Legislature(2019 - 2020)SENATE FINANCE 532
02/28/2019 09:00 AM Senate FINANCE
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| Audio | Topic |
|---|---|
| Start | |
| Presentation: Investment Funds Update, Cash Flow Deficiency Plan | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
| + | TELECONFERENCED | ||
| + | TELECONFERENCED |
SENATE FINANCE COMMITTEE
February 28, 2019
9:01 a.m.
9:01:58 AM
CALL TO ORDER
Co-Chair Stedman called the Senate Finance Committee
meeting to order at 9:01 a.m.
MEMBERS PRESENT
Senator Natasha von Imhof, Co-Chair
Senator Bert Stedman, Co-Chair
Senator Click Bishop
Senator Peter Micciche
Senator Donny Olson
Senator Mike Shower
Senator Bill Wielechowski
Senator David Wilson
MEMBERS ABSENT
Senator Lyman Hoffman
ALSO PRESENT
Senator Cathy Giessel; Senator Mia Costello; Bruce
Tangeman, Commissioner, Department of Revenue; Michelle
Prebula, State Investment Officer, Department of Revenue;
Bob Mitchell, Chief Investment Officer, Department of
Revenue.
SUMMARY
PRESENTATION: INVESTMENT FUNDS UPDATE, CASH FLOW DEFICIENCY
PLAN
Co-Chair Stedman noted that the committee would continue an
earlier discussion on the cash flow and investments of the
state. He had wanted presentations pertaining to the
overall budget and had heard introductory comments on the
state's cash position. After hearing more about the budget,
the cash deficiencies of the state were becoming clearer.
Co-Chair Stedman continued his remarks and spoke to the
balance in the Constitutional Budget Reserve (CBR) and the
Statutory Budget Reserve (SBR). He thought it appeared that
the state was getting down to its minimum comfort level
with regard to savings. The presentation would give further
detail on the state's cash positions and investment funds
and would opine the minimums that should be left as shock
absorbers for the budget. He mentioned contingency funds
for state emergencies and unplanned events.
^PRESENTATION: INVESTMENT FUNDS UPDATE, CASH FLOW
DEFICIENCY PLAN
9:05:00 AM
BRUCE TANGEMAN, COMMISSIONER, DEPARTMENT OF REVENUE,
introduced himself. He recalled that Director Pam O'Leary,
Director, Treasury Division, Department of Revenue had
reviewed a presentation earlier in the month. There had
been many comments, questions, and requests as a result of
the presentation. He introduced his staff.
9:07:39 AM
MICHELLE PREBULA, STATE INVESTMENT OFFICER, DEPARTMENT OF
REVENUE, discussed her work experience. She had started
with the state in 1993, working with the Legislative Audit
Division, where she earned her Certified Public Accountant
certificate before working as the internal auditor for the
Department of Labor and Workforce Development. She had
taken the position of cash manager for the state in 1998,
where she worked for 20 years before transitioning to her
current position the previous July. She had degrees in
economics and accounting, as well as a master's degree in
business administration. She relayed that she was an
accredited ACH professional, which meant she had experience
in electronic fund transfers; and had a certified treasury
professional designation.
Ms. Prebula discussed the presentation "State of Alaska
Discussion of State Cash Flows," (copy on file).
Ms. Prebula turned to slide 2, "Daily General Fund
Sufficiency Balance Calculation," which showed a flow
chart. She discussed the definition of "cash" as cash in
the bank less payments outstanding, warrants that had not
cleared, electronic fund transfers that had left the state,
and less cash receipts in suspense. She stated that the
vast majority of revenue came into the treasury through the
General Fund (GF). She qualified that at the point the
funds came in, it was not known if the funds would remain
GF money or not, and the funds were not considered
available to be spent until the determination was made.
Ms. Prebula reviewed slide 3, "Cash vs. Accrual Accounting
Periods":
FY19 Cash Accounting Period
July 1, 2018 June 30, 2019
FY20 Begins
July 1, 2019
FY19 Accrual Accounting Period
July 1, 2018 August 31, 2019
Ms. Prebula thought the slide showed the difference between
cash accounting and accrual accounting. She thought it was
an important distinction to know when discussing cash flow
that two months of every year (July and August) the state
expended funds both on behalf of the prior year and the
current year.
9:10:48 AM
Ms. Prebula spoke to slide 4, "Seasonal Cash Flow
Fluctuations":
• Summer Peak season for construction projects
and seasonal workers.
• Re-appropriation (July & August):
• Finishing prior FY expenditures + current FY
expenditures.
• Allocating funds in or out of GF per new
legislation.
• July Debt service payments.
• June Annual oil & gas property tax revenue.
Ms. Prebula informed that there had been a request for more
information regarding the nature of flows. The state had a
very seasonal flow to its cash. There was a lot of fund
transfers early in the year for debt servicing, school
district funding, and payment retirement funds. The bulk of
expenditures was early in the year, but there was a lag in
revenues. The majority of revenues came at the end of each
month, or quarterly. The biggest revenue day of the year
was June 30, when the state received oil and gas property
tax revenues.
