Legislature(2003 - 2004)

02/24/2004 03:37 PM Senate STA

Audio Topic
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
               SB 326-PERMANENT FUND INVESTMENTS                                                                            
CHAIR GARY STEVENS  announced SB 326 to be  up for consideration.                                                               
He asked Mr. Storer to step forward.                                                                                            
ROBERT STORER,  executive director  of the Alaska  Permanent Fund                                                               
Corporation sat down and introduced  himself and Ron Lorenson who                                                               
is outside counsel to the permanent fund.                                                                                       
MR.  STORER  described the  request  to  increase the  investment                                                               
flexibility  of the  permanent  fund as  a  timely and  important                                                               
issue.  As background  he  reported that  AS  37.13.120 sets  out                                                               
statutory investing guidelines for  the board to follow including                                                               
adherence  to  the  prudent-investor  rule.  He  noted  that  the                                                               
permanent fund is  one of the last public  funds, including those                                                               
managed by the Department of Revenue, that is guided by statute.                                                                
He  maintained   that,  "The  challenges  for   managers  of  the                                                               
permanent  fund  are  to  be  able   to  manage  the  fund  in  a                                                               
contemporary way in what is in  fact a very dynamic industry, and                                                               
deal  with  legislative  changes  that  allow  us  to  meet  that                                                               
MR.  STORER noted  that  he  would address  his  comments to  the                                                               
Investment  Flexibility   handout  that  members  had   in  their                                                               
packets. The following is his verbatim testimony.                                                                               
     Over the  next couple of  pages you'll see  the history                                                                    
     of some  of the legislative changes  that the permanent                                                                    
     fund  has asked  for  and received  support  for.   The                                                                    
     bottom of  page 3,  which was SB  156, was  approved in                                                                    
     1999.  In 1999  the  Permanent Fund  Board of  Trustees                                                                    
     were allowed one exemption from  the statutory list and                                                                    
     it's what we call the "basket clause."                                                                                     
     SB  156  actually  did  a couple  of  things.  One  was                                                                    
     increase  our  statutory  limitation investing  in  the                                                                    
     stock  market  from  50  to 55  percent.  But  it  also                                                                    
     allowed  the administrators  of the  permanent fund  to                                                                    
     make  investments outside  of the  statutory list,  but                                                                    
     still following the prudent  investor rule. The prudent                                                                    
     investor rule really defines a  process that allows one                                                                    
     to make an informed  decision. That's the criteria that                                                                    
     is involved in the prudent investor rule.                                                                                  
     The permanent  fund was given  permission to  invest up                                                                    
     to  5 percent  of  the fund  outside  of the  statutory                                                                    
     list. To suggest that we  took this ability and ran out                                                                    
     and got  into all  kinds of investments  is not  so. In                                                                    
     fact, we are just now four  years later, after a lot of                                                                    
     evaluation  of  different  opportunities; we  are  just                                                                    
     about  to implement  some of  the  strategies that  are                                                                    
     embedded  in the  basket  clause. I  think  that is  an                                                                    
     important issue.  When we ask for  permission, we still                                                                    
     approach our responsibility prudently.                                                                                     
     Page 4 simply  shows if you look at the  statutes - and                                                                    
     I call  it the maturation  of the permanent fund  - the                                                                    
     permissible list.  You'll see how the  asset allocation                                                                    
     of the Alaska Permanent Fund  has changed over years. I                                                                    
     actually started work ... at  the permanent fund in May                                                                    
     of 1983. Why do  I say that? One, I do  have a sense of                                                                    
     history and the  other is I arrived in May  of 1983 and                                                                    
     the  permanent fund  had  just  received permission  to                                                                    
     invest  in the  U.S. stock  market and,  in fact,  they                                                                    
     funded their first  equity managers in June  or July of                                                                    
     1983. You can see  the non-U.S. investments occurred in                                                                    
     the late 1980s etc.                                                                                                        
     Why  are we  proposing  -  and Ron  will  tell you  the                                                                    
     technical  aspects  -  we're   proposing  a  couple  of                                                                    
     things. The  essence and the  most important  thing may                                                                    
     be  increasing  the  "basket  clause"   from  5  to  15                                                                    
     percent.  That is  to allow  future administrations  of                                                                    
     the  permanent fund  to  meet what  is  a very  dynamic                                                                    
     industry changing  its investment  options to  have the                                                                    
     latitude  to address  a  changing  investment world  as                                                                    
