Legislature(1995 - 1996)

04/03/1996 03:28 PM L&C

Audio Topic
* first hearing in first committee of referral
+ teleconferenced
= 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              
 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           
 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                         
 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             
 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.                                                  

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