Legislature(2003 - 2004)
02/12/2003 09:06 AM Senate FIN
| Audio | Topic |
|---|
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
MINUTES
SENATE FINANCE COMMITTEE
February 12, 2003
9:06 AM
TAPES
SFC-03 # 3, Side A
SFC 03 # 3, Side B
CALL TO ORDER
Co-Chair Gary Wilken convened the meeting at approximately 9:06 AM.
PRESENT
Senator Lyda Green, Co-Chair
Senator Gary Wilken, Co-Chair
Senator Con Bunde
Senator Ben Stevens
Senator Lyman Hoffman
Senator Donny Olson
Also Attending: SENATOR JOHN COWDERY; SENATOR FRED DYSON; SENATOR
HOLLIS FRENCH; SENATOR ROBIN TAYLOR; SENATOR THOMAS WAGONER; ROBERT
D. STORER, Executive Director, Alaska Permanent Fund Corporation,
Department of Revenue; ERIC E. WOHLFORTH, Chair, Alaska Permanent
Fund Board of Trustees; CLARK GRUENING, Vice Chair, Alaska
Permanent Fund Board of Trustees; CARL BRADY, Member, Alaska
Permanent Fund Board of Trustees; WILLIAM A. CORBUS, Commissioner
Elect, Department of Revenue and Member, Alaska Permanent Fund
Board of Trustees; MICHAEL J. O'LEARY CFA, Executive Vice
President, Callan Associates Inc.; CHRIS PHILLIPS, Director of
Finance, Alaska Permanent Fund Corporation, Department of Revenue
Attending via Teleconference: There were no teleconference
participants.
SUMMARY INFORMATION
The Committee heard an overview from the Permanent Fund Corporation
regarding the Fund's current and projected financial status.
Presentation by the Permanent Fund Corporation Board of
Trustees
Co-Chair Wilken informed the Committee that the Alaska Permanent
Fund Corporation's presentation would include an introduction of
its Board of Trustees, a general update on issues being addressed
by the Corporation, a capital market outlook, and a financial
forecast for fund growth and income.
ROBERT D. STORER, Executive Director, Alaska Permanent Fund
Corporation introduced Eric Wolfforth who is serving a second term
as Chair of the Alaska Permanent Fund Corporation Board of
Trustees.
ERIC WOHLFORTH, Chair, Alaska Permanent Fund Corporation Board of
Trustees, acknowledged Clark Gruening, Carl Brady, and William
Corbus as members of the Permanent Fund Corporation Board of
Trustees who were in attendance. He mentioned that other attendees
include Bob Maynard and Allen Bufford, who, as members of the
Fund's Council of Advisors, provide a professional "outside look
and a critical look" as to how the Fund is performing. He noted
that today's presentation would be conducted by Michael O'Leary,
senior officer of Callan Associates, a consulting firm that reviews
and advises on the activities of the Fund's managers and the Fund's
internal investment strategies.
Mr. Storer informed the Committee that, in addition to generating a
five-year financial forecast based on market conditions, Callan
Associates performs an annual review of the Fund's capital markets
and asset allocations. He noted that the review, which includes the
earnings return expectations for each asset category such as real
estate, stocks, and bonds, is presented to the Corporation each
February in the form of an educational meeting. He remarked that
the Corporation would address the review's findings during an
upcoming March meeting.
MICHAEL J. O'LEARY CFA, Executive Vice President, Callan Associates
Inc. referred the Committee to the Callan Associates Inc. "2003
Capital Market Outlook Legislative Work Session" handout [copy on
file], dated February 2003. He stated that the information on page
two of the handout reflects that the years 2000, 2001, and 2002
were the first years since the 1930's that the Stock Market "has
been down" three consecutive calendar years. He stressed that these
three years fared worse than the market decline of the 1973-4 bear
market and were similar to "the market descent" of the 1930's.
However, he voiced optimism that these years were "the bottom of a
retractive bear market" that has been "very deep in terms of
percentage loss."