     they occur.                                                                                                                
     Another  [reason]  is  potentially to  allow  different                                                                    
     instruments that  will allow us to  increase our return                                                                    
     objective over  some time. Another  one - and  it's not                                                                    
     necessarily  contradictory  -  is the  more  investment                                                                    
     options  you  have, the  more  you  can diversify  your                                                                    
     portfolio or reduce your risk.  In a conversation I had                                                                    
     with Senator  Stedman I believe  if you asked us  do we                                                                    
     have  all the  diversification  we need  right now  the                                                                    
     answer is  yes. And  we had  that conversation.  But if                                                                    
     you ask me  what do we need in the  future, we need the                                                                    
     flexibility to  respond to changing  financial markets.                                                                    
     To address them  in a contemporary manner  so we cannot                                                                    
     ignore the need  for potential expanded diversification                                                                    
     in the future.                                                                                                             
     Last  item  and  it's  not  on this  list  but  it's  a                                                                    
     management  tool.  There  are certain  things  that  we                                                                    
     could  do  in  the  course of  business  that  are  not                                                                    
     incurring  more  risk.  It's  sort  of  the  arcane  or                                                                    
     complexity of  investment management,  but it  would be                                                                    
     ways to implement strategies in  a low cost way that we                                                                    
     are   precluded   from   currently   because   of   the                                                                    
     limitations on the statutory list.                                                                                         
     I've added a  list of the asset  allocation. Every year                                                                    
     we  visit  our asset  allocation  and  we adopt  it  by                                                                    
     resolution. Our March  10 and 11 board  meeting we will                                                                    
     be making a recommendation  for some adjustments to the                                                                    
     asset allocations.  What you  see is our  current asset                                                                    
     allocation. You'll see it  broken down between domestic                                                                    
     equities, U.S. stocks;  international equities, foreign                                                                    
     stocks;  U.S. bonds  and  I would  note  that the  U.S.                                                                    
     bonds  are  all  investment   grade.  Either  all  U.S.                                                                    
     treasuries [which are] agencies  of the U.S. government                                                                    
     or  high  grade  corporate debt,  and  then  non-dollar                                                                    
     bonds,  which are  mostly  sovereign  issues by  Japan,                                                                    
     England etc. and 10 percent allocation to real estate.                                                                     
     I'll use  domestic equities as  an example.  Our target                                                                    
     is 37  percent, but we  create bands around  it. You'll                                                                    
     see on domestic equities it's  plus or minus 7 percent.                                                                    
     Our  goal is  to  create a  discipline,  that when  you                                                                    
     reach a certain point  - hopefully through appreciation                                                                    
     - you automatically rebalance closer  to target. By the                                                                    
     same token,  when our equity investments  go down there                                                                    
     is an  inflection point where we  must rebalance closer                                                                    
     to target.  That's a tough  one because usually  it's a                                                                    
     lot  harder  to put  new  money  in a  declining  stock                                                                    
     market because it takes a  real discipline. It occurred                                                                    
     in October  of 2002.  No great  insight other  than the                                                                    
     fund  went  outside its  bands,  but  it turns  out  we                                                                    
     missed  the bottom  of the  bear market  by about  four                                                                    
     days. It  was a  superb piece of  timing, but  that was                                                                    
     more discipline than it was a particular skill.                                                                            
     The point is  we try to have bands  that are reasonable                                                                    
     but not  get into  a lot  of rebalancing  because there                                                                    
     are a  lot of  transaction costs  that one  occurs when                                                                    
     you rebalance so  we try to have  some reasonable bands                                                                    
     around our target.                                                                                                         
     Why am  I noting that?  I'm noting that because  on the                                                                    
     current  statutory limitations,  we  will be  - if  the                                                                    
     board  adopts the  recommended  asset  allocation -  up                                                                    
     near  our statutory  limitations  in  both the  "basket                                                                    
     clause" and  equities. What does that  mean? That means                                                                    
     that our investment  managers in the board  will not be                                                                    
     deciding  our   asset  allocation.  Statutes   will  be                                                                    
     deciding our  asset allocation. It suggests  that right                                                                    
     now  our  stock  -  our managers  -  decide  when  we'd                                                                    
     maximize  our return.  They will  then sell  that stock                                                                    