Mr. Prebula continued to discuss slide 4. She noted that
the state had specific monthly trends, when flows in were
allocated and payroll went out. She discussed weekly cash
flows and referenced a previous question about Medicaid
payments, which caused a large outflow once per week. She
qualified that generally in-flows and out-flows varied by
department.
9:13:17 AM
Ms. Prebula referenced slide 5, "Cash Deficiency Memorandum
of Understanding":
o Original MOU signed 1994 by DOR, DOA, OMB & LAW.
o Updated December 1, 2017.
o Targets $400 million dollar minimum threshold in
the GF.
o Outlines procedures for addressing cash
deficiencies:
square4 Develop monthly cash projections.
square4 Monitor daily general fund cash balances.
square4 Transfer from SBR, CBR & ERA as
appropriated.
square4 Perform temporary interfund borrowing.
square4 Borrow from general fund sub funds.
square4 Seek legislative action through governor.
square4 Prioritize disbursements, restrict
expenditures.
Ms. Prebula stated that there was an agreement of what was
done during times of cash deficiency.
Co-Chair Stedman asked about the bullet referencing
transfers. He asked if the order of accounts listed
depicted the order of execution if a transfer was made.
Ms. Prebula stated that generally the order of execution
was whatever had been appropriated. She recalled generally
only one account at a time had been appropriated.
9:15:38 AM
Co-Chair Stedman asked about statutory authority to access
the SBR or CBR. He recalled that the legislature normally
gave the treasury access to one of the accounts for
budgetary purposes if the state missed on the revenue and
expense relationship at the end of the year. He wanted to
make clear the point that a simple majority vote was easy
compared to a three-quarter vote needed to access the CBR
or the Earnings Reserve Account (ERA). He was concerned
that if the state started relying on the ERA and diminished
or depleted the CBR or SBR.
Commissioner Tangeman addressed Co-Chair Stedman's
question, and noted that DOR followed what the
appropriation bills allowed for the state to do. The order
of use was the order that the executive branch had
authority to access.
Co-Chair Stedman asked if the department could access the
CBR for a cash deficiency if the legislature did not
produce a three-quarters vote in the budgetary process.
Commissioner Tangeman stated that the question might need
to be addressed by the Department of Law (LAW), because the
memorandum gave authority to borrow against accounts, but
he was not sure about not having an authorization through a
CBR vote.
9:18:44 AM
Senator Micciche pondered the impetus for the signing of
the Memorandum of Agreement in 1994. He saw that transfers
were only appropriate as appropriated. He asked if there
had been a cash flow emergency after appropriations from
the legislature were too tight.
Ms. Prebula stated she was not much of an alarmist and
would not refer to anything as a "cash emergency," but
there had been times the state had been low on cash. She
referenced FY 99, the first year that legislature put a cap
of $700 million on the borrowing from the CBR. She recalled
that there had been a drop in oil prices, the state had
spent the money quickly, and there was a subsequent special
session in which the legislature voted to increase the cap.
Senator Micciche was interested in the topic being
discussed. He recalled that Co-Chair Stedman had remarked
that the budgeting process provided some level of
stability. He commented on the volatility of oil prices. He
was curious how the department would manage if the state
was appropriated tightly and there was a drop in oil price.
Co-Chair Stedman added that there was separate language in
the budget for borrowing versus a three-quarter vote to
extract funds to balance the budget.
Commissioner Tangeman thought with the percent of market
value (POMV) draw of the ERA being in place, it was
possible to absorb minor changes in oil price. He pondered
the different oil price levels that could be considered an
emergency. He questioned a drop of $20 in the price of oil.
He discussed the timing of action taken to react to big
changes in oil price.
9:22:21 AM
Co-Chair von Imhof asked about the monthly cash
projections, and asked about the amount of flexibility with
the Department of Education and Early Development (DEED)
and the Department of Health and Social Services (DHSS).
She wondered if the funds were paid out in a lump sum or
otherwise. She recalled a letter that referenced 'slow
paying' of Medicaid payments and asked how it could be used
to manage cash flow.
Commissioner Tangeman thought Co-Chair von Imhof's question
was policy related. He relayed that the department was
instructed to pay out as required by the departments and
thought Co-Chair von Imhof's question about slow-pay was a
policy call.
Ms. Prebula stated that the department used to make the
full school funding appropriation at the beginning of the
year; however, with increased tightening control over cash
it had been reduced to four quarterly payments. She
addressed Medicaid and Medicare and stated that DOR tried
to encourage Department of Administration (DOA) to
continually stay on top of reports in order to continually
bill the federal government. She added that DOR had not
made any recommendations with regard to payment.
Co-Chair von Imhof thought it was important that Ms.
Prebula had an ACH credential, and thought electronic
transfers were a way to get federal payments faster. She
hoped requests for payments were sent electronically. She
asked if Ms. Prebula did nightly sweeps of cash going in
and out to earn some type of interest.