Mr. O'Leary stated that the Leman Brothers (LB) Aggregate Bond
Index numbers on the page reflect the "magnitude of the bond market
returns" over the same three-year period. He ventured that "the
relative performance difference between stocks and bonds…has never
been greater," and he identified declining interest rates as a
contributing factor to the "extraordinary" bond performance. He
stressed that the implications of this bond market trend would be
significant as the market moves forward.
Mr. O'Leary continued that, additionally, the Standard and Poor
(S&P) Stock Index "rolling 20 quarter returns" graph titled
"Rolling 5 Year Returns for Stocks" depicts that, in 2002, stocks
had their first negative return since 1973-4. He noted that, if the
returns for 1998 and 1999 were removed from the chart, "the
cumulative returns would be horrendous because those two years were
so strong."
Mr. O'Leary stated that page four reflects cumulative return and
growth comparison tables for stocks, bonds and cash for the
previous forty years, in five-year increments. He expressed the
importance of noting that overall stock returns have been
"comfortably above the return" generated by bonds. He pointed out
that this is denoted by the 10.49 percent cumulative 40-year stock
return achieved in spite of the recent bear market. He compared the
relative value of a dollar to stocks and bonds returns as depicted
in the table at the bottom of page four.
Co-chair Wilken asked how a stock is defined in this review.
Mr. O'Leary replied that the stocks referred to in this research
are defined as the Standard and Poor (S&P) 500.
Mr. O'Leary continued that while evidence such as a growing economy
indicates that the recession is coming to an end, the information
on page five addresses the current economic environment which
includes: a weak business investment trend; the lowest treasury
bond yield in forty years; a narrowed spread between corporate and
treasury bond yields; and the fact that the equity risk "premium is
unusually wide." He stated "that people are very risk adverse,
currently," which, he stressed, is supported by the public's
immediate and negative response to daily news reports regarding
terrorism and the result that this response has on the investment
market.
Mr. O'Leary voiced that numerous state and local governments are in
"difficult financial circumstances" as a result of declining tax
revenues, continuing growth and expenditures, and "very
unfortunately, a real increase in pension funding requirements" on
the national level which is affecting both public and corporate
pension funds.
Mr. O'Leary stated that the graph on page six "depicts the yield to
maturity for the bond market as measured by the Lehman Aggregate
Index." He identified the first of the seven daily yield points
highlighted on the graph as being September 10, 2001, the day
before the terrorist attacks on New York City and the Pentagon. He
stated that this point signifies the beginning of a "dramatic"
daily yields "fall." He stated that, "people running to quality,
drove the interest rates down" as a result of the federal
government "opening the faucet to provide sufficient liquidity in
the system." He continued that on December 31, 2001 the interest
rates rose to approximately the same level as before the September
th
11 terrorist attacks. He continued that during the first quarter
of 2002, interest rates increased, and an economic recovery
appeared to be occurring; however, he shared, economic factors
began to decline and the "whole investment grade bond market from
Triple A to B double A" continued in a downward trend to "a very
low level" in September 2002. He stated that the bond market
recovered at the beginning of the fourth quarter of 2002 "with
interest rates spiking back up" then declining again at the end of
2002 to an interest rate of approximately four percent. However, he
expressed, during the first two days of 2003 "the yield to maturity
of the bond market increased approximately 25 basis points."
Mr. O'Leary stressed that the "yield to maturity on the bond market
is a good naïve indicator of the rate of return" expected for
investment grade bond earnings over the next five years; however,
he shared, "there have been some structural changes in the bond
market in the composition of this index so that as we look ahead,
this indicator would not be quite as reliable as it has been in the
past." Nonetheless, he continued it does provide "a starting point"
for what could be expected of a bond investment.
Mr. O'Leary explained that the graph on page seven compares the S&P
500 earnings yield over a twenty year period to the corresponding
ten-year treasury bond yields. He pointed out that in 1981-2, the
treasury bond yield, which is currently four percent, was 14
percent. He furthered that the stock market yield exceeded ten
percent in 1981-2; however, he qualified, its yield is also
currently four percent. He expressed that over time, "there is a
linkage between the price investors are willing to pay for future
earnings and the general level of interest rates as measured by a
riskless investment" in a ten-year treasury bond.
