Gambling With Kids’ Futures

[November 14th, 2007]

Oregon’s rainy-day fund for K-12 education has a leak that’s trapping tens of millions of dollars in a welfare account for Oregon’s venture-capital industry.

The leak is legal and disclosed, but troubling to critics of the Education Stability Fund. They’re calling on the 2008 Legislature to fix it.

“The Legislature really should change the way the stability fund operates,” says local investment adviser Bill Parish. State voters created the stability fund in 2002 by approving an amendment to the Oregon Constitution that converted what was an endowment account to an emergency fund for schools. The fund’s money comes from a dedicated stream of 18 percent of the Oregon Lottery’s net proceeds.

The program does provide a strong buffer for economic downturns, with state economists projecting that the lottery allocation over the next two years will inject $223 million into the fund—which currently holds about $300 million.

But the Oregon Center for Public Policy recently raised concerns in a report that another pre-existing law diverts 10 percent of the fund—before a dime goes to education—to venture-capital funds that are legally required to invest in Oregon start-up firms.

That diversification was probably appropriate when the fund was an endowment whose principal could not be touched. But Parish and the OCPP say such investments don’t make sense for an emergency fund.

Venture-capital investing is a long-term, high-risk game. Most start-up companies either fail or do not generate profits for many years.

And Chuck Sheketoff, director of the left-leaning OCPP, says investing funds earmarked for school budget emergencies is wrong because such investments are illiquid and inherently too risky.

“Those kinds of investments are unsuitable for a rainy-day fund,” Sheketoff says.

Laurie Wimmer Whelan, a lobbyist for the powerful Oregon Education Association, says she didn’t know such a big percentage of the stability fund was unavailable for use. As for whether the OEA would lobby for change in the next legislative session, she said she will seek more information As of the end of September, according to state Treasurer Randall Edwards’ office, the Education Stability Fund held $81 million in venture-capital investments, or more than a quarter of the fund’s assets.

Put another way, $81 million would be enough to pay 1,620 schoolteachers’ salaries and benefits for a year.

The Legislature created the Oregon Growth Account in 1995. The account aimed to address the historical difficulty that Oregon start-ups have faced when competing with companies in wealthier neighboring states such as California and Washington for seed money.

That means the Legislature has chosen to subsidize start-ups and Oregon venture capitalists with money set aside for budget meltdowns (such as when lawmakers sucked $220 million out of the stability fund in 2003 to help cover a general-fund budget deficit).

In recognition of venture capital’s risky nature, the growth account’s creators established its benchmark return objective as the Russell 3000 index (a widely followed benchmark for small capitalization stocks) plus 2 percent annually.

“We have a mandate to invest the money in Oregon, and the field of candidates here is not that big,” says Mike Mueller, the investment manager who oversees the investments for the Treasurer’s Office.

In the Treasurer’s Office’s description of the Growth Account, the language is pretty pessimistic. “The return expectation should be tempered, however, given the concentration of investments within Oregon,” says a description on the treasury website.

So how have those investments fared since the fund’s predecessor, the Education Endowment Fund, began making venture investments in 1999?

Mueller says the answer isn’t simple.

“You can’t really tell,” he explains. “Most of the funds we’ve invested with expect to exit their investments—and hopefully return money—five to 10 years after the initial investment.”

But Mueller adds that, so far, the funds invested by the Growth Account in the early years have been slow to return any money. Some investments, such as those made by Portland-based Endeavor Capital, look promising. Others do not.

Sheketoff says Mueller’s answer proves venture capital is not an appropriate investment for the stability fund, an issue he hopes legislators will address in their February 2008 session or before the next recession.

Mueller says the policy issue of whether emergency funds should be invested in venture capital is a question for lawmakers, not for an investment manager like him.

“All we know is what the Legislature told us to do,” Mueller says.