Ms. Prebula deferred the question to Commissioner Tangeman.
Commissioner Tangeman thought the question would be best
addressed by the state's chief investment officer.
Senator Wielechowski asked how oil severance taxes and
royalties were paid.
Commissioner Tangeman stated that the taxes were paid on a
monthly basis.
9:25:39 AM
Ms. Prebula looked at slide 6, "General Fund Sufficiency
July 1, 2018 December 31, 2018," which showed a line
graph depicting a monthly cash flow projection. She stated
that the projection was the biggest tool for anticipating
the cash needs of the state. The department considered the
cash flows of the previous year, and adjusted bigger
payments, fund transfers, and borrowings. The department
wasn't able to forecast for the year until the month of
May. The department considered the projection on a daily
basis and made adjustments monthly. She cautioned that
things diverged within the month, and the projection was an
estimate.
Ms. Prebula pointed out the large inflows and outflows
shown in the box atop the line graph on slide 6. She
explained that six-month increments were the most effective
for looking at completed transfers.
Co-Chair von Imhof was curious about what bank the state's
cash was in.
Ms. Prebula informed that there was a conglomeration of the
available state funds, which were in five different banks.
Co-Chair von Imhof asked for the names of a couple of the
banks.
Ms. Prebula specified that the state's primary custody bank
with the bulk of investments was State Street Bank in
Boston, Massachusetts. Primary depository activity was done
within the state. She noticed that ACH payroll payments,
retiree payroll, and vendor payments were done through U.S.
Bank. There were also deposits to First National Bank of
Alaska. She mentioned Key Bank and Wells Fargo.
Co-Chair Stedman explained that the chart showed transfers
from the ERA to the General Fund, including dividend monies
to be paid out, and other monies used in the previous
year's budget. He wanted to clarify that the funds were not
used for general expenditures outside of the 5.25 percent
POMV draw.
Commissioner Tangeman answered in the affirmative. He
pointed out that the first green line in the box showed a
CBR transfer. It had been agreed that leaving the funds in
the ERA as long as possible to earn the highest return was
in the best interest of the state. The decision had been to
draw the CBR down first (which was earning a lower return)
and then engage in a cash-call process which was
choreographed between the department and the Alaska
Permanent Fund Corporation (APFC). In October and December
there had been cash-calls to the ERA, in the amounts of
$350 million and $250 million.
9:30:42 AM
Ms. Prebula explained slide 7, "General Fund Sufficiency
January 1, 2019 June 30, 2019," which showed a line graph
depicting a balance projection for the second part of the
fiscal year shown on the previous slide.
Senator Wielechowski asked about a $982 million transfer to
the Permanent Fund Dividend Fund on September 11, 2018 as
shown on slide 6. He asked if there was a reason that the
funds were transferred three weeks before the dividends
were paid out. He estimated that there was a few hundred
thousand dollars in interest that had been missed out on.
Ms. Prebula was not involved in the transfer. In prior
years, the funds were transferred when the books were done
at APFC. She couldn't speak to the timing for 2018.
Commissioner Tangeman stated that he would look into the
matter.
Ms. Prebula displayed slide 8, "Takeaways":
• Cash flow forecasting is always wrong.
• Even if the State budget is balanced, borrowing
for cash flow deficits will occur.
• Budget deficit borrowing may occur if forecasted
assumptions are wrong.
• How much is borrowed depends on the actual
amounts and timing of revenues and expenses.
Ms. Prebula emphasized that cash forecasting was an art,
and the direction and magnitude of changes was unknown.
9:33:11 AM
Ms. Prebula discussed slide 9, "General Fund Sufficiency
July 1, 2019 June 30, 2020 With Projected Cash Outflow
Reduction of $1.6B/year," which showed a line graph showing
a depiction of cash outflow and what might happen with a
proposed reduction in outflows of $1.6 billion. She
explained that the need for cash would depend on what sort
of fund transfers were appropriated, and what other things
occurred.
Commissioner Tangeman thought the slide put something into
perspective. He thought it was important to discuss the
appropriate size of the CBR. He thought the graph gave a
little bit of a glimpse into where the state should be
looking. He pointed out an almost $800 million drop in the
initial part of the graph. He noted that many expenditures
for the fiscal year occurred in the first part of July.
Throughout the year it was possible to see other drops, and
he estimated that about $1.4 billion was reflected on the
graph. He opined that the state was at a level it needed to
be at for the CBR. He thought a balance of $1.7 billion or
$1.8 billion provided a needed cushion.
Senator Bishop asked to revisit slide 6. He asked about the
ERA draw, which was $1.6 billion, out of an authorized $2.7
billion; and a remaining balance of $1.1 billion available
to draw.
Commissioner Tangeman answered in the affirmative.
Senator Bishop considered that if revenues rebounded and
there was $1 billion in surplus - and wondered if the state
would not need to draw the $1.1 billion from the ERA.
