Legislature(2005 - 2006)CAPITOL 106
04/12/2005 08:00 AM STATE AFFAIRS
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|Human Rights Commission|
* first hearing in first committee of referral
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HB 215-PERM FUND CORP. INVESTMENTS/REGULATIONS CHAIR SEATON announced that the next order of business was HOUSE BILL NO. 215, "An Act relating to the investment responsibilities of the Alaska Permanent Fund Corporation; relating to regulations proposed and adopted by the Board of Trustees of the Alaska Permanent Fund Corporation and providing procedures for the adoption of regulations by the board; and providing for an effective date." 8:28:44 AM MICHAEL J. BURNS, Executive Director, Alaska Permanent Fund Corporation, Department of Revenue, presented HB 215 on behalf of the department. He said the bill would change the [legal] list of permissible investments for the permanent fund currently found in statute to "the prudent-investor rule." He noted that currently, 45 of the 50 states' pension funds, including Alaska's, use the [prudent-investor] rule. He said Alaska's Public Employees' Retirement System (PERS) and Teachers' Retirement System (TRS) have no statutory guideline, but use the [prudent-investor] rule. He said when the fund was originally created, it was 100 percent in fixed income, which made sense at the time. Over time, investments have been liberalized, and the fund's performance has reacted positively to that. Today, he emphasized, the statutory list is actually impeding progress, "causing us to take higher risks for lower returns." MR. BURNS directed attention to page 4 of a handout from the Alaska Permanent Fund, included in the committee packet, which is entitled, "Reducing Risk, Increasing Return." On page 4 is a graph called, "Efficient Frontier." He noted that the lower blue line shows the expected returns of various asset mixes, and the blue square shows "were we are today." He added that that's where the trustees made their asset allocation, in [March 2004]. He explained that the vertical axis shows "expected historical returns" and the horizontal axis shows "increase in risk" from left to right. He continued as follows: So, if you go directly above the blue box to the purple box [showing standard deviation], that's the efficient frontier without a statutory list; that is the return that we could get today for exactly the same risk we are taking. Or conversely, if you look to the left at the green box [showing expected return], we could get the same return we're getting today for that much less risk. So, the statutory list is putting us in a position where we are taking more risk for less return. 8:32:30 AM MR. BURNS, in response to a question from Representative Gardner, explained that the numbers 1-10 along the blue and red lines stand for different asset mixes that the trustees would look at. He added, "We landed on number 8, and that's probably 55 percent equities [and] ... 35 percent bonds." He indicated that he was also referring to page 5 of the handout. He said, "That's how the efficient frontier is - the different mixes of assets are those points along there, and we've highlighted the square one, because that's the one we decided on a year ago." He added, "Those are driven by the historical returns of the various asset categories." 8:33:26 AM REPRESENTATIVE GARDNER responded that she didn't see "on the chart where 8 is." She indicated that what she could not see is what is corresponding to the current target or goal. 8:33:36 AM LAURA ACHEE, Research and Communications Liaison, Alaska Permanent Fund Corporation, Department of Revenue, in response to a question from Representative Gardner, explained: We don't have all of the possible portfolios; so, the triangles that you're looking at that are numbered - we don't have those in your packet. What we do have are the main points - the blue box, the green box, the brown box, the purple box - and those are on page 5. And, unfortunately, they're not labeled so clearly that you can immediately spot them, but they match up in color. ... For instance, the brown box is labeled, "expected return equals 8.5 percent," and so, if you look on page 5, there's a column [with a matching title] ..., and ... that shows you the asset allocation that corresponds to that point. 8:34:23 AM CHAIR SEATON said what is being considered in HB 215 is changing the philosophy from having the legislature dictating what the basket of investments will be to requiring the prudent-investor rule to be used for the management of the permanent fund. 8:34:46 AM MR. BURNS, in response to a question from Representative Gatto, said there is an existing definition of the prudent-investor rule. 8:34:59 AM MS. ACHEE said the idea of the "prudent man rule" has existed for a long time, and the prudent-investor rule was defined in the early 90s. 8:35:33 AM MR. BURNS pointed out that one of the important concepts of the prudent-investor rule is that "you don't have to be right, but you have to ... document ... your thought process ...." He said he thinks that's what the board meetings are about, and that's why there are investors and advisors. He stated, "The fund is governed today by the prudent-investor rule and further governed by the statutory limitations; so, we do operate as prudent investors today." 8:36:04 AM REPRESENTATIVE GATTO gave opposite examples of what two different investors may call "prudent." He asked, "Isn't that kind of a self concept?" 8:36:32 AM MR. BURNS replied that both of Representative Gatto's examples would defy [the term] prudent investor, because they lack diversity, which is necessary. He stated, "A very important thing today is lack of correlation." He explained that portfolios were previously constructed whereby a great deal of thought was given to each particular asset. Today, he continued, the same thought is given to the asset, but also to how it interacts within the whole portfolio. He said it's important to have things that don't correlate, but rather respond to different things. He added, "A lot of those [uncorrelated] assets that we're talking about are really not available to us today, and that's, I think, one of the things that's impeding our performance, or holding us back." 8:37:39 AM REPRESENTATIVE RAMRAS asked if it would follow the prudent- investor rule to borrow money on $400 million at standard bond rates and then pay it back with permanent fund earnings. He said, "I'm thinking about the Amerada Hess [Corporation]-type of approach that the House is contemplating. Does that follow the prudent-investor rule?" 8:38:43 AM MR. BURNS responded as follows: We would actually not be making that investment. I think from just the financial mathematics, any time you can borrow tax exempt and invest taxable ..., or use it in a taxable fashion, I think that makes ... a great deal of sense. The Amerada Hess [Corporation] - that's not a decision that the trustees would make, so it doesn't fall under the prudent-investor [rule]; that's not an investment that they would be making, or the leverage is a decision that they would not be making .... They would continue to invest the Amerada Hess [Corporation] dollars just as they did the rest of the fund. 8:39:58 AM CHAIR SEATON, in response to further comments from Representative Ramras, asked that the discussion be focused on the issue at hand. 8:40:23 AM REPRESENTATIVE GARDNER asked Mr. Burns if he knows of anyone who is or may be opposed to the change proposed in HB 215. 8:40:33 AM MR. BURNS said the permanent fund has historically been supported in changes to its asset mix by the legislature. He said the only reluctance he has heard from some people is that perhaps this [change] should be taken more incrementally. He said, "I think with the asset types that we're talking about - that doesn't really work." He offered an example as follows: We have a commitment today under the basket clause of, I believe, $600 million to private equity. We have a commitment today of ... about $240 million to private equity of that commitment of $600 million. Actually outstanding, that people have drawn down, is $2.6 million. So, there's a real execution risk in trying to incrementally do this in a process that's incremental already .... We're looking at - today - our commitment to private equity. And to get to the point where we want to be, we need to commit more than we want to get to, just because it takes so long. And some of them, you have returns starting to come back before the money is actually drawn down. So, you need to commit beyond what you want. If you have statutory limitation, that's a real problem. MR. BURNS offered an example regarding the University of Alaska foundation. 8:42:54 AM REPRESENTATIVE ELKINS moved to report HB 215 out of committee with individual recommendations and the accompanying fiscal notes. There being no objection, HB 215 was reported out of the House State Affairs Standing Committee.