Mr. O'Leary noted that the linkage between the S&P Earning Yield
and the Ten-Year Treasury Yield is reflected in the ratio
comparison chart at the bottom of page seven. He noted that in
1987, the graphing line dipped "very low" which indicates that
consumers viewed stocks "as very expensive relative to interest
rates" at that time. He continued that this relationship was
"corrected" in the fourth quarter of 1987 when the stock market
"tanked" and stock values declined more than twenty percent. He
noted that interest rates also declined at this time. He
characterized the years 1999 and 2000 as "bubble-mania," when the
market was "absurdly" valued and "interest rates were comparatively
low." He stated that the correction to this situation has been the
recent three-year "painful bear market." He summarized that
currently, "stocks appear to be attractively priced relative to
treasuries."
Mr. O'Leary stated that page eight reflects a valuation measurement
comparing the United States stock market to other national markets.
He noted that, "all markets appear to be below their long run
averages."
Mr. O'Leary informed the Committee that page nine identifies
features imbedded within the financial analysis including:
continuing economic recovery; continuing low inflation rates;
"comparatively little risk" of deflation; a slowing of consumer
spending to align with disposable income levels because "everyone
who could refinance has already done so;" a slow stock market
recovery; and a tapering off in the housing market as interest
rates begin to rise. He noted that it should be considered a
"blessing" that the housing market has remained as strong as it
has.
Co-Chair Wilken asked the problems created by deflation.
Mr. O'Leary voiced that "moderate inflation of three percent or
less" is healthy for the economy, as it makes for "easy adjustments
in relative prices." In response to Co-chair Wilken's question, he
characterized an employee review as being similar to the "scary
scenario" of an "deflationary environment;" wherein, the employee
is told that as a reward for doing a great job, his or her salary
would be decreased only one percent rather than the four percent
designated in the budget. He commented that in a deflationary
environment, it is hard "to pay off your debt." He continued that
the value of a person's home "has been a great source of the growth
of equity;" however, he stressed, "in a protracted period, the
price" of a house would decline rather than being stable or
increasing. He declared that this would adversely affect an
individual's sense of well-being and the economy as a whole.
Co-Chair Wilken asked when the United States experienced its most
recent deflationary period.
Mr. O'Leary responded that the most recent deflationary period
occurred in the 1930's. He continued that, within the last six
months, national economists announced that people "were really
worried about" the risk of deflation occurring; however, "that risk
seems to have diminished."
Senator Bunde commented that Alaska experienced a downturn in the
value of homes during 1985-6, which, he reminded the Committee,
corresponded with, among other factors, a decrease in State
spending.
Mr. O'Leary stated that the information on page ten provides
details from the five-year capital market projection that Callan
Associates, Inc. generates each year.
Mr. O'Leary explained that the chart on page eleven identifies "the
middle point of a range" of projected market possibilities, and
that the range is referred to as the Standard Deviation or risk
factor. He stated that Standard Deviation is further explained on
page twelve.
Mr. O'Leary noted that page 13 depicts the 2003 Capital Market
Projections. He pointed out that the 2002 inflation number
projection has been reduced from 2.9 percent to 2.6 percent in
2003, which, in effect, causes a 0.3 percent reduction "in the
expected return of every asset category."
Mr. O'Leary continued that the biggest change in this year's annual
report when compared to previous reports is "the change in the
expectation of bond return" as the result of the "substantial"
decline in interest rates. He stated that the 2002 bond return
projection was 5.75 percent; however, he noted, the actual return
for 2002 was ten percent, with four years remaining on that five-
year forecast. He stated that some analysts consider Callan
Associates' 2003 bond return projection of 4.75 percent optimistic;
while others consider the projection to be low, in light of the
2002 ten percent return. He noted the approximate 4.75 percent 2003
bond return would lower the overall return level during the five-
year projection period.
Mr. O'Leary continued that an internal debate occurred within
Callan Associates "about the likelihood of an equity return." He
commented that, "over a protracted period of time, the real return
to common stock investors" has averaged six percent, "even
incorporating" the recent sharp decline in the stock market. He
voiced that "we are closer to the end of a bear market than the
beginning of a bear market," and he commented that it could be
argued that the expectation is "for an above average real return"
for the next five years. He stated that the 2003 forecast
identifies a 6.1 percent real return on the S&P 500 and that,
including inflation the nominal rate of return is projected to be
8.7 percent.