Commissioner Tangeman thought Senator Bishop posed a good
question, and that oil prices were slightly higher than
forecast. He thought the forecast $700 million deficit
would be closer to $250 million. The plan was to still draw
the ERA down as anticipated, and the funds would remain in
the General Fund.
Co-Chair Stedman summarized that the state was at its
minimum comfort level in the CBR. He thought the committee
needed to take the matter under consideration as it
pondered shock-absorber mechanisms in the budget and other
budgetary issues.
Commissioner Tangeman agreed.
9:37:07 AM
AT EASE
9:38:02 AM
RECONVENED
BOB MITCHELL, CHIEF INVESTMENT OFFICER, DEPARTMENT OF
REVENUE, discussed his experience. He referenced a February
5, 2019 presentation on investments by Treasury Division
Director Pamela Leary; and stated there had been a number
of performance questions that had come up in committee. He
hoped to provide additional information on the questions.
He had worked with the treasury division for twenty years.
He had worked in the fixed income team, including as the
senior portfolio manager for 13 years. He was named deputy
chief investment officer (CIO), and had made
recommendations to the CIO relating to asset allocation and
risk management. He was hired as CIO in May 2017.
Mr. Mitchell discussed his educational background. He had
received a Bachelor's degree in Economics and a Master's
degree in Business Administration from the University of
Alaska Fairbanks. He had attained the right to use the
charter financial analyst designation.
9:40:49 AM
Mr. Mitchell discussed the presentation "State of Alaska
Performance Comparison," (copy on file).
Mr. Mitchell turned to slide 2, "Investment Performance,"
which showed a table. There had been questions centered
around apparent differences in returns among state
portfolios. He recalled that the committee had questions in
a previous meeting about the Public School
Trust Fund (PSTF). He informed that there had been
references to differences in return expectations between
the state funds and the retirement funds, which he would
address. He noted there was a request to compare
performance of the state retirement systems with the
performance of the Permanent Fund.
Mr. Mitchell continued to address slide 2. He noted that
state funds had investments that were in publicly traded
securities; and as a result, the performance information
was available fairly quickly. He considered the portfolios
in the retirement system and Permanent Fund, which had
significant parts invested in non-liquid assets; more time
was required to get performance information. When Director
Leary had made a presentation, there was different
performance information. The slide attempted to break out
the performance for specific time periods.
Mr. Mitchell continued to discuss slide 2. There were four
tables on the slide. The top two tables covered the
December 31 time period. He had made the determination that
there was a more appropriate "high-risk" designation for
the Alaska Retirement Management (ARM) Board Fund and the
Permanent Fund rather than the "moderate" designation
reported by Director Leary. Mr. Mitchell clarified that the
determinations were his own.
Mr. Mitchell addressed the error on slide 2, which
pertained to the FY 19 Equity Target column for the ARM
Board for private and public equities.
9:44:19 AM
Mr. Mitchell continued to address slide 2, noting that
there was no performance available for the retirement
systems for the December 31, 2018 period. He discussed the
'Equity Target' column, in which one could observe that
both the Permanent Fund and the retirement systems had
significant equity allocations, as well as significant
alternative investments. The numbers did not fully reflect
the risk profile of the portfolios. To the right of the
equity numbers, he pointed out the 10-year return target
and projected standard deviation. The ARM board expected
return for an over 10-year horizon was 6.6 percent, with a
long-term objective of 7.38 percent. The reason for the
difference was due to increased returns expectations over
time. He discussed sources of information. He thought it
was important to be cognizant of the time horizon being
considered when discussing expected returns.
Mr. Mitchell stated that the existing allocation for the
ARM board had 7.4 percent expected return, but over 10
years was 6.6 percent. He hoped it was possible to see that
expected returns were somewhat consistent. He noted that
the information on the Permanent Fund was sourced from the
APFC website.
9:46:56 AM
Mr. Mitchell addressed state funds on slide 2. He noted
that the asset allocation of PSTF had changed fairly
significantly over the previous five years. He thought it
was useful to consider the five-year average equity
allocation in order to understand the risk profile of the
portfolio over time. He discussed average return targets
for the PSTF; which was 53 percent for the five-year
average and was currently in the high 60s. The reason for
the difference was two-fold. He detailed changes to the
asset allocation that started December 1, 2019 which
reflected new spending methodology for the PSTF.
Mr. Mitchell continued discussing the difference in the
return targets for the PSTF. There was a change to a more
risk-seeking portfolio, which had a substantially higher
equity allocation. He discussed the management of asset
allocation. He discussed inflation-proofing and noted that
a 3 percent cushion had been used. Over the previous five
or more years, the expected return had a declining pattern.
To achieve the expectation of PSTF's purchasing power, it
was necessary to increasingly ramp up the equity allocation
in the fund. Conceptually if the return expectation was
lower, it required more risk in the portfolio to maintain a
minimum threshold of purchasing power.
Mr. Mitchell discussed equity allocations by fiscal year.
