Legislature(1995 - 1996)
04/03/1996 03:28 PM L&C
* first hearing in first committee of referral
= bill was previously heard/scheduled
= bill was previously heard/scheduled
HB 345 - PENSION INVESTMENT BOARD PROCUREMENTS Number 960 CHAIRMAN KOTT announced the committee would hear HB 345, "An Act relating to the procurement of investment and brokerage services by the Alaska State Pension Investment Board," sponsored by Representative Foster. JOHN WALSH, Legislative Assistant to Representative Richard Foster, said HB 345 would require that the Alaska Pension Investment Trust Board increase the utilization of brokerage and investment services provided by persons located in the state to at least 7 percent. Additionally, there is a provision to provide an option to take a look in Alaska. If these services are not available or the quality of service is not available, the board wouldn't be required to make that local procurement. In support of the bill, he would reiterate on behalf of the sponsor, that the findings section of the bill where the case is made for a healthy competitive private sector is of paramount importance to Representative Foster. He said he is aware of the impending fiscal gap that is motivating much of the fiscal restrictions in the House and Senate operating budget. The opportunities before us are not limited to general fund only. We think that use of the assets that the state has access to including, the pension investment fund, could be used to circulate somewhat through the state and thereby, enhance the economy in support of the local firms that operate here. Mr. Walsh said they, in no way, have any intentions to jeopardize the investments or the integrity of the fund. That is not the objective of the sponsor. He said there are attractive investments in the state and quality firms that can handle some of the brokerage transactions and investment counseling. He said it is incentive to take a look in Alaska before going out of state. Currently, the board uses 100 percent out-of-state investment counseling. CHAIRMAN KOTT noted there is a new committee substitute which couldn't be adopted because of a lack of a quorum. He asked Mr. Walsh to review the changes. Number 1119 MR. WALSH said, "In the State Affairs hearings, there was some confusion as to whether we were talking about actual investments or investment services and we thought about that and took a look at the statute for the permanent fund investment. This committee substitute would incorporate Section 11, page 3, lines 7 through 13, -- would incorporate the same language that's currently in statute for the permanent fund. And that would be to take a look at investments for which the board is responsible in-house, to the extent that state investments are available and if the in-state investments have a risk level and expect to yield comparable to the alternative investment that the board would be looking otherwise -- and are certainly consistent with the investment policies established by the board. So the point here is an expansion to the original intent. It goes from beyond the investment counseling and brokerage services to actually requiring the board to take a look at investments in the state that meet or exceed those which the board would be looking for outside of the state. And we think if it's suitable for the permanent fund, it certainly is worthy of consideration in this legislation. And, again, the intent is to not in any diminish or disrupt the critical analysis or integrity that the board places on their current investments. REPRESENTATIVE ROKEBERG questioned what the number is in terms of the gross amount of pensions related to this area in terms of the Pension Investment Board. He referred to it being multiplied by 7 percent and questioned the meaning. MR. WALSH said, "I think I see members of the Department of Revenue here - staff to the Department of Revenue. If I understand, I think the actual transaction fees or investment fees by the Pension Investment Board are in the neighborhood of $7.4 million for the PERS (public employees retirement system). Well here, I have a schedule investment management fees, year ended June 30, 95, that's $7.4. I don't expect that those -- I guess -- I'm not sure how often the contract is turned, but that appears to be - just for the PERS - the amount of management fees for the fiscal year 94." REPRESENTATIVE ROKEBERG asked if the 7 percent would be based on the gross of the corpus of those funds. MR. WALSH explained the corpus of the funds is approximately $7 billion combined. Number 1338 MICHAEL KIRK came before the committee to testify against HB 345. He said he is addressing the committee not merely as a pension retiree, but as a fellow pension retiree as the committee members will be. Mr. Kirk said, "The reason I'm here to testify against HB 345 is because I consider the need that you will be given as an arm twister and maybe a little bit of a red herring, I've submitted incidently testimony to you which is in your file. It is unbelievable that presumably competent entrepreneurs, presumably competent investment brokers, presumably