     and  buy  other  stock,  but   we  will  be  forced  by                                                                    
     statutory limitations to limit  the upside potential on                                                                    
     stocks. Of course, risk is  not symmetrical because the                                                                    
     stock  market can  go down  so we  have some  statutory                                                                    
     controls on how  much we can gain  on appreciation, but                                                                    
     not so on the down side.                                                                                                   
     That is another  reason why I think it  is a compelling                                                                    
     argument  and I  hope you  will agree  that we  need to                                                                    
     expand  our flexibility.  Not in  terms of  making pure                                                                    
     decisions, but  simply to let  the permanent  fund take                                                                    
     advantage of the appreciation  in the financial markets                                                                    
     when they occur.                                                                                                           
     This is the  first opportunity I've had  to address the                                                                    
     Legislature on this issue. On  the last page I tried to                                                                    
     think  of  what  would  be   some  of  your  questions,                                                                    
     criticisms - whatever you want to  call it - and I came                                                                    
     up with three.                                                                                                             
     The first thing I would  ask if I was scrutinizing this                                                                    
     is would the fund be taking  too much risk if they were                                                                    
     given  this  latitude. Of  course  we  can't speak  for                                                                    
     future administrators of  the fund, but I  can give you                                                                    
     a  history lesson.  I've had  the privilege  of working                                                                    
     with  all but  four  trustees of  the Alaska  Permanent                                                                    
     Fund  Corporation. I  have worked  for,  been or  known                                                                    
     every executive  director of the Alaska  Permanent Fund                                                                    
     Corporation and I  have worked for or  with every chief                                                                    
     investment  officer  in  the   history  of  the  Alaska                                                                    
     Permanent Fund Corporation.                                                                                                
     What I  have observed is  the corporate culture  of the                                                                    
     administrators  of the  fund -  they  have always  used                                                                    
     this  investment  privilege  very  prudently  and  very                                                                    
     conservatively.  We have  always spent  time trying  to                                                                    
     ferret out  fads from real  contemporary issues  and we                                                                    
     are more than  content to watch and  learn from others'                                                                    
     mistakes. If history  is a lesson of this,  I would say                                                                    
     that we've  used our  privilege of  expanded investment                                                                    
     flexibility  judiciously,  carefully  and I  think  the                                                                    
     fund has benefited from that.                                                                                              
     How will  the board  of trustees use  this flexibility?                                                                    
     That's a  key issue  that I  would ask  and one  of the                                                                    
     main  things,  as  I've  noted,   is  to  allow  future                                                                    
     administrators the flexibility  to address contemporary                                                                    
     investment  management  issues.  So to  some  degree  I                                                                    
     don't know. I  can identify some sort  of cornucopia of                                                                    
     options or  the myriad  of options that  are available.                                                                    
     Clearly one use, and the  immediate use would be to not                                                                    
     have  the statutory  constraints  if  the funds  assets                                                                    
     appreciate and  we would hope  that they would.  We are                                                                    
     currently using a bit of  the statutory "basket clause"                                                                    
     or  the outside  of  the  statutory identifications  to                                                                    
     invest  in  private equities.  [It  would  be a]  small                                                                    
     weighting  - no  more  than 3  percent  and [we  would]                                                                    
     probably take  several years to implement.  We probably                                                                    
     won't  start investing  our  first  dollars until  late                                                                    
     spring, early  June. That alone, if  we're successful -                                                                    
     and of  course we  spent a  lot of  time studying  it -                                                                    
     success  actually will  take that  3 percent  over a  5                                                                    
     percent limit  because of appreciation right  there. We                                                                    
     are  going to  propose to  the board  something that  I                                                                    
     think is unique.                                                                                                           
     The term of art right  now is called an absolute return                                                                    
     strategy. You see it in the  papers a lot - it's called                                                                    
     a  hedge  fund. Sometimes  you  see  negative press  on                                                                    
     hedge  funds.  You  always see  the  headlines  in  the                                                                    
     negative.  It's not  necessarily  bad,  but what  we're                                                                    
     doing in the first time  of the permanent fund is we're                                                                    
     recommending a pilot  program - a program  that will be                                                                    
