail spaces.
They “created thousands of construc-
tion jobs and financed child-care facil-
ities and senior citizen centers. The
five-year overall return on the pension
funds’ targeted investments was 6.30
percent and the 10-year return was
8.34 percent.”8
The Texas Growth Fund was estab-
lished in 1988 and invests in the local
economy, too, specializing in “structur-
ing equity and subordinated debt
investments that finance buy-and-
build strategies, internal expansions,
and buyouts of small- to middle-mar-
ket companies.”9 Through 2004, the
Fund has invested more than $400
million in 44 Texas businesses.
And as of December 2005, the
Washington State Investment Board
had $1.3 billion (2.7 percent of total
funds) in Washington-based investments,
including public equity, fixed income,
real estate, and private equity.10
Perceived Barriers
Issues remain. A challenge for funds
is that direct investments, including
ETIs, are time-consuming. That’s why
commingled real estate and mortgage
accounts are popular. Because they
provide liquid, diversified investments
with solid returns, they are easier 
to implement. 
A second concern is that complex
direct ETIs often have high 
administrative costs. Mortgages and
mortgage-backed securities entail fewer
such expenses. 
Finally, overzealousness and political
interference sometimes cause prob-
lems, and fund managers need to be on
guard. Connecticut, for example, lost
millions in the 1990s by investing in
the failing Colt Manufacturing
Company to save jobs. Connecticut
officials have since learned to give ade-
quate consideration to risk-adjusted
returns. In another instance, when oil
prices collapsed in 1987, 40 percent of
Alaska’s in-state mortgages became
delinquent or ended in foreclosure.
Alaska learned that having 35 percent
of its fund assets in mortgages was an
unreasonable allocation.
But since the early days of ETIs, 
pension funds have developed more
sophisticated in-house expertise and
have hired established professionals to
help manage the programs. The num-
ber of existing programs (and the bil-
lions invested) is evidence that ETI
programs can succeed. 
Economically targeted investments
are prudent if well conceived and man-
aged. Numerous public pension funds
have utilized small portions of their
assets to fill financing gaps for afford-
able housing, small business develop-
ment, and venture capital. The avail-
able data suggest that return on invest-
ment is reasonable and comparable to
similar non-ETI investments. 
The primary responsibility of state
pension boards is to protect the work-
ers and retirees who depend on the
funds’ assets. However, with economi-
cally targeted investments, they have
an opportunity to advance additional
goals. To the extent a successful ETI
program helps to create a more 
sustainable economy, it will directly
benefit the workers and pensioners the
funds represent.
Doug Hoffer is a policy analyst and
consultant in Burlington, Vermont. This
article is a shorter version of a report
completed for the Vermont State Treasurer.
Endnotes
1 CalPERS Statement of Investment Policy for
Economically Targeted Investment Program,
February 14, 2005; see http://www.calpers.
ca.gov/eip-docs/investments/policies/other/eco-
nomically-targeted/eco-target-inv-prg.pdf. 
2 R. Ferlauto and J. Clabourn, Economically
Targeted Investments by Statewide Public Pension
Funds (Washington, D.C.: The Center for Policy
Alternatives), September 1993, p.4.
3 U.S. Dept. of Labor, Advisory Council
on Pension Welfare and Benefit Plans,
“Economically Targeted Investments: An ERISA
Policy Review,” 1992.
4 U.S. General Accounting Office, “Public
Pension Plans: Evaluation of Economically Targeted
Investment Programs,” March 17, 1995.
5 Economically  Targeted Investments: A
Reference for Public Pension Funds (Sacramento,
California: Institute for Fiduciary Education),
June 1993.
6 See http://www.treasurer.ca.gov/publications/
dbl/five_years.pdf.
7 See http://www.mapension.com/Investment
Program/CoreDescrip.html#AltInv. The Pension
Reserves Investment Trust (PRIT) Fund is a
pooled investment fund established to invest the
assets of the Massachusetts State Teachers’ and
Employees’ Retirement Systems, and the assets of
county, authority, district, and municipal retire-
ment systems that choose to invest in the Fund.
8 See http://www.comptroller.nyc.gov/.
9 See http://www.tgfmanagement.com/
investment/i2.html. The Texas Growth Fund “is
an equity-oriented investment fund based in
Austin. The TGF is backed by the state’s four
largest public trust funds: the Permanent School
Fund (PSF), the Permanent University Fund
(PUF), the Teacher Retirement System (TRS)
and the Employees Retirement System (ERS).
Each of these trust funds, as well as any local gov-
ernment trust fund, is authorized to contribute
to TGF ‘trusts.’ Each of the four major state trust
funds is represented on the Texas Growth Fund
Board of Trustees.”
10  See http://www.sib.wa.gov/financial/
pdfs/eti/2005.pdf. “The  Washington State
Investment Board manages $65 billion in assets
for 34 separate state retirement and other 
trust funds.”
This Communities & Banking article is copy-
righted by the Federal Reserve Bank of Boston.
The views expressed are not necessarily those of
the Bank  or the Federal Reserve System.  Copies
of articles may be downloaded without cost at
www.bos.frb.org/commdev/c&b/index.htm.

Public pensions: the multiplier effect

http://www.bostonfed.org/commdev/c&b/2006/fall/publicpensions.pdf

Public pensions: the multiplier effect

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