competent investment counselors would have to attempt to twist your arm to say that they should have special privileges for being in this state at this moment, they could have moved in any time as far as I'm concerned, and trying to persuade you or stampede you into believing, first of all, that the American free market economy has singled them out and is unfair to them, that the U.S. pension funds, contrary to court decisions, are the employer's property when the courts have ruled constantly otherwise. They are the earned property of the retiree. Number three, to have you believe that the epidemic in U.S. pension trust looting, as reported in the New York Times repeatedly and as reported in Business We repeatedly never happened." Mr. Kirk continued to give testimony against HB 345 and noted he submitted testimony which was included in the committee member's committee file. Number 1667 TIM VOLWILER was next to come before the committee to testify on HB 345. He informed the committee he has 16 years in the teacher's retirement system, he hopes to retire in the next century and he hopes there is money there for it. Mr. Volwiler said he believes the pension investment board is a trust fund for the teachers and the public employees. He said he thinks the pension investment board is working well in its present format and he doesn't see any reason to change the freedom of the board as it is. Mr. Volwiler said he was distressed to see the work draft, Section 11, page 3, lines 7 through 13. He noted he has sent letters to the committee members against the original bill. MR. VOLWILER said, "Number one, there doesn't seem to be any percentages in the bill; and number two, to me this kind of puts a burden of proof for consideration on to things which are not provable. I mean you're looking at risk level and expected yield and that is guess work. I mean you can have good analysis, but you can have a difference of opinion and I don't believe that you should tell the pension investment board that they are required to look at someone in-state or look at, you know, a municipal bond in- state that's AA rated is equivalent to a municipal bond AA rated anywhere else. So there is different analysis and I don't think you should put a burden of proof on the pension investment board to justify why they're not using local people. I think there are people in the state that have good ideas, but I don't think we should make any recommendations towards the board as to who they should hire. MR. VOLWILER said, "The second comment I would have is there is a difference between making your first investment in this state and then making other investments. If you have a wide diversification in your portfolio, all those risks balance out. If you concentrate a lot of investments in the state, such as Alaska with relatively few people, that concentrates your risk more. So each additional investment unbalances your portfolio. My main point, though, is I believe that `why fix what's not broken to start out with?' I think the pension investment board is working well. I think if they so choose to invest in-state, that's fine but the benefits should be the retirees and, as I consider myself, an expected retiree. When there is not a conflict here, I don't believe, I mean the recipients want their money to be there, when it comes they can spend it and that's how we can get economic development in this state. I don't think we should mandate a certain percentage or a certain broker that they have to go through. I think that the retirees have earned their money and when they get it in the terms of their retirement pay, they'll spend it in-state and that's the way we see the economic benefit in the state. If they choose to do so, I don't oppose that, but I don't think the legislature should be tying their hands and saying, `You must invest in-state.'" Number 1858 MILT BARKER came before the committee to testify on HB 345. He informed the committee he is a PERS beneficiary, served the state for eight years as deputy commissioner of Treasury. He said his concern is both for the state and the beneficiaries and that mean upholding the high standards we currently have in legislation the legislature has passed. Mr. Barker said the defining principle of the trust fund, as quoted in standard legal text, is the most fundamental duty owed by the trustee to the beneficiaries of the trust, which is the duty of loyalty and that duty is defined as, "A trustee owes a duty to the beneficiaries to administer the affairs of the trust in the interest of the beneficiaries alone and to exclude from consideration the welfare of third persons." Mr. Barker said HB 345 would be a retreat from these standards and would be a costly one. The cost would come from higher trading costs, poor investment performance, greater administrative costs and potentially litigation. The board is currently obligated to obtain the best performance and the lowest transaction costs that it can. Even if Alaskan firms provided equal service, mandating their use can increase costs by increasing the number of firms that the board deals with. Mr. Barker