     small  enough so  that if  there are  problems it  will                                                                    
     have, we  hope, virtually no impact  on the performance                                                                    
     of the fund.  By the same token, if  it's successful it                                                                    
     will have virtually no impact on the permanent fund.                                                                       
     These are sophisticated  investment philosophies and we                                                                    
     want  to  learn from  the  live  experience. The  other                                                                    
     thing that  is unique in  this proposal is  we're going                                                                    
     to have  a sunset  clause. The  contracts will  be good                                                                    
     for up to  36 months and then  that investment strategy                                                                    
     will die  as a  matter of course.  We're not  saying we                                                                    
     want this  flexibility in perpetuity.  We think  it has                                                                    
     merit, but we want to learn more from it.                                                                                  
     The  last   one  is  derivatives.   That  was   a  more                                                                    
     pejorative word in  the '80s and earlier  '90s and less                                                                    
     so now.  What are derivatives? The  simplest definition                                                                    
     -  it  is an  investment  instrument  that derives  its                                                                    
     return from some other investment.  An example would be                                                                    
     hedging your  equity exposure using an  equity contract                                                                    
     - either  a forward or  a futures contract.  That's not                                                                    
     investing in the stock market,  but the returns on that                                                                    
     contract  will  be  derived  by  the  reality  of  what                                                                    
     happens   in  the   stock  market.   That's  called   a                                                                    
     derivative  - people  use  derivatives  to hedge  their                                                                    
     exposure. You can use a  derivative to gain exposure in                                                                    
     a certain  market - immediately  while you  invest then                                                                    
     systematically in the stocks you want as an example.                                                                       
     Would there  potentially be derivatives? The  answer is                                                                    
     yes, hopefully in a very deliberate manner.                                                                                
CHAIR GARY STEVENS asked Mr. Lorenson for his comments.                                                                         
RON LORENSON, outside counsel for the Alaska Permanent Fund                                                                     
Corporation, walked members through the bill and gave an                                                                        
explanation of the recommended changes.                                                                                         
He suggested  focusing on Section  2 first because  that contains                                                               
the "basket clause." The provision begins  on page 1, line 14 and                                                               
continues  through  line   10  on  page  2.   He  explained  that                                                               
subsection (g) is what Mr. Storer  referred to as the legal list.                                                               
It  describes  the  investment  forms  that  the  Permanent  Fund                                                               
Corporation is authorized to invest  in with the exception of the                                                               
basket clause.                                                                                                                  
He continued  to say  that in  addition to  (g), there  are other                                                               
provisions  under [AS]  37.13.120 that  provide a  restriction on                                                               
investments under certain circumstances.                                                                                        
     That's what has  raised the concern or  the interest of                                                                    
     the Permanent Fund Corporation in  terms of making some                                                                    
     adjustments  in   the  way  the  basket   clause  would                                                                    
     operate. Right now, under  the basket clause provision,                                                                    
     it  says, 'Notwithstanding  (g)'  and  that means  even                                                                    
     though  there is  this legal  list, you  don't have  to                                                                    
     follow the legal list for up  to 5 percent of the value                                                                    
     of  the assets  of the  fund.  You can  go outside  the                                                                    
     legal  list as  long as  the other  investments satisfy                                                                    
     the prudent investor rule.                                                                                                 
     With  respect  to  that  5 percent,  it's  okay  to  go                                                                    
     outside that legal list. There  are, however, under (h)                                                                    
     and (i),  which are  the two  provisions you'll  see at                                                                    
     the bottom of page 1 in  section 2 that are proposed to                                                                    
     be  added  to  the  language  authorizing  the  'basket                                                                    
     clause'  - there  are some  additional restrictions  in                                                                    
     (h) and (i),  which by a legal  interpretation, if they                                                                    
     aren't  specifically  acknowledged, would  continue  to                                                                    
     operate to restrict the use of the 'basket clause.'                                                                        
     I was involved  in 1999 when the bill  was presented to                                                                    
     the Legislature and passed, it  wasn't the intention of                                                                    
     the   drafters  or   ever   in   discussion  with   the                                                                    
     Legislature that  those two  provisions operate  to act                                                                    
     as restrictions on the 'basket clause.'                                                                                    
     What (h)  does is say  that futures contracts  can only                                                                    
