Legislature(2003 - 2004)

03/04/2004 03:30 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                                                               
and asked Mr. Storer to identify himself for the record.                                                                        
ROBERT   STORER,  executive   director,  Alaska   Permanent  Fund                                                               
Corporation,  introduced himself  and  advised  members that  Ron                                                               
Lorenson, outside counsel, was on line to answer questions.                                                                     
To address  the discussion  about how  the corporation  would use                                                               
the  increased investment  flexibility,  he  distributed a  chart                                                               
outlining  how they  would use  the basket  clause over  the next                                                               
several years. He said:                                                                                                         
     We are  in the  late stages  of implementing  a private                                                                    
     equity program ... and that  takes several years to get                                                                    
     it  up  to  the  3  percent  target.  Then  we're  also                                                                    
     recommending a pilot program that  will be - we call it                                                                    
     alternative   investments   -   that's  the   sort   of                                                                    
     contemporary term  - many people  call it  hedge funds.                                                                    
     Hedge funds have some notoriety  in the sense that they                                                                    
     use a  lot of  leverage and when  they don't  work they                                                                    
     get  a lot  of  headlines. This  proposal  that we  are                                                                    
     suggesting will not  be that kind of  hedge fund. We're                                                                    
     suggesting a pilot  program to learn with  no more than                                                                    
     1 percent. It  will expire within 3 years,  but I think                                                                    
     the key  is that  it is  not going  to be  risky. We're                                                                    
     going to have a targeted,  expected risk of equal to or                                                                    
     less  than the  fixed income  market -  a bond  market.                                                                    
     It's  not  going  to  be leveraged  up  to  get  excess                                                                    
     returns over the equity market.  It'll be structured in                                                                    
     a very  conservative manner and  we hope to  learn from                                                                    
     this program,  but it will  not be designed as  a risky                                                                    
     One  of the  problems with  where we  are right  now is                                                                    
     that  we are  close  to our  statutory limitations.  We                                                                    
     hope  we  have  a  wonderful  problem,  which  is  what                                                                    
     happens  if it  all works.  If it  all works,  the fund                                                                    
     will   increase  -   these   target  allocations   will                                                                    
     increase,  but  we're also  going  to  have a  problem,                                                                    
     which means statutes not the markets will define when                                                                      
     we must liquidate the assets.                                                                                              
       That, Mr. Chair, is why we're asking for increased                                                                       
     flexibility in the basket clause.                                                                                          
CHAIR  GARY STEVENS  referred  to  the new  chart  and asked  for                                                               
verification that the  traditional asset class [gray  bar] is not                                                               
part of the basket clause.                                                                                                      
MR. STORER  said, the blue  bar represents the unused  portion in                                                               
the '03 bar chart.  He then pointed out that as  the 5 percent is                                                               
implemented there would be a 1  percent target to hedge funds and                                                               
1.5 to  2 percent in private  equities. Moving out to  '05, there                                                               
will be 3  percent private equity investment and  over that time,                                                               
the basket clause will essentially be  used up on a cost basis so                                                               
with appreciation there will be problems.                                                                                       
SENATOR BERT STEDMAN  asked Mr. Storer to go over  the effects of                                                               
the leverage when it moves from 5 to 15 percent.                                                                                
MR. STORER said he would answer  the question at the extreme, but                                                               
because they  are driven by  diversification, the  probability of                                                               
placing  all the  eggs in  one basket  is extremely  unlikely. He                                                               
continued to  say that  if they  increased risk  for dramatically                                                               
higher returns they  could only use the full 15  percent. He said                                                               
he wasn't prepared to suggest they  do that, but even that is low                                                               
versus  some real  estate  portfolios that  are  leveraged to  50                                                               
percent. "That would probably be  the most volatile scenario that                                                               
I could think of in terms of using all the investment."                                                                         
SENATOR STEDMAN used the example  of putting $100 down to control                                                               
$1,000  of some  entity  and  said, "I  assume  then that  you're                                                               
looking  at  the  weighting  effect of  the  $1,000;  you're  not                                                               
counting the $100."                                                                                                             
MR. STORER replied  that is correct. In that  example, they would                                                               
use the  basket clause and  count the  leverage and not  just the                                                               
$100 investment.                                                                                                                
SENATOR  STEDMAN asked  if  there is  a  diversification gain  by                                                               
targeting a return  that would be about equal to  the bond market                                                               
MR. STORER said that's true,  but you can gain diversification in                                                               
far  more  ways than  just  more  equities  or more  return.  The                                                               