Mr. O'Leary continued that the chart on page 13 compares the 2002
projections to the 2003 capital market projections for equities,
fixed income assets, inflation, and other investments such as real
estate, and their corresponding projected annual returns and
standard deviations. He commented that the Alaska Permanent Fund
has benefited from its "substantial allocation" of real estate
since real estate has fared well during the recent market downturn;
however, he noted, the real estate market, and in particular the
competitive leasing market situation, on the national level has
weakened.
Mr. O'Leary indicated the graph on page 14 reflects the range of
return and standard deviation mixes using "the most conservative to
very aggressive" 2002 equity numbers and also reflects the range
using the 2003 projections. He explained that, in 2003, a
conservative and "low volatility" equity allocation percentage of
twenty percent would generate approximately a six percent return.
Mr. O'Leary, referring to market risks such as terrorist attacks,
inflation, and a stagnating economy, stated that the five-year
market projection detailed on page 15 takes into consideration the
current political conflict in the Middle East with "the key
assumption" that were military action to occur, it would be
contained to that area and would be short in duration. He stated
that this projection must be revisited, were the conflict scenario
to differ from this assumption.
Mr. O'Leary continued that the chart on page 16 applies the 2003
financial projections to the Alaska Permanent Fund Corporation
(APFC) portfolio components. He compared the current portfolio
component allocation percentages as established "by the policy of
the Fund" to various asset allocations referred to as "mixes." He
declared that the target allocations are projected to result in a
2003 expected rate of return of approximately 7.38 percent with a
standard deviation of 10.84 percent. He explained that the 10.84
percent standard deviation number indicates that the range of the
return could be between negative 3.56 percent and positive 18.22
percent.
Mr. O'Leary stated that, "the Permanent Fund's current policy is
essentially at the statutory limit for equity exposure, exclusive
of the basket clause." He explained that, "the basket clause
provides added flexibility" and in the case of a strong stock
market rally, would "allow for the percent allocated to equities to
be increased." He continued that the basket clause also allows the
Corporation "to invest in areas that otherwise are not explicitly
approved by statute."
Mr. O'Leary utilized the term "efficient frontier" to refer to the
market position in which the asset allocations produce the
projected rate of real return. He mentioned that the chart on page
17 depicts the "efficient frontier" and the current "target mix" of
investments.
Mr. O'Leary continued that the bar graph on page 18 illustrates the
target rate of return and the various rates of returns generated by
differing asset allocation mixes for a one-year period. He stated
that the targeted asset allocation mix's medium range of return is
th
projected to be 7.38 percent; the 5 percentile projection is 26.62
th
percent; and that the 95percentile projection, "which is two
standard deviations," is a negative 8.93 percent.
Mr. O'Leary noted that page 19 and page 20 portray the rate of
return over a three-year and five-year period, respectfully. He
noted that the contrasting "worst and best case scenarios are both
less extreme" than those experienced in a one-year period, and, he
continued, the five-year period range of returns has the lowest
extremes. He reiterated that, "most of the benefit derived from
diversification really occurs within a five-year period."
Mr. O'Leary characterized the information on page 21 as a
"forewarning" of the impact of the statutory limitation of 55
percent asset allocation in equities. He explained that as the
allocation "moves toward higher volatility, higher risk, and higher
return alternatives, that's when the statutory constraint begins to
have an effect."
Mr. O'Leary, referring to the review's conclusion on page 22,
stated that an important question is whether the fund's policy is
on the efficient frontier, and he concluded, "the answer is yes."
He continued that the policy is "prudent and produces the highest
expected return for the level of risk that is undertaken." However,
he expressed, in the auspice of today's five-year projection, "the
policy mix is inconsistent with the obtainment of a five percent
real return target."