said this could be increases in administrative costs and managerial distractions from it pursuing investment performance. It also can increase costs because typical investment management contracts have graduated fee scales - the more money under management, the lower the rate. You divide the money between more firms and you'll raise your total fees. MR. BARKER said when the permanent fund's adviser, Michael O'Leary of Callen, Associates, was asked how many domestic fixed income managers should be heard, he stated, "Any more than two and fees would affect the return, if the board hired three to make room for an Alaska based emerging manager." The trust fund standards that we have are really global standards of excellence and this has paid off. These funds are among the best funded pension funds in the country. Their performance is better than the permanent fund even though the permanent fund, as an endowment, has a longer investment horizon. MR. BARKER explained the cost of HB 345 would be born, not only by employees, but by employers. Contribution rates can only go up. He said for public employer higher costs, it means higher taxes or fewer services. He questioned whether this is the time to be subsidizing in-state business when the state faces a half a billion deficit and is cutting education and other essential services. MR. BARKER said by ignoring standards of fiduciary conduct, HB 345 could expose the state to risks of litigation. Plaintiffs might be beneficiaries to PERS, TRS, SBS, deferred comp, etc. He said you could also find that municipal or other employees besides the state would possibly take the state to court. Mr. Barker said he thinks the ordeal of the mental health trust law suit ought to give us pause. In short, HB 345 can only exacerbate the state's budget crises and cheapen the promises public employers have made to their retirees. Mr. Barker pointed out there is no bar to in-state businesses performing services to the state's trust funds, but it should not be handed to them on a plate or given as a political favor. He said like the commercial says, "Let them get the business the old fashion way, earn it." MR. BARKER said he would like to make a comment regarding the additional language in the proposed committee substitute. He said the goal, he believes, is to increase in-state investment and a lot of that would be targeted through commercial mortgages, both multi- family and business. The state already has major effort in that regard, both AIDEA and now AHFC. He said just recently AHFC announced a new financing program for market rent multi-family housing and that should address a lot of the concern that is behind some of this legislation. Number 2112 WILLIE ANDERSON, NEA-Alaska, was next to address the committee. He stated NEA-Alaska opposes HB 345, primarily for the reasons stated previously by earlier speakers. He said their concern is that the bill mandates that there is a percentage of the pension fund that is required to be invested in-state. The pension board was elected about four years ago, has been operating as an independent pension investment board and has done a good job. The returns have continued to increase since the board has been in place; the fund is healthy; the unfunded liability has decreased over time; and with the potential of this requirement, the unfunded liability could very well increase and could cost the state additional funds instead of increasing the revenue to the state. He said it could impinge upon the state's liability to bail out yet another investment system. Mr. Anderson referred to when the SBS situation went sour in the late 1980s - early 1990s, there was a requirement for the state to bail that fund out. They later sued and recovered some of that money. The same potential exists for this situation. He urged that the bill not move out of committee. MR. ANDERSON referred to the new language in Section 11 and said it causes additional concern to NEA-Alaska because it doesn't appear to have a limit as to how much can be and should be invested. He said there is a risk level and an expected yield. Currently, the yield for the pension investment for Alaska is above average and is well respected in the arena of state employee pension funds throughout the nation. If this bill is passed, we cannot tell what that performance will be. He urged the bill be held in committee. Number 2211 REPRESENTATIVE SANDERS asked if the Alaska teacher's retirement fund buy or carry mortgages in Alaska. MR. ANDERSON said he doesn't think that is part of their portfolio at this time. He said someone from the Department of Revenue could better answer that question. Mr. Anderson noted there is nothing to preclude them from doing so. If it is a worthy investment, they can pursue it. Number 2242 BOB STORER, Chief Investment Officer, Treasury Division, Department of Revenue, was next to come before the committee. He pointed out that the Department of Revenue provides staff to the Alaska State Pension Investment Board. He said the intent and the benefits of the legislation are fairly obvious, but he would like to speak to