corporation is working to develop  a conservative instrument such                                                               
as the targeted risk  of a bond market or less  as opposed to the                                                               
more volatile equity market.                                                                                                    
At present the  corporation is looking for  alternatives to fixed                                                               
income, not  increasing their  equity exposure  so the  1 percent                                                               
target would  reduce the  fixed income  exposure. They  expect to                                                               
get  some additional  incremental return  greater than  the fixed                                                               
income market.                                                                                                                  
SENATOR  STEDMAN asked  Mr.  Storer to  explain  the effect  that                                                               
interest rates have on their bond portfolio.                                                                                    
MR. STORER explained:                                                                                                           
     The major component  of a fixed income  security is the                                                                    
     yield of  the security  and when you  buy it,  you will                                                                    
     buy  that security  to yield  X. That's  a snapshot  in                                                                    
     time, but during  that whole period you  will earn that                                                                    
     yield.  Let's  just  say  that  the  environment  is  5                                                                    
     percent so  that means that  if you earn  that security                                                                    
     for life,  you get  a 5 percent  yield. But  every time                                                                    
     interest  rates  change,  the price  of  that  security                                                                    
     changes   to  reflect   the   changing  interest   rate                                                                    
     environment. So  what will happen in  a rising interest                                                                    
     rate  environment is  we will  continue to  get that  5                                                                    
     percent yield, but that security  that we paid $100 for                                                                    
     will  become  worth  $99  become   worth  $98  so  that                                                                    
     diminishes the  value of the  investment. Of  those two                                                                    
     components,  historically   the  yield  has   been  the                                                                    
     largest contributor of return,  but in a lower interest                                                                    
     rate  environment  you  get greater  profits  from  the                                                                    
     principal  and in  a rising  interest rate  environment                                                                    
     you will end up losing some principal.                                                                                     
SENATOR  STEDMAN opined  that the  concept  is important  because                                                               
"the impression I'm getting is that  you want to broaden out this                                                               
asset  class and  you  want to  target that  bond  - roughly  the                                                               
return you  would get in  a normal  bond environment -  and there                                                               
probably will  not be a normal  bond environment coming at  you -                                                               
and  you want  to  have  some diversification  for  that area  to                                                               
hopefully  give you  an incremental,  if not  a positive  rate of                                                               
return, at least pushing in that direction."                                                                                    
MR. STORER  agreed with  the assessment.  If interest  rates stay                                                               
stable  or rise  they would  expect the  1 percent  allocation to                                                               
have a higher return plus  some diversification from a volatility                                                               
factor, but part of our goal is  to have a higher return than the                                                               
bond option.                                                                                                                    
SENATOR STEDMAN  noted that historically  returns are  yield rate                                                               
averaged  over  the   years.  He  then  brought   up  a  previous                                                               
discussion regarding reducing  the request from 15  percent to 10                                                               
percent.  If that  change were  made, he  questioned how  long it                                                               
might be before  the corporation would return  to the Legislature                                                               
and ask for a review of the basket clause limit.                                                                                
MR.  STORER  said it  would  depend  on  need and  the  financial                                                               
markets,  but he  estimated that  they would  be back  within two                                                               
SENATOR COWDERY asked about the reason for the request.                                                                         
MR. STORER replied  there are two basic reasons  for the request.                                                               
The  immediate  one  is  to  address  that  there  are  arbitrary                                                               
constraints  on  the  successful  management  of  the  fund.  The                                                               
corporation  could  be  forced to  liquidate  assets  because  of                                                               
statutory constraints  rather than due to  market conditions. The                                                               
other more  long-range reason  is to  create flexibility  to meet                                                               
the ever-changing financial markets.                                                                                            
CHAIR GARY STEVENS asked Mr.  Lorenson whether he had anything to                                                               
MR.  LORENSON told  him that  he was  listening and  available to                                                               
answer questions from a legal standpoint.                                                                                       
SENATOR STEDMAN offered  an amendment to change  the request from                                                               
15 percent to 10 percent [page 2, line 3].                                                                                      
CHAIR  GARY STEVENS  asked  if  there was  any  objection to  the                                                               
amendment and there was none.                                                                                                   
He asked for a motion to pass the bill from committee.                                                                          
SENATOR  COWDERY  made  a  motion  to  move  CSSB  326(STA)  from                                                               
committee  with  individual   recommendations  and  the  attached                                                               
fiscal note. There being no objection, it was so ordered.                                                                       

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