Mr. O'Leary declared that this is the first time the Permanent
Fund's rate of return on its investments has faced this situation,
and the reason, he clarified, is because bonds are a "very
substantial part of the Permanent Fund portfolio" and "the expected
real return on bonds is so low." He stressed that after factoring
in inflation, the projected real return on bonds would be 2.1
percent, which is below the projected five-year return of five
percent. He stated that the Permanent Fund Board of Trustees would
be addressing this issue. He noted "that there have been other
periods in history when the financial markets haven't produced the
types of targeted real returns that people were striving for, and
that can change, but right now…it is unreasonable to expect a five
percent real return over the next five years."
Co-Chair Wilken asked for further information regarding the various
market mix allocations depicted on page 20, particularly
information about Mix 3 in which all of the projected returns are
positive.
Mr. O'Leary responded that Mix 3 reflects a 95 percent probability
of a 0.09 percent return with a median return of 7.12 percent. He
commented that Mixes 4 through 8 reflect larger medians than the
Target allocation median of 7.38 percent; however, he noted "there
is also an increased chance of some negative returns over that
five-year period."
Co-chair Wilken understood, therefore, that the efficient frontier
would be between Mix Three and Four.
Mr. O'Leary referred the Committee to the asset allocation mixtures
detailed on page 16. He explained that Mix 3, with a domestic or
non-dollar bond component of 43 percent, reflects "a heavier bond
component" than Mixes 4 through 8; however, he clarified, these
various "mixes are all efficient in that they produce the highest
return possible for that level of risk." He qualified that these
mixes "are riskier, that is there is more volatility, but that
doesn't make them any less appropriate."
Senator Bunde noted that in previous presentations, Mr. O'Leary
projected a targeted goal of an eight percent return with an actual
realized gain of five percent. However, now, he noted, the targeted
goal reflects a lower return. He asked whether this is the result
of the lower inflation factor.
Mr. O'Leary replied yes, "a lower total return is in part a
function of a reduction in the inflation number." He noted that at
the time of the eight percent return projections the inflation
factor was approximately three percent. He continued that this
would result in a five percent rate of real return were this the
only factor. However, he continued, another factor in the reduction
of returns is the "significant change in the level of interest
rates."
Senator Bunde commented that Permanent Fund Dividends have been
calculated based on a five percent rate of return.
Mr. Storer concurred that the dividend projections were factored at
a five percent rate of real return. He noted that upcoming
Permanent Fund Division testimony would address this matter.
Senator Bunde asked whether the price of oil is a factor in the
projections.
Mr. O'Leary assured the Committee that the issue of fluctuating oil
prices is addressed in the report.
Senator Bunde asked whether this fluctuation affected the accuracy
of the 2002 projections.
Mr. Storer noted that the analysis is conducted on a five-year
basis rather than on an annual basis.
Mr. O'Leary furthered that Callan Associates routinely conducts an
annual review of previous five-year projections to ascertain "how
accurate they were." He stressed that the objective is for the
projections to be within the forecast range, both within each asset
allocation and as a total portfolio. He announced that this
objective has been achieved with one exception in which the equity
return was higher than projected; however, he clarified, the total
portfolio projections were within the projected range.
SFC 03 # 3, Side B 09:53 AM
Co-chair Wilken asked the effect of the growth of global industry
on the American economy, as, he noted, American jobs have been lost
and capital investments into the U. S. economy have been reduced.
Mr. O'Leary responded that the globalization concern has prompted
responses "from free marketers arguing that globalization benefits
all by helping accelerate growth and efficiency." He stated that
"fortunately" the United States' economy is flexible and better
able to cope with this issue than other nations. He continued that
"composition of the United States economy" is transitioning toward
becoming more service and high technology oriented, and that "the
traditional manufacturing base" is now being serviced from abroad.
However, he noted, foreign economies are impacting American
manufacturing and high end, traditional blue-collar jobs, and he
stressed that people would require retraining "in the service
equivalent of those jobs." He mentioned that an increase in foreign
industry sales also could affect inflation. He explained that the
United States' dollar value is weakened as the cost of importing
goods increases. He stated that this issue has resulted in a
variety of inflation range projections within the financial
industry.