a number of things for the committee's consideration as they evaluate the merits of the legislation. Mr. Storer said AS 14.25.180 does name the Alaska State Pension Investment Board as the fiduciary of the trust funds. In that context, they must consider the funds investments and the liabilities. They must determine the appropriate investment objectives and act only in regard to the best interests of the system's plan and beneficiaries. MR. STORER explained that one of the things this legislation does is, by statute, it creates policy and in the modern investment world, it is changing and is very dynamic. These issues need to be addressed on an ongoing basis throughout the world. Some of the unintended consequences of the legislation is it could have the effect of actually dictating the asset allocation of the retirement system. If you have a limited universe in Alaska to choose from, you select managers in Alaska that provide a certain investment vehicle. Then by default, you have other asset allocation questions to deal with externally. Mr. Storer referred to testimony relating to fees and those statements are reasonably accurate. He said they are always very aggressively trying to cut management fees as much as possible. Over the last couple of years, they have successfully cut about $2 million in management fees. He said he believes PERS and TRS in the aggregate, are about $13 million. The fees are published annually in the Retirement and Benefit Annual Report. MR. STORER said, "There is one thing, if I was an Alaskan manager and I knew you had to come to me for investment services, basically you've taken all my leverage - my negotiation leverage away from me. Why would I acquiesce to lower fees, and again, we do this on an ongoing basis if I know you must come to me. So I think there are some implications there, not only in the number of managers, but the ability to negotiate lower fees on an ongoing basis." MR. STORER said, "In terms of brokerage, I'd like to come back to that. I did so well at describing at the last committee, I decided to draw pictures this time and so hopefully, it will be helpful for the committee members. The new piece, in terms of investing in Alaska -- this is sort of classic language, if you will, for economically targeted investments. `Is that done out there elsewhere?' -- And the answer is `Yes.' A study done in 1995, by a firm named Grenich (ph) Associates indicated that public funds in excess of $1 billion, about 17 percent of those public funds do economically target investments. So if you want to look at it -- glass half full or half empty, 83 don't - 17 do, or however you want to perceive that. I would revisit the question of risk and yield and what I've known is that the farther away you get from markets where (indisc.) reported trading, the greater the difference on the perception between what is appropriate risk and yield and it depends on whether you're the buyer or the seller. And there can be distinct differences on that opinion as you move forward." MR. STORER said a distinction that one should consider versus the permanent fund and the retirement system is that the retirement system has a distinct liability stream - the beneficiaries. The permanent fund doesn't have a liability stream and they do not have to deal with that issue when they're evaluating investments. MR. STORER said, "If I may, in talking about activity for a minute I'd like to hand out these diagrams. And the answer on public employees, in terms of in terms of asset management fees and investment advisory counsel is $7.5 million and for TRS it's $4.3 million is what's paid for asset management - a substantial sum. Trades are really divided into two groups. The brokerage firms, when they deal with it, you have institutional level trading and that's what the retirement system, the permanent fund, any public fund - private entities use. And then you have retail which we at this table probably use." MR. STORER continued to explain the diagram he had given the committee members. He said the manager makes the trade decision and they make the decision to buy or sell the securities. Mr. Storer said they are not just trading just on behalf of the Alaska State Pension Investment Board. They have many other funds that they deal with. [END OF TAPE....] TAPE 96-33, SIDE B Number 001 MR. STORER continued, "...They're trained to be execution. There is quality execution. They're used to what we call `large blocks - large trading.' And that's how you obtain the best execution. And it goes through the institutional sales office and then on to the institution trade desk, and we've heard about electronic trading a bit earlier. It's done very quickly and that's important because you want to get maximum execution. I should also note that by contract, managers accept fiduciary responsibility and they have held to a standard of best execution possible. Now what happens, in terms of if we were trade through offices in Alaska, these would go through a retail entity. What happens is the manager must complete all trades (indisc.