He noted that the equity allocation was about 42 percent in
FY 14, which increased to 50 percent the following year and
hovered in the mid-50s for the subsequent three years. He
referenced HB 213 [legislation passed in 2018 that created
an education endowment fund and dividend raffle fund],
after which the asset allocation was changed. He detailed
declines in the domestic equity market.
9:51:21 AM
Mr. Mitchell continued to discuss equity allocations as
shown on slide 2. He discussed the low performance of the
PSTF and pointed out that substantially lower equity
allocation. He compared the PSTF to the Power Cost
Equalization (PCE) Fund and expected that the asset
allocation and performance of the two funds would be more
similar in the future.
Mr. Mitchell discussed the low one-year performance of the
PSTF. He noted that during the same period, the Permanent
Fund had a substantially better performance during the same
period. He commented that risk was rewarded over time,
either in the public or private markets. He expected funds
like the Permanent Fund and the retirement systems (which
had illiquid investments) would show some impact.
9:54:04 AM
Mr. Mitchell continued to discuss slide 2. He noted that
shorter term performance could be harder to interpret and
encouraged members to think about long-term performance
from five-year numbers or longer. He commented on state
funds, which unlike the Permanent Fund and retirement
systems, were not permitted to invest in unregistered
securities. State funds could not be invested in private
investments, which was a primary reason for state funds
being invested in stocks and bonds.
Mr. Mitchell noted that he provided the information to show
the impact of different quarters, but also because there
had been a request to compare returns of the pension
systems, state funds, and the Permanent Fund. He noted the
similarity in performance of the funds. He did not expect
all five-year periods to equal out but reiterated that it
was important to focus on "the long game."
Co-Chair von Imhof appreciated slide 2, and thought it was
a "dashboard" that would be helpful to continue reviewing.
She pointed out the difference between the performance of
the funds in different quarters. She commented on the
volatility amongst the funds. She pondered another quarter
of poor returns and considered the impact on the state's
daily cash flow. She suggested that when the CBR was low,
and if the ERA was transferred, the state would have less
of a collective cushion to address medium returns if there
was a prolonged market recession. She thought it was
important and fiscally prudent to maintain a cushion to
monitor the state's cash flow. She hoped members would
recognize the importance of volatility.
9:58:40 AM
Senator Micciche thought it seemed that the PCE was
disproportionately adversely affected above the Permanent
Fund and the Alaska Retirement Management Board allocation.
With the expectation of upcoming lower returns, he
questioned if the asset allocation was over-exposed.
Mr. Mitchell thought it was necessary to take risk in order
to generate returns over time. He considered the
requirements of funds within the state system and mentioned
taking the least amount of risk to achieve the objective.
The objective for the PCE was a 5 percent return, which
required a meaningful allocation to the equity market. The
fund had a long time-horizon, so the portfolio could handle
lower market periods. In the long term, it was expected
that the equity market would provide higher returns, but it
was necessary to absorb short-term losses. He did not think
the state should take more risk than necessary to achieve
objectives. He believed the maximum amount of risk the
state could take was roughly 70 - 30. The PCE had a higher
allocation to equities five years previously, and return
expectations were going down.
Mr. Mitchell continued to address Senator Micciche's
question. The expected returns shown on slide 2 were a
function of the capital market assumptions provided by the
state's general consultant, Callan and Associates, and were
updated annually. There were revised capital market
assumptions that would be used for the upcoming fiscal
year. The early indications were that the ten-year return
expectations in the capital market assumptions were higher
than the previous year. There was a declining trend that
was flat and then rose. He discussed how Callan and
Associates generated the assumptions. He expected
marginally higher returns.
10:02:58 AM
Co-Chair Stedman asked Mr. Mitchell to discuss capital
market assumptions in greater detail.
Mr. Mitchell stated that assumptions were required when
formulating expected returns, such as performance of the
bond market and stock market. Volatility of returns was
considered. Fixed income tended to have less volatility,
while there was more volatility on the equity side. He
summarized that in the context of retirement systems or
other asset classes, it was best to first consider the
return and time horizon.
Mr. Mitchell discussed volatility of returns and to what
extent did investments move up or down together. He
mentioned diversification. Capital market assumptions were
used to do math to determine what allocation would achieve
the best outcome with a minimum amount of certainty.
Co-Chair Stedman asked about "basis points."
Mr. Mitchell stated that in fixed income, every basis point
mattered, and was 1 one-hundredth of a percent.
10:06:20 AM
Senator Micciche appreciated Mr. Mitchell's answer, but did
not hear an explanation of the inconsistency in investment
logic between the PCE endowment, the Permanent Fund, and
the ARM Board investments.
Mr. Mitchell characterized the funds as having similar risk
tolerances. The funds were all long-term, and the
proportion of the funds going out were relatively low. The
three funds had fairly aggressive return targets, which
required aggressive risk in the portfolios. The Permanent
Fund and the retirement systems had the ability to invest
in illiquid assets, a tool which was not available for
state funds. The funds with illiquid assets were not
affected as quickly by drawdowns in the market.
