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. REPRESENTATIVE NORMAN ROKEBERG, SPONSOR, noted that the bill was brought forward by the Alaska Permanent Fund Corporation. He stated that the bill would change the current policy of statutorily limiting the allocation of the agency's portfolio. Representative Rokeberg referenced Amendment #1, #24- LS0698\A.1, Cook, 4/1/405. (Copy on File). He requested consideration of the amendment, which would provide that the Board of Trustees could go through the rule adoption prior to the effective date of the bill. He reiterated his support of Amendment #1. The Board needs authority in order to be able to start drafting regulations and would happen with passage of the amendment. 2:47:27 PM Vice-Chair Stoltze inquired if the amendment would delete the effective date. Reprehensive Rokeberg said it would change the effective date in order to allow for the rule making authority to move forward. MICHAEL BURNS, CHIEF EXECUTIVE OFFICER, ALASKA PERMANENT FUND CORPORATION, directed his comments to the legislation. Initially, the fund was limited to a bond portfolio. Overtime, the Legislature loosened those restrictions, creating a statutory list of permissible investments. He noted that that 45 of the 50 states have eliminated the statutory lists and now use the prudent investor rule. 2:49:25 PM Mr. Burns provided a handout "Reducing Risk, Increasing Return", and referenced Page 4. (Copy on File). The chart indicates potential risk and return for various portfolios under the Fund's current investment restrictions and under the prudent investor rule. The underlying asset allocations for the main points of the chart are shown. The chart demonstrates that under the prudent investor rule, the Fund could potentially earn the same return as the current portfolio with 3% less risk. 2:52:03 PM LAURA ACHEE, ALASKA PERMANENT FUND CORPORATION, offered to answer questions of the Committee. Representative Rokeberg requested that Mr. Burns explain the impacts on the fixed income portfolio. Mr. Burns advised that in a raising rate environment, the portfolio is very vulnerable to price declines. Representative Rokeberg added that as interest rates go up, the principle balance is actually loosing money. He asked how the bill allows managing that risk. Mr. Burns responded that addressing the value of the principle, there are a number of "tools" the Corporation might use: · Absolute return strategy; · Various hedging; and · Derivatives. Mr. Burns mentioned "hard" assets. There are a variety of strategies and combinations of assets that can protect the State against rising rates. 2:54:54 PM Representative Holm referenced the prudent investor rule and asked how it relates to the current discussion. Mr. Burns responded that the prudent investor rule was established in 1994. The requirements are "not to be right", instead encouraging a process involving questions and standards. Representative Holm asked what happens if there are no standards. Mr. Burns replied that it is the process in place, managing oneself and measuring the risks. The prudent investor rule is about the diligence placed on the controls and how the fund operates. He acknowledged that was vague. 2:57:15 PM Representative Holm commented that investing is a form of art. He asked how the Board determines if the standards of the prudent investor rule are being met. Mr. Burns stated that the Board has to measure how things are presented and follow-up on those concerns. The prudent investor rule is a management process tool and a way of doing business. He mentioned the legal components. 3:01:11 PM In response to Representative Holm, Mr. Burns pointed out the primary decision the Board makes is determining what the asset allocations are going to be. From there, it is determined who will be responsible for implementing it. He agreed it is a "term of art". Representative Holm acknowledged he was nervous given concerns managing the Public Employment Retirement System (PERS) and the Teachers Retirement System (TRS). 3:02:33 PM Co-Chair Meyer asked if the investment strategy was conservative. Mr. Burns responded it was a very conservative managed fund, consisting of a balance of asset categories and styles for growth and equity in the fund. He emphasized that it is diversified. Co-Chair Meyer asked if the investment strategies would stay the same through passage of the legislation. Mr. Burns explained that some of the asset categories would replace some of the fixed income categories, which would remove the price swing vulnerability. The private equity deals are hopeful and that the Board would like to expand the private equity type investments. 3:06:24 PM Representative Croft inquired the expected return in March 2004. Mr. Burns pointed out that the historical status is a 7.83% return of the picked asset mix. The standard deviation is 10.29%. Representative Croft understood that is an asset mix used to achieve those goals. Representative Croft referenced Page 5 of the handout, inquiring about the regulatory interest. Mr. Burns noted those are some category potentials. Representative Croft asked that with a little more risk, was it possible that the Fund could receive higher returns. Mr. Burns replied it is such a small draw on the fund, not like a pension fund and the draw tends to be around 5%. The Board has the patience to stay in a fund for a longer term. Representative Croft inquired about the relative individual risk. Mr. Burns responded that the Permanent Fund functions as an endowment. 