     be  used under  certain very  restricted circumstances.                                                                    
     Overall  it  makes sense  in  terms  of a  conservative                                                                    
     approach  to investment,  but in  terms of  the prudent                                                                    
     investor rule and flexibility  under the basket clause,                                                                    
     applying that  limitation on futures has  the effect of                                                                    
     potentially  limiting  various   kinds  -  particularly                                                                    
     hedge funds  - that the permanent  fund might otherwise                                                                    
     be able to invest in as a result of the basket clause.                                                                     
     (i) says that  the permanent fund cannot  invest in any                                                                    
     fixed  income asset  bond -  essentially -  where there                                                                    
     has been a default on  the interest payment in the last                                                                    
     5  years.  It  makes  a  lot  of  sense  as  a  general                                                                    
     investment guideline,  but to the extent  that you want                                                                    
     to be  able to  take advantage  of the  'basket clause'                                                                    
     and use  various funds of alternative  investments such                                                                    
     as  some of  the  high yield  bond  type products  that                                                                    
     might  be  available.  It acts  as  a  restriction  and                                                                    
     limitation  that  again,  wasn't intended  when  people                                                                    
     were visualizing  what the basket clause  might be used                                                                    
He pointed out  the other change on page 2  increases the size of                                                               
the basket clause from a maximum of  5 percent to a maximum of 15                                                               
Subsection (e)  in section  1 says  the corporation  can't borrow                                                               
money as  part of  its investment  strategy. The  second sentence                                                               
was then  added to  permit investments  that the  corporation was                                                               
involved  in -  and  at that  time  the only  focus  was on  real                                                               
property  investments -  to permit  real property  investments of                                                               
the fund  - to borrow money  is a way of  leverage potentially as                                                               
part of the investment in a particular piece of real estate.                                                                    
     What  (e) does  is say  the permanent  fund corporation                                                                    
     can't borrow money as part  of its investment strategy.                                                                    
     It makes a  lot of sense and no one  has suggested that                                                                    
     the permanent fund  should borrow money as  part of its                                                                    
     strategy.  But the  second sentence  was then  added to                                                                    
     permit  investments that  the corporation  was involved                                                                    
     in  - and  at  that time  the only  focus  was on  real                                                                    
     property   investments  -   to  permit   real  property                                                                    
     investments of the  fund - to borrow money is  a way of                                                                    
     leverage  potentially as  part of  the investment  in a                                                                    
     particular piece of real estate.                                                                                           
     When  the permanent  fund invested  in real  estate, it                                                                    
     always does it through a holding  company - an LLC or a                                                                    
     limited  partnership. It  doesn't  do  it directly  and                                                                    
     that's  what  this  language  authorizes.  The  holding                                                                    
     company  can borrow  money as  part  of its  investment                                                                    
     strategy with respect  to an asset as long  as there is                                                                    
     no   recourse   back   against   the   permanent   fund                                                                    
     corporation.  In  other  words,  as long  as  the  only                                                                    
     reliable entity is the holding  company and there is no                                                                    
     ability  to go  back  and  sue or  pursue  a claim  for                                                                    
     default against the corporation.                                                                                           
     That's the way it's set  up for real estate. There's no                                                                    
     reason not  to provide  the same flexibility  for other                                                                    
     forms  of holding  entities -  limited partnerships  in                                                                    
     the area  affirmative investments - private  equity for                                                                    
     instance.  We're  just  recommending  there,  that  the                                                                    
     restriction  for real  property be  taken out,  but the                                                                    
     limitation  remains.  That   is  that  the  corporation                                                                    
     cannot borrow money  directly. If money is  going to be                                                                    
     borrowed, it is part of  the investment strategy of the                                                                    
     corporation.  It has  to be  through  some other  legal                                                                    
     entity that isolates the  corporation from liability if                                                                    
     things don't go right.                                                                                                     
SENATOR  JOHN COWDERY  asked how  many dollars  15 percent  might                                                               
represent at today's value.                                                                                                     
MR. STORER answered 10 percent would represent $4.2 billion.                                                                    
SENATOR COWDERY inquired  about the type of  investments that are                                                               
TAPE 04-9, SIDE B                                                                                                             