Senator Wielechowski wanted to understand the PSTF and PCE
equity targets. He wondered how it was possible to have 5-
year equity targets of 53 percent for the PSTF and 70
percent for the PCE endowment, yet with the same 10-year
projected return and projected standard deviation.
Mr. Mitchell stated that one amount reflected looking back
and one reflected looking forward. There had been
substantial changes for the asset allocation for the PSTF,
primarily as a result to changes to the POMV payout from
the Permanent Fund. The previous five years the PSTF had a
lower equity allocation (reflected in the 53 percent versus
the 70 percent for the PCE); but looking forward, the funds
had substantially the same asset allocation and same return
target.
Senator Wielechowski discussed the equity target of the PCE
and the Permanent Fund. He thought it seemed that a 50
percent equity target was not a very high risk.
Mr. Mitchell commented that if the other 50 percent was
invested in bonds, then the fund had a relatively lower
risk allocation than the fund with 70 percent in equities.
The Permanent Fund and retirement portfolios both had
significant allocations to things such as private real
estate and hedge funds. He thought it was harder to discern
how equity-like some of the investments were. He discussed
aspects and risk profiles of real estate investments. He
commented that focusing on the equity portion of a
portfolio that had illiquid investments might not fully
appreciate the risk being brought to the portfolio.
Mr. Mitchell continued addressing Senator Wielechowski's
question. He stated that in the Treasury Division, the
thought of high risk included a significant chance of
seeing a negative return in a given year. He thought it was
appropriate to consider the Permanent Fund and the
retirement systems as having a meaningful chance of a
negative return. The Permanent Fund did show a negative
return for a one-year period.
10:11:50 AM
Senator Shower asked how to receive the data on slide 2
more frequently.
Mr. Mitchell stated that the department produced return
information for state funds on a monthly basis, and the
information was located on the Treasury Division's website.
There was quarterly information on the retirement system
also available on the website.
Co-Chair Stedman recognized the work of DOR and the ARM
board as functioning as two different offices. He looked at
the projected standard deviation numbers of the Permanent
Fund and the ARM Board Non-participant Directed Fund. He
did not think the numbers correlated when there was a
significant change in risk and barely a change in projected
return. He thought it would be nice to have a
representative from the ARM Board as well as DOR in
committee to discuss the funds.
Mr. Mitchell stated that with the exception of the
Permanent Fund, the underlying capital market assumptions
were very similar for the retirement system and the state.
He continued that for the retirement system and the
Permanent Fund, the department relied less on the generic
Callan and Associates capital market assumptions, which
were suitable for state funds. He cited differing
definitions of asset classes and noted that it was not
uncommon to enter into conversation with Callan about what
were appropriate assumptions. Ultimately Callan made the
determination, but to some extent the capital market
assumptions for the Permanent Fund and retirement system
were influenced by the discussions. He believed that (with
respect to private equity) the standard deviation
expectation employed by the ARM Board was significantly
higher than it was for the Permanent Fund, which was why
there were differences in the assumed standard deviation.
10:15:12 AM
Co-Chair Stedman noticed that the ARM board always had a
higher standard of deviation and higher projected
volatility than the Permanent Fund. He considered that the
Permanent Fund was in perpetuity, and the Defined Benefit
Plan might last another 30 years. He thought the Permanent
Fund (being in perpetuity) would have a higher standard
deviation expectation versus something that was finite in
nature.
Mr. Mitchell thought to some degree the difference was
embedded in slight differences in the capital market
assumptions that were employed. He thought the source of
the difference was the need to provide capital market
assumptions that were reflective of the underlying
investments in each of the portfolios. He believed private
equity had consistently been higher than the risk
assumption employed by the Permanent Fund. He was happy to
provide a comparison for further information.
Mr. Mitchell thought Co-Chair Stedman was correct to point
out that the Defined Benefit Retirement System was finite,
and new employees were entering the Defined Contribution
Plan. Legacy defined benefit employees would remain in the
Defined Benefit Plan, which would extend the life of the
liabilities that would need to be paid. He thought it was a
significant consideration that would enter into the ability
to take risk in the portfolio, but he did not believe the
point had been reached yet. To supplement, DOR frequently
engaged in an asset liability study, and was in one
currently. He expected at the April 2019 board meeting the
ARM board would receive the study from Callan and
Associates. One of the key elements of the study was to
what extent did the shortened time horizon impact the
ability to take risk and to give liquidity in illiquid
assets.
10:18:50 AM
Co-Chair von Imhof thought the projected standard deviation
was important to consider. She asked if the projected
standard deviation described volatility or the extreme ups
and downs. She opined that the Permanent Fund, even with a
POMV, was correctly invested. She wanted to point out that
it was imperative to keep the ERA somewhat protected so the
state could weather high volatilities. She noted that the
Permanent Fund had not been inflation-proofed in three
years and thought there was associated risk. She thought
that there was a balance needed to inflation-proof the
corpus and keep the ERA intact. She appreciated the
comparison with the ERA and the CBR, which was more of a
daily cash flow.