Senator Wilken asked whether globalization has been a significant
factor in the recent recession in America.
Mr. O'Leary voiced that he could not adequately respond to that
question.
Co-chair Wilken thanked Mr. O'Leary for the presentation.
Mr. Storer informed the Committee that Chris Phillips would present
the current Permanent Fund balance, models, and projections. He
stated that he would then comment about the Fund's performance and
asset allocations.
CHRIS PHILLIPS, Director of Finance, Alaska Permanent Fund
Corporation, Department of Revenue, spoke regarding the "Alaska
Permanent Fund Brief history and financial outlook for Fund growth
and income" booklet [copy on file], dated February 2003. She noted
that the history of the Permanent Fund total value, which is
comprised of the Fund principal and the earnings reserve account,
is portrayed on the first page of the booklet. She noted that the
Fund's balance, as of 12/31/02, was $22.9 billion and is comprised
of the following: $7.5 billion of dedicated oil revenues; $7.5
billion from inflation proofing; and $7 billion from special
appropriations. She noted that the special appropriations component
is comprised of "special appropriations from the general fund in
the early years and recently from the earnings reserve account into
principal."
Senator Bunde asked which of these three units the Corporation
recognizes as the corpus of the Fund.
Ms. Phillips responded that the Corporation recognizes the corpus
to be the entire principal balance of $22 billion.
Ms. Phillips noted that the graph on page 2 identifies the earnings
reverse account balance. She explained that the $3.5 billion
earnings reserve account balance on June 30, 2000 is the value
after the State accounted for the June 2000 dividend and inflation
proofing appropriations. She noted that the earnings reserve
account is "split between the realized earnings reserve and the
unrealized earnings reserve." She explained that the realized
earnings reserve is defined as the "cash flow from interest from
bonds, dividends from stocks, and cash flow" from Corporation real
estate holdings, as well "as the realized gain or loss on manager
sale of assets."
Ms. Phillips continued that the unrealized earnings reserve income
is the accumulated appreciation of the assets that remain in the
Corporation. She noted that the Fund market value as of 12/31/02
was approximately $900 million, comprised of $1.2 billion in
realized earnings reserve and a loss of $300 million in the
unrealized earnings reserve. She explained that the earnings
reserve account absorbs the market volatility for the entire Fund.
Ms. Phillips stated that the chart on page 3 explains how the
earnings reserve account balance has been reduced from a $6.5
billion balance on June 30, 2000, to the $900 million balance on
December 31, 2002.
Senator B. Stevens asked for confirmation that "the Earnings
Reserve absorbs the entire volatility of all the principal."
Ms. Phillips responded that is correct.
Senator B Stevens surmised that, "the principal is the dedicated
revenue in nominal dollars, not in dollars that have any increased
gain."
Ms. Phillips responded, "yes, it is a nominal notational number,
and the entire market volatility is recorded in the earnings
reserve."
Senator B. Stevens concluded, therefore, that $22 billion is the
value of the dollars deposited into the fund.
Ms. Phillips concurred. She reiterated that the Earnings Reserve
account balance of $6.5 billion at the beginning of June 2000, as
depicted in the chart on page three, "already" factors in the
removal of the June 2000 dividend and inflation proofing dollars.
She explained that the chart additionally reflects all activity
since that date, including: a gain of $2.4 billion for two years of
interest, dividends and real estate; a negative $0.8 billion in
realized losses; a negative $1.3 billion total for the years 2001
and 2002 inflation-proofing transfers to the principal; a negative
$2.0 billion payout for two years of distributions for Permanent
Fund Dividends; and a negative $3.9 billion loss reflecting two
years of changes in unrealized holdings that the State owns. She
concluded that the total Earnings Reserve Balance as of December
31, 2002 is $0.9 billion.
Senator Bunde opined that the fund could be recognized as being
"double inflation proofed." He exampled normal inflation proofing
as the fund earning eight percent, including a three percent
inflation-proofing factor; thereby resulting in a real gain of five
percent. He continued that the "current practice is to take money
out of the earnings reserve and, once more, inflation-proof" the
fund. He asked whether "it is fair to describe this practice as
double inflation proofing."