4:22 pm                                                                                                                       
MR. STORER  replied there are  numerous options most of  which he                                                               
wouldn't support,  but an example  of investment  expansion could                                                               
be private equity buyouts. Some  hedge funds have absolute return                                                               
strategies and  there are a  myriad of  sophisticated approaches.                                                               
An obvious  approach would  be high  yield debt,  which can  be a                                                               
speculative investment. Another category of  high yield debt is a                                                               
company  that  has   fallen  out  of  investment   grade  and  is                                                               
restructuring.  The  latter  doesn't  offer  as  much  investment                                                               
opportunity as  the more  speculative type,  but it  is a  way of                                                               
increasing  fixed  income  returns beyond  investment  grade.  He                                                               
suggested that is a standard tool that deserves consideration.                                                                  
Some  funds  are looking  at  timber,  agriculture and  commodity                                                               
based investments.  He wasn't endorsing  those, but they  do fall                                                               
within investment grade.                                                                                                        
He noted  that many  funds are  diversifying and  some endowments                                                               
and  foundations are  becoming  more aggressive  on the  absolute                                                               
return strategies.                                                                                                              
SENATOR COWDERY  mused the corporation  must support  the concept                                                               
and a number of desirable options must be unavailable currently.                                                                
MR.  STORER maintained  the  options are  numerous  and some  are                                                               
worthy of evaluation.  He asked members to remember  that it took                                                               
more  than two  years of  study before  they concluded  that they                                                               
wanted  to  invest   in  the  private  equity   market.  When  he                                                               
identifies  the options  as worthy  of consideration,  he assured                                                               
members  that  a lengthy  and  in  depth  study  is part  of  the                                                               
process. Certainly,  he wouldn't support  some of the  options he                                                               
SENATOR  COWDERY  asked  if  new  investment  managers  would  be                                                               
selected or guidelines changed.                                                                                                 
MR. STORER replied nothing like  that would change. He noted that                                                               
the corporation manages  quite a lot of money  internally and the                                                               
staff does  very well.  However, "These, by  and large,  are more                                                               
sophisticated  investments  that  require  more  personnel,  more                                                               
analysis  etc.  So the  answer  is  we  would most  clearly  seek                                                               
outside expertise to assist us in managing those assets."                                                                       
To  do  that,  he  said, they  establish  criteria,  which  might                                                               
include expected  returns, types  of options, and  benchmarks and                                                               
standards. The  consultant would  be told  to review  peer groups                                                               
that have  expertise in  that area. They  look at  performance as                                                               
well as how long they have  managed that type of discipline. They                                                               
look at the depth of the  organization and an analysis of whether                                                               
or not  repeated success is  likely. After that,  three prospects                                                               
are  brought in  for interview  and the  board makes  a selection                                                               
from there.                                                                                                                     
He advised  that any time  they make  an investment policy  it is                                                               
posted on  the web  site. There are  resolutions for  every asset                                                               
class or  discipline that managers  must follow broadly  and then                                                               
contracts further tighten the guidelines.                                                                                       
SENATOR COWDERY  asked if a  manager had ever  underperformed and                                                               
had to be changed.                                                                                                              
MR. STORER  replied they try  to stay with  a manager as  long as                                                               
their  discipline  works  because  there  are  transaction  costs                                                               
associated with  change. Although there  are a number  of issues,                                                               
one is whether the assets  are managed as represented and another                                                               
questions  whether  they  are  managing it  well.  They  look  at                                                               
whether the management  style is out of favor or  whether the job                                                               
is simply done poorly.                                                                                                          
He  pointed out  that one  equity manager  they selected  in 1983                                                               
still  has "a  substantial relationship  with the  permanent fund                                                               
and the others have not so  they have been fired for performance,                                                               
for  personnel  turnover  or  for  mergers...or  simply  we  have                                                               
decided that we need to implement different strategies."                                                                        
SENATOR HOFFMAN noted he was  around in 1999 when the Legislature                                                               
made the last  change. Although he doesn't  have any reservations                                                               
about adding (h) and (i), the  request also triples the amount of                                                               
funds that wouldn't be restricted  by the investment rule. To put                                                               
$4.2  billion  into perspective,  he  called  it $4,200  million.                                                               