Commissioner Tangeman stated that there was an inflation-
proofing appropriation just short of $1 billion in the
current budget submitted by the governor.
Senator Wielechowski asked if SB 26 [legislation passed in
2018 relating to the Permanent Fund and the ERA] and the
requirement for billions of dollars in funds from the
Permanent Fund be available from the ERA would impact the
risk tolerance and return targets from the Permanent Fund.
Commissioner Tangeman thought the bill would help stabilize
the investment strategy around the Permanent Fund,
considering the fact that the exposure to the entire ERA
was laid out up until the previous year. He thought putting
in a structured draw around a certain portion would give
stability. He recalled the previous year there had been
discussions with big swings around accessing the CBR. He
thought the Permanent Fund had to stay liquid since the
appropriation structure coming from the legislature was not
known. He thought the fact that there was a structure
around a good portion of the ERA helped stabilize the ERA
itself and helped stabilize the Permanent Fund's assets in
the market to earn a higher return on the remaining
balances.
10:22:44 AM
Co-Chair von Imhof appreciated Commissioner Tangeman's
remarks about how a disciplined structured draw somehow
insulated or protected the ERA. She pointed out that the
Senate was hearing two bills proposed by the governor to
take additional transfers from the ERA outside the
structured draw in order to pay back dividends. She
recounted that Office of Management and Budget Director
Donna Arduin had also stated for the record that it was the
administration's interpretation that transfers from the ERA
at any given point were within the realm of the
administration, and the funds were available for
expenditure. She emphasized that there was a structured
draw in place that was a disciplined and sustainable
approach.
Co-Chair Stedman commented that the committee was very
protective of the Permanent Fund. He recounted that in
previous years when the legislature had dealt with the
issue of unfunded pension, the state owed roughly $6
billion. He thought the legislature would struggle over the
next years to pay down a current $6 billion debt for
unfunded pension obligations. He commented on rising
interest rates. He asked about duration matching the
state's liability and assets. He recognized that a decade
previously the equity infusion was out of reach due to the
state's financial position at the time. He pondered a
mechanism to fix part or all of the state's unfunded
liability.
10:26:59 AM
Mr. Mitchell stated he could conceptually speak to Co-Chair
Stedman's question. He thought a significant part of the
process of the retirement system was estimating what was
due and when it was due. He continued that DOA hired an
actuary, and DOR hired another actuary to check the actuary
and make sure the assumptions were acceptable. He stated
that the result of the analysis was an expectation of how
much cash was required to make the benefit payments each
month. He considered that there was a fair amount of
investment risk to gain a return. He thought one strategy
for addressing the mismatch was to purchase high quality
bonds. He thought it was possible to build a portfolio of
bonds to the extent the bonds were available in the
maturity range the state wanted. He thought it was
theoretically possible to build a portfolio that would have
a cash flow profile that matched expectations of benefit
payments when due.
Mr. Mitchell continued to address Co-Chair Stedman's
question. He stated there were two issues with the
portfolio he described. He qualified that bonds did not
yield as much as stocks. In the short term, the volatility
was significant and there was uncertainty. He discussed
selling assets for assets that matched cash flows. If
return assumptions were lowered (for bond portfolios), the
state's funded situation would deteriorate. There was an
embedded return assumption with the state's assets; when
lowered, there would be a magnified impact.
Mr. Mitchell continued to address Co-Chair Stedman's
question. To the degree that actuarial assumptions did not
reflect reality, the state could end up building a
portfolio of bonds that did not have the cash flow profile
that it ultimately needed. He thought the bigger issue was
that when the expected return of the asset went down, it
required the state to pay more into the system.
10:31:57 AM
Co-Chair Stedman mused that when volatility decreased, one
neutralized the volatility, which took an upfront cost. If
the state had the cash and tried to do it year by year over
the same amortization schedule, it would not be possible.
It would take an up-front appropriation to match volatility
of liabilities against assets. He thought it was possible
with partial pieces of the portfolio.
Co-Chair Stedman had asked Mr. Mitchell's predecessor why
the portfolio had not been duration-matched. He thought the
issue had been burning in the background over the years the
state had been trying to pay the liability off.
Mr. Mitchell thought that duration matching would remove
some uncertainty about what the payments would be. He
relayed that the department would take up the issue
internally, and would work with Callan and Associates to
explore the issues as part of the asset liability study it
was engaged in.
Co-Chair Stedman thought volatility could be removed from
the table with strategies.
10:34:26 AM
Senator Olson considered slide 2 and asked why there was
not a comparison between international investments versus
domestic investments. He thought that there had been
concern that there were countries that were allegedly
involved in activities the state found offensive such as
terrorism.
Mr. Mitchell stated that international equities were a
significant component of state funds as well as the ARM
Board funds and the Permanent Fund. The previous ten years
had been remarkable in that domestic equities had
significantly outperformed international equities. He
stated that DOR was guardedly optimistic about the relative
performance of international equities over domestic
equities going forward.