Ms. Phillips responded that the State makes the decision on the
amount to be granted to inflation proof the fund each year and
"actually physically moves it from the earnings reserve to
principal."
Mr. Storer pointed out "if the five percent limit" were included in
the State's constitution the second action of moving money from the
Earnings Reserve Account to the principal would not be required. He
continued that were statute changed, "the money would reside there
but would not be formally moved to the principal, therefore, it
would not be considered as inflation proofing."
Senator Bunde concluded that an actual transfer of money from the
earnings reserve would be considered inflation proofing; however,
he continued, if the inflation proofing calculations were made but
not transferred, it would not be considered as such.
Mr. Storer noted that a State statute specifically mandates a
reduction be reflected in the earnings reserve account with a
corresponding increase reflected in the principal account. He
continued that "absent the constitutional amendment memorializing
the limitation, if that stayed, then you would not in fact be
inflation proofing then you would really be increasing the size of
the earnings reserve which could be a appropriated at a future
date."
Mr. Storer explained the bar chart on page three, titled "Fund's
total return." He stated that the total Fund "annualized return"
over the last 18.75 years is 9.6 percent, and that the five-year
return of eight percent was projected prior to the February 2003
report from Callan Associates. He noted the projected rate would be
adjusted to reflect the report. He explained that the chart also
indicates the negative total returns of the Fund in the fiscal
years 2001, 2002, and 2003. He remarked that the negative returns
could not be ignored. He continued that, "it is clear that during
this bear market the Fund has suffered along with everyone else."
He described a Division evaluation that judges the performance of
the Alaska Permanent Fund against other public fund peer groups,
"predominately retirement funds", which found that the Fund is
faring approximately two percent better than other funds.
SENATOR JOHN COWDERY asked the loss the Fund has experienced, "in
hard dollars", during the last three years.
Mr. Storer referred the Committee to the earnings reserve
reconciliation chart on page three that specifies $800 million in
realized losses and negative $3.9 billion in depreciation.
Senator Cowdery declared that this would affect "the dividend
payout by approximately a billion dollars a year."
Ms. Phillips clarified that the dividend formula utilizes a five-
year average, and that the previous two fiscal year appropriations
were approximately one billion dollars. She continued that the
average appropriation is expected to be reduced as the older,
higher earning years are removed from the five-year calculation.
Senator Bunde, referencing testimony that the Fund's earnings are
"on target," asked whether earnings in the worst-case scenario of
th
the 95 percentile, which is within the targeted range, are
possible.
Mr. Storer informed the Committee that the Fund "is experiencing
lower case probability in virtually every instance from market
value, from returns, from the dividend payout, etc." He stated that
"it was studied, it was understood when we adopted the asset
allocation that this was a probability, albeit an extreme
probability." He reiterated that, "this is one of the worst bear
markets since the '30s."
Mr. Storer stated that page four denotes the Fund's current asset
allocation as being: 37 percent invested in the domestic stock
market; 16 percent invested in international equity market; 35
percent invested in United States investment grade bonds rather
than high yield bonds; two percent invested in non-dollar bonds
comprised of sovereigns of high quality countries such as England,
France and Germany; and ten percent in real estate.
Mr. Storer noted that the chart on page four supports Mr. O'Leary's
testimony regarding the probability of achieving a goal over a
five-year period. Mr. Storer referenced the chart information that
states, "there is a 1 in 4 (25%) chance that the Fund will earn a
negative return in any single year, there is only a 1 in 20 (5%)
chance over a 5-year period and a 1 in 100 (1%) chance over a 10-
year period of a negative return" if current asset allocations were
maintained. He emphasized the importance of adopting "the
appropriate asset allocation" that combines near and long term
objectives, and in holding that course. He explained, "Funds that
shift and react to near-term news are the ones that are the
unsuccessful funds ultimately because they are always responding to
yesterday's headlines."
Senator Bunde understood Mr. O'Leary to say that the Fund would not
earn five percent under the asset allocation restrictions that have
been placed on the Corporation. Therefore, he asked whether the
Corporation would be requesting changes to be made involving the
current asset allocation restrictions.