Although  they are  the same,  the  latter sounds  like a  larger                                                               
number.  "You're  asking  for  a lot  more  flexibility"  and  he                                                               
questioned whether that might not be too much risk.                                                                             
He  reminded members  that  the POMV  (percent  of market  value)                                                               
question  was  also  before   legislators.  Currently  the  state                                                               
doesn't use the earnings from  the permanent fund, but that could                                                               
change  if  POMV passes  and  a  percentage  of the  earnings  is                                                               
allotted  to government  and  the  state comes  to  rely on  that                                                               
income.  When  you  become dependent  upon  your  earnings,  it's                                                               
natural  that  you  become  less   willing  to  assume  risk,  he                                                               
MR.  STORER agreed  with  the last  statement  saying that,  "The                                                               
sooner you need the money, the more conservative you should be."                                                                
SENATOR HOFFMAN interjected, "The more you're dependent on it."                                                                 
MR. STORER agreed adding that  stock market investment is for the                                                               
long   term.  He   confirmed  that   Senator  Hoffman   correctly                                                               
identified  the  two issues.  He  called  the first  issue  house                                                               
cleaning related  to the original  intent and the other  issue is                                                               
potentially expanding the risk from  5 to 15 percent. However, as                                                               
he identified earlier,                                                                                                          
     As a  management tool, one  of the things that  we will                                                                    
     be doing right now  is restricting ourselves because of                                                                    
     the statutory  limitations so it actually  could work -                                                                    
     we wouldn't have  to change our asset  allocation - and                                                                    
     the  current  statutes would  be  an  inhibitor on  our                                                                    
     return simply  because we would be  forced to liquidate                                                                    
     assets because of statutory limitations, not what the                                                                      
     market and asset allocation tells you.                                                                                     
He also  made the point  that even  at 15 percent,  the permanent                                                               
fund  is probably  the most  restrictive and  conservative public                                                               
funds in the  country. It is far more restrictive  than the state                                                               
retirement system, he said.                                                                                                     
They are  not cavalier when it  comes to large numbers,  but they                                                               
are  used  to  managing  money  and  the  implications  of  large                                                               
numbers. He  said, "I'm not  prepared to suggest that  the future                                                               
managers of the  fund would put all their eggs  in a $4.2 billion                                                               
basket. I don't  know, but I think the opposite  would occur." He                                                               
agreed  that   Senator  Hoffman's   concern  is  valid,   but  he                                                               
maintained  that  the  increased  investment  latitude  would  be                                                               
diversified  and  they would  continue  to  follow the  rules  of                                                               
prudent investing.                                                                                                              
SENATOR  HOFFMAN  recalled  that  in the  early  '90s,  the  fund                                                               
managers  asked to  invest in  foreign stocks  and that  wasn't a                                                               
very good decision for the first several years.                                                                                 
He then asked where the sunset clause was referenced.                                                                           
MR. STORER  explained that it related  to just the one  issue and                                                               
they  intend to  impose  the sunset  clause  in their  investment                                                               
policies and not statute. That  one investment strategy will be a                                                               
very small component, he said.                                                                                                  
SENATOR  HOFFMAN said,  "You're not  saying that  that should  be                                                               
considered in  this legislation and  the Legislature  should look                                                               
at it in three years and see how the fund is doing."                                                                            
MR. STORER maintained  that a statutory sunset  on the investment                                                               
strategy  would not  be  a good  idea,  but frequent  performance                                                               
evaluation is always a good idea.                                                                                               
SENATOR BERT  STEDMAN said he  understood private  placements but                                                               
he needed further  clarification on increasing the  basket from 5                                                               
to  15 percent.  He questioned  whether future  markets might  be                                                               
used and if so, how much and where would they be used.                                                                          
MR.  STORER  replied  they  would be  used.  Future  markets  are                                                               
currently used  to a  small degree  and he could  see a  day when                                                               
they would be  used more. Although they have never  done so, they                                                               
can use futures  to hedge a long position. Fund  managers use the                                                               
futures market  on currency on international  investments because                                                               
they  tend to  have longer  settlement  dates. When  you make  an                                                               
international investment,  you invest in  the company and  in the                                                               
currency. Managers  use futures to  lock in the currency  rate at                                                               
the time.                                                                                                                       