Mr. Mitchell addressed diversification and social concerns.
To the degree that it was possible to diversify into
international equities, he thought it lowered the risk
profile. He relayed that the state's interests were for the
financial best interest of the funds; and on the retirement
side, the fiduciary duty was to the financial best interest
of the participants. He explained that to the extent that
there were social concerns (which came up from time to
time), the department was guided by the rule that it was
looking out for the sole economic best interest of the
participants. Absent a compelling reason, the agency
preferred to diversify rather than to restrict investments.
He restated that absent any statutory restrictions for
investing, the preference was to diversify the portfolio.
10:37:09 AM
Mr. Mitchell reviewed slide 3, "Investment Fund Snapshot
12/31/2018," which showed several data tables that were
primarily for informational reasons. He highlighted that
the annual presentations to the committee from the Treasury
Division had evolved over time. The slide was to provide a
comprehensive look at the funds managed in the division.
The 5 funds that had been the focus of the presentation by
the director's presentation comprised about 80 percent of
the total assets managed by the division, while the slide
was a complete list.
Senator Wielechowski commented on the longest bull run in
history. He asked if Mr. Mitchell had heard that there was
a forthcoming recession and if he was changing risk
tolerance or event horizons to prepare for a potential
market crash.
Mr. Mitchell thought it was possible to see a recession
coming, but he tried to resist the temptation to desire to
tactically change the portfolio and tried to stay with the
long-term asset allocation. He thought chances of achieving
the long-term return was higher if discipline was
maintained in terms of asset allocation. He could see the
impacts of forward-looking views in Callan and Associates
capital market assumptions. He mentioned the declining
trend of expected returns. The goal of DOR was to set a
strategic asset allocation and rebalance towards to the
strategic allocation with in-flows and retirement payments.
10:41:00 AM
Senator Shower thought it was important to protect the ERA
and the Permanent Fund. He thought a structured draw added
stability was important, and an adequate stream of revenue
from the POMV draw. He asked about the equitable split of
the earnings between the people and the government. He was
curious about Commissioner Tangeman's thoughts and he would
agree the items were important.
Commissioner Tangeman agreed that Senator Shower's points
were important and thought that it was reflected in the
administration's budget. He thought the state was in a
position that was much better than most state's even
thought it was experiencing a struggle. He thought Alaska
had a very healthy Permanent Fund, had good laws in place
to inflation-proof the fund, and had accessibility to the
ERA. He thought it was fortunate that there were
protections. He had found that during discussions of the
POMV that it was a wise move of the legislature to
bifurcate the issues of protecting and accessing the funds.
He referenced the state's credit rating and thought rating
agencies recognized the healthy Permanent Fund. He thought
the urgency and importance of getting a structure in place
had been more important than the split.
Commissioner Tangeman thought the Permanent Fund could
provide adequate revenue. He mentioned optimism from the
oil sector and good investments. He discussed a flat
production curve and a fairly stable price. He thought the
POMV was a structured dependable revenue stream. He thought
the state was as stable as it could be.
10:45:36 AM
Co-Chair von Imhof referenced the commissioner's comments
about a healthy Permanent Fund and stability; and asked if
he would say the state was in a fiscal crisis.
Commissioner Tangeman stated that the state was in a
revenue stream crisis. He thought the state had depleted
its accessible shock absorbers and opined that the state
could not sustain the budgets it had enjoyed for some time.
He thought revenues did not match expenditures.
Co-Chair von Imhof asked if the state had a revenue crisis,
the commissioner was suggesting the state should look at
new taxes.
Commissioner Tangeman relayed that he was on the record as
saying that a tax would be in place someday. He personally
thought a tax could be pushed off for some time; because he
thought the state was in a position to match expenditures
with revenue.
Co-Chair Stedman thought the conversation was drifting off
topic. He anticipated that the commissioner would be back
in committee when it considered the updated Revenue Sources
Book and spring forecast presentation in the middle of
March. He was optimistic that the legislature would make a
forward step but was not sure it would reach a final budget
solution. He thought the state would still be struggling
with the same issues in one year. He thanked the testifiers
and DOR. He discussed the agenda for the following day.
ADJOURNMENT
10:48:36 AM
The meeting was adjourned at 10:48 a.m.
| Document Name | Date/Time | Subjects |
|---|---|---|
| 022819 Final and Signed Cash Borrowing MOU 2017.pdf |
SFIN 2/28/2019 9:00:00 AM |
Investment Funds/Cash Flow |
| 022819 Performance Comparison_20190228_Draft.pdf |
SFIN 2/28/2019 9:00:00 AM |
Investment Funds/Cash Flow |
| 022819 Cash Flow presentation_Senate Finance_20190228_Draft.pdf |
SFIN 2/28/2019 9:00:00 AM |
Investment Funds/Cash Flow |
| 022819 Investment Presentation_Updates_20190228_Draft.pdf |
SFIN 2/28/2019 9:00:00 AM |
Investment Funds/Cash Flow |