--coughing) and there is some level of our market impact when that execution occurs. So if you can see, if we were to be held back by the diagram, we would go after all the other trades would be completed and then you would have to execute the trades through the Alaskan desks, and typically but this is not an absolute statement, major brokerage firms have an intermediary between the retail and the institutional desk to get the trading. So you must wait and complete the order before we can do our trade. There are other delays, there is clearly market impact. Under additional costs, what will be the market impact? You cannot determine it until after the fact. So you could only determine the (indisc.) costs by hiring an independent consulting firm to evaluate the trading costs after the fact. And, of course, hiring has some cost implications also. With that in mind, if I may, I'd like to be available to answer any questions the members of this committee might ask. Number 079 REPRESENTATIVE ROKEBERG referred to when the department goes out for management services contracts and asked if they go through the procurement code. He also asked how contacts are worded. MR. STORER said, "This process is unique. It's actually recognized that it is exempt from the procurement process. Nevertheless, you do have a process. You're obligated as a fiduciary. The board will evaluate an array of asset classes, make the decision. And we do have a consulting firm that assists the board in: (A) Those decisions; and then (B) When we're looking for a specific type of manager. The consulting firm essentially runs the RFP process in concert with the board and members of an investment council also assists the board. And I would suggest that to some degree it is far more rigorous than the RFP process. These firms are constantly appraising the investment community at large. I think the one we use evaluates something like 1,200 management firms that provide due diligence and they look at a lot of issues as you suggest - the depth of an organization, the abilities. Yes, fees are some distinction but they're not an absolute distinction. It is a rather vigorous process and then the final component is bring some element -- some group of finalists before the board for the final selection process." MR. STORER continued, "In answer to your question about Alaskan money management firms, I think one of the things that is very important is communication. I think that the investment board must understand what investment options are available in Alaska. And I think that the management firms must convey how they manage their assets so that the board would be well educated when those investments are appropriate. In fact, the board has invited, on two occasions, money management firms in Alaska to make educational presentations before the board. One was a fixed income manager and another was one that proposed managing mortgages. From the investment board side, this is important because the more we know it'll assist us in evaluating these firms. And then as we evolve our way through the asset allocation decisions, that could be embedded in the process. So I do think it is important that the communication be in place and that there be ongoing education in terms where managers are in Alaska. Number 211 REPRESENTATIVE PORTER asked Mr. Storer if he has had any experience with in-state providers. MR. STORER informed the committee that to date, the board has not hired an investment manager to provide services in Alaska. REPRESENTATIVE ROKEBERG asked if anybody in the state has made a proposal to the board. MR. STORER said they have always asked the consulting firm to take a very long look at the management firms in Alaska. He said that has always been his instructions as the chief investment officer to the consulting firm. REPRESENTATIVE ROKEBERG referred to when the permanent fund was started there was a percentage of quota provision for investments within financial institutions, specifically banks within the state. MR. STORER said he helped develop that policy as he worked nine years for the permanent fund. There was the Alaska Certificate Deposit Program. He said they made up to $300 million available to the institutions in Alaska. These were fully collateralized certificates of deposit. Mr. Storer said, "We worked with the banks, not always to their satisfaction because they like to pay a little bit less and we'd like to get a little bit more. But we developed a program that did make funds available in what we felt was a market rate - a favorable market rate to both entities. The most that I can remember that the banks availed themselves of was about $200 of the $300 million and, while I have not been over in the last four years, I think the average balance has been about $80 or $100 million the last four years. What that suggests is that banks don't need capital because that was designed as a source of capital for them. CHAIRMAN KOTT thanked Mr. Storer for his testimony and said it is not his intent to move HB 345. He asked the committee to review the proposed committee substitute as it would be brought up at the next meeting on the measure.