He  said  more and  more  often,  managers  are employed  to  use                                                               
futures  in more  sophisticated  ways. There  is  danger in  that                                                               
though  because   a  residual   futures  contract   is  potential                                                               
leverage. They  aren't suggesting such  use and are  very mindful                                                               
of that issue.                                                                                                                  
However,  using   futures  as  a  management   tool  to  mitigate                                                               
transaction costs can be worthwhile. For example,                                                                               
     We  have a  significant payout  annually to  - for  the                                                                    
     dividend payout and one could  take their cash flow and                                                                    
     instead  of investing  in -  and  it would  be a  small                                                                    
     component   -  the   stock  market   and  incurring   a                                                                    
     transaction  cost   and  then  selling  it   later  and                                                                    
     incurring  another  transaction  cost.  One  could  use                                                                    
     either future  or forward contract that  expires - that                                                                    
     takes the cash and commits that  to a future so that it                                                                    
     expires  right  on  that  date  to  reduce  transaction                                                                    
     costs. My guess is that  the dividend costs right about                                                                    
     2 to  $5 million  in transaction  costs. So  that's one                                                                    
     type of tool, but there are  a myriad of ways one could                                                                    
     use them.  I would assume  they would be used  not now,                                                                    
     not next  year, but maybe  five years down the  road. I                                                                    
     would expect  to see  more use  of futures  contracts -                                                                    
     forward contracts, but I can't tell you the magnitude.                                                                     
SENATOR STEDMAN said they would  use short-term futures to bridge                                                               
a  settlement  timeframe  versus  hedging  the  currency  on  the                                                               
MR. STORER replied that would be  one way and another would be to                                                               
mitigate transaction costs for funding the dividend.                                                                            
SENATOR STEDMAN viewed it differently.  He said, "If you're going                                                               
to access  the futures  market for  short timeframes  to mitigate                                                               
your calendar  on your settlement  versus using futures  to hedge                                                               
currency  in your  international  portfolio  - particularly  your                                                               
international bond portfolio. So there's no intent to do that?"                                                                 
MR. STORER replied, "No, not right now."                                                                                        
SENATOR STEDMAN  said, "So  there's no intent  to use  the basket                                                               
move  from 5  to  15 [percent]  - where  you  can actually  start                                                               
getting a  fairly good chunk of  leverage on your portfolio  - to                                                               
go in  and speculate or  leverage up your equities  portfolio. It                                                               
would always be used as a hedge?"                                                                                               
MR. STORER  replied they  weren't discussing  that use  right now                                                               
and although he  couldn't say it would never  happen, he couldn't                                                               
envision that the board would  leverage their equity portfolio in                                                               
the foreseeable future.                                                                                                         
With regard to  increasing the flexibility now  and the reference                                                               
to the ability to invest  in the international equity markets, he                                                               
said, "There  seems to be  a classic  event that occurs  when the                                                               
permanent   fund  is   trying   to   increase  their   investment                                                               
capabilities. What happened during that  period [1999] is that it                                                               
was only through the success  of the international equity markets                                                               
-  and  specifically  in  Japan  -  that  we  were  able  to  get                                                               
legislative ability to make international investments."                                                                         
The  point  Senator Hoffman  made  was  correct, he  said;  their                                                               
initial  investment in  the  international  equities market  went                                                               
down. Fortunately they  didn't invest a great deal  of money, but                                                               
since  that  time  the international  market  returns  have  been                                                               
significant.   In  fact,   international   equity  markets   have                                                               
outperformed  the  domestic equity  market  in  the last  several                                                               
He concluded,  "You have to  justify your ability by  showing how                                                               
these high returns occur and  it's like all things, you overshoot                                                               
in  both directions.  That is  the point  of getting  flexibility                                                               
4:50 pm                                                                                                                       
CHAIR  GARY  STEVENS noted  that  it  was  getting late  and  the                                                               
members had a  number of questions on the  issue. Furthermore, 35                                                               
people  were waiting  to speak  on the  next bill.  He stated  he                                                               
would like to return to this at a later date.                                                                                   
MR. STORER  replied, "We  would be delighted  Mr. Chair.  It's an                                                               
important issue and we want to make everybody comfortable."                                                                     
CHAIR GARY STEVENS held SB 326 in committee.                                                                                    

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