Mr. Storer responded that the Corporation recently "reconstituted"
its Board of Trustees and "reformed" its Legislative Committee. He
continued that the Board would be familiarizing itself with
numerous issues, including the five percent clause and evaluating
whether the basket clause should be expanded.
Ms. Phillips stated that the chart on page five portrays the
results of statistical models that evaluate and project future
earning returns. She explained that these "returns are just not a
firm number, but a range around an expected value." She voiced that
the range model developed by Callan Associates is applied two times
a year and "incorporates market volatility into the projected
outcomes" of its "300 scenarios of capital market returns." She
stated that the charts depict "an array of outcomes with their
associated probabilities." She stated that all models contain
assumptions, such as: the fall revenue forecast; the dividend
formula as defined in statute; as well as the most recent financial
data. She explained various components of the graph, and she
stressed that, "the range of market value does already assume that
the dividend has been deducted from this market value."
Ms. Phillips stated that the chart at the bottom of page five,
depicts the range of the realized earnings reserve projected for FY
03 through FY 08. She reminded the Committee that the earnings
reserve, combined with the principal, comprise the total Fund
value.
Ms. Phillips continued that the chart at the top of page six
reflects the range of the total earnings reserve. She specified
that the realized earnings reserve is the cash flow. Furthermore,
she asserted, it is the portion of the Fund on which the permanent
fund dividend allocation is calculated. She noted, "the total
earnings reserve includes the realized earnings and the accumulated
market appreciation or depreciation on the assets."
Ms. Phillips communicated that the chart at the bottom of page six
projects the range of per capita dividends for the current fiscal
year and the subsequent five years.
Co-chair Wilken asked for further information regarding the "Range
of total earnings reserve" chart on page six, specifically the
information pertaining to FY 08. He voiced the understanding that,
in FY 08, there is a 90 percent chance that the earnings reserve
would reflect a negative amount.
Ms. Philips replied that these numbers project a ten percent
probability that the fund would reflect a negative $1.4 billion or
less or a 90 percent chance that it would be negative $1.4 billion
or greater.
Co-Chair Wilken asked for further explanation about the FY 08
earnings in the Range of total earnings reserve chart on page six.
Ms. Phillips provided further interpretation regarding the
projected totals for FY 08. She reminded the Committee that the
total amount reflected in this chart does not contain the money
dedicated for the permanent fund dividends and for the inflation
proofing transfer as they are already subtracted from the total.
Senator Bunde asked for clarification that the $400 permanent fund
dividend levels projected in FY 05 and FY 06 are based on a five-
year average that includes years in which the fund's earnings were
in a negative range.
Ms. Phillips concurred, and noted that the average is lowering as
the higher earning years are removed from the five-year calculation
formula. She stated that the monthly-realized earnings of
approximately $70 million is a known factor; however, she
explained, the managers' buy and sell activity and market
appreciation or depreciation are unknowns.
Ms. Phillips remarked that the chart on page seven "reflects the
comparison of the historical and projected realized income of the
Fund." She stated that this information is overlaid with actual and
projected State oil revenue. She stated that this information
anticipates the realized income from the Permanent Fund to
increase, while revenues from oil decrease.
Co-chair Wilken ascertained from the chart that by FY 2018, oil
revenue deposited into the general fund is projected to be $500
million and Permanent Fund revenue is projected to be $3.2 billion.
Ms. Phillips concurred; however, she reminded the Committee that
these numbers do not account for market volatility.
Senator Bunde asked when further direction from the Board might be
anticipated.
Mr. Storer informed the Committee that the newly reconstituted
Alaska Permanent Fund Board of Trustees recently met for the first
time. He shared that committees were formed, some committee
meetings were scheduled, and that the next scheduled Board meeting
is March 25 and 26, 2003. He voiced that the Legislative Committee
would probably meet prior to the next Board meeting.
Co-chair Wilken congratulated the new appointees to the Alaska
Permanent Fund Board of Trustees.
ADJOURNMENT
Co-Chair Gary Wilken adjourned the meeting at 10:20 AM
| Document Name | Date/Time | Subjects |
|---|