3:10:22 PM Mr. Burns spoke to the risk factors and return levels. Representative Croft asked if that was addressed through switching the large cap equities. Mr. Burns said whatever the combination, the intent is to accumulate a portfolio of assets, where performance is not connected to each another. He pointed out that some private equities do not always have a correlation to each another. It is of no concern how each asset performs but instead, how the portfolio performs as a whole. Representative Rokeberg added that the asset mix can lower the risk. 3:13:30 PM Representative Weyhrauch noted a new section of the bill addressing regulation adoption. Mr. Burns discussed that the constitutional amendment, which created the Permanent Fund, describes assets prescribed by law and that the Legislature should grant rule-making authority to the Board of Trustees. Vice-Chair Stoltze inquired if that could alter the basket requirement amount. Mr. Burns responded that at present, the basket clause is at 10%. Vice-Chair Stoltze inquired if there was a statutory amount indicating a specific dollar figure. Mr. Burns reiterated it was 10%. The overriding principle will always be the prudent investment rule and one tenant is diversification. 3:16:35 PM Representative Croft read from AS 37.13.121: "Mortgages are capped at 15%, real estate investment capped at 15%, CD's and other investments capped at 20%; domestic and non- domestic capped at 55%." Vice-Chair Stoltze asked if the legislation provides for investing in the gas line proposal. Mr. Burns said that the Permanent Fund would need specific statutory authority to invest in something like that. Vice Chair Stoltze asked if the language was broad enough to allow for it. Mr. Burns thought it might be depending on the proposed amount. Representative Weyhrauch pointed out that last year's legislation had an amendment that allowed the Permanent Fund to specifically invest in the gas pipeline. The Senate Finance Committee stripped that clause out. 3:19:42 PM Co-Chair Chenault asked if the legislation would provide that hedge funds be used and the 1% Permanent Fund designation. (Testimony inaudible). Mr. Burns replied that a hedge fund strategy could very well be a part of the legislation. Hedge funds can provide a broad handle. There is no percent at this time on in-State investments. The Board was insulated from political pressure last session by stripping out the clause that members could be removed for "cause". The Board is independent and members have a four-year staggered term. He pointed out that the Board would like to do more in-State investing. 3:22:06 PM Representative Hawker added comments toward diversification as mandated by the prudent investor rule and prohibiting the concentration of risk in small environments. Mr. Burns acknowledged it has been a challenge attempting to invest in Alaska because there are only a few projects in the State large enough. 3:23:14 PM Representative Rokeberg mentioned investment in the gas pipeline. He thought that a pipeline investment would provide a more fixed income portfolio. He added it could be limited by that investment strategy. Mr. Burns mentioned the categories of the prudent investor rule: · Diversification, · Concentration, and · Determining if it is of an investment grade. Representative Rokeberg maintained that the only possible way to use any funding above the criteria would be through passage of the proposed legislation. Mr. Burns thought that, however, the process could be addressed such as legislative intent and it would be appropriate. 3:26:02 PM Representative Weyhrauch interjected that if the investment meets the prudent investment rule, then the State should invest in it. Representative Croft pointed out that he could not find a provision within statute that would prevent investing in the pipeline. He thought investing would be limited as it is currently within the 5% market basket. He thought it could be difficult to justify under the prudent investor rule, but saw no restrictions in what could be done through regulation. Mr. Burns informed members that the Trustees take their fiduciary role seriously. He believed that the limitations of the prudent investor rule could limit pipeline investment. Representative Kelly stated the proposed legislation is important and understood it would take the decisions from the Legislature and place it with the qualified Board. 3:29:42 PM Representative Hawker MOVED to ADOPT Amendment #1, #24- LS0698\A.1, Cook, 4/14/05. (Copy on File). Vice-Chair Stoltze OBJECTED. Representative Rokeberg explained that Amendment #1 was a housekeeping measure, authorizing the Board to proceed with the regulation rule making it prior to the effective date. Vice-Chair Stoltze WITHDREW his OBJECTION. There being NO further OBJECTION, it was adopted. Representative Weyhrauch MOVED to ADOPT Amendment #2, Page 3, Line 8, delete "mailing" and insert "providing". Vice- Chair Stoltze OBJECTED. Representative Weyhrauch explained that current language does not include other options such as emailing and faxing. The amended language will be broader. Representative Rokeberg supported the change. Vice-Chair Stoltze WITHDREW his OBJECTION, Amendment #2 was adopted. 3:32:17 PM Representative Foster MOVED to REPORT CS HB 215 (FIN) out of Committee with individual recommendations and with the accompanying fiscal note. There being NO OBJECTION, it was so ordered. CS HB 215 (FIN) was reported out of Committee with a "no recommendation" and with zero note #1 by the Alaska Permanent Fund Commission. 3:32:45 PM