HOUSE FINANCE COMMITTEE April 28, 1999 8:30 A.M. TAPE HFC 99 - 111, Side 1 TAPE HFC 99 - 111, Side 2 CALL TO ORDER Co-Chair Therriault called the House Finance Committee meeting to order at 8:30 a.m. PRESENT Co-Chair Therriault Representative Foster Co-Chair Mulder Representative Grussendorf Vice Chair Bunde Representative Kohring Representative Austerman Representative Moses Representative J. Davies Representative Williams Representative G. Davis ALSO PRESENT Senator Dave Donley; Representative Gail Phillips; Clark Gruening, Vice Chair, Alaska Permanent Fund Board, Juneau; Jim Kelly, Legislative Liaison, Alaska Permanent Fund Corporation, Juneau; Terry Brown, Chief Investment Officer, Alaska Permanent Fund Corporation, Juneau; Ron Lorenson, Attorney, Simpson, Tillinghast, Sorensen and Lorensen Law Firm, Juneau; Mike Bell, Investment Officers, Alaska Permanent Fund Corporation, Juneau; Peter Naoroz, Manager, Real Estate Investment, Alaska Permanent Fund Corporation; Michael Bell, Investment Officer, Alaska Permanent Fund Corporation, Juneau; SUMMARY HB 156 "An Act relating to investments by the Alaska Permanent Fund Corporation; and providing for an effective date." CSHB 156 (FIN) was REPORTED out of Committee with a "do pass" recommendation and with a fiscal impact note by the Department of Revenue. CSSJR 11(FIN) Urging the Congress of the United States to provide federal education funds as a block grant to the state. CSSJR 11 (FIN) was REPORTED out of Committee with a "do pass" recommendation and with a zero fiscal note by the Senate Finance Committee. CS FOR SENATE JOINT RESOLUTION NO. 11(FIN) Urging the Congress of the United States to provide federal education funds as a block grant to the state. SENATOR DAVE DONLEY, testified in support of SJR 11. Senate Joint Resolution 11 is a Senate Finance Committee resolution. It urges Congress to provide federal education funds as block grants to the state of Alaska. Senate Joint Resolution 11 encourages Congress to give the State of Alaska greater control over the education funds provided by the federal government. By taking control of funds from an agency thousands of miles away and placing the disbursement responsibility in the hands of the state and communities the funding will directly impact, the money will be put to its most appropriate use. Currently, the federal government provides funding for education that is specifically earmarked for education programs within the state. SJR 11 will encourage Congress to instead disburse the money in the form of a block grant, as they do with welfare funding, directly to the State of Alaska. Senate Joint Resolution 11 will give the state flexibility to maximum the use of federal education funds. In the 105th Congress, the House of Representatives passed HR 3248, which would have created an education block grant system. Unfortunately, the bill did not pass the Senate. Congress is considering a similar resolution in the 106th Congress. Co-Chair Therriault asked if there is new money coming from Congress or would existing programs be appropriated as a block grant. Senator Donley stated that a battle is being waged in Congress regarding an increase in funding. He noted that the legislation does not take a position on additional funds. The legislation requests that the system of federal education appropriation, with dozens of specifically delineated federal programs and individual requirements be merged into a single block grant. Vice-Chair Bunde asked what other states support a single block grant system. Senator Donley stated that many states are supporting this system. Co-Chair Therriault asked if the Conference of Governor's had taken a position. Senator Donley did not know if the Conference of Governor's had taken a position on the issue. Co-Chair Therriault pointed out that there is a zero fiscal note. Vice-Chair Bunde MOVED to report CSSJR 11 (FIN) out of Committee with the accompanying fiscal note. There being NO OBJECTION, it was so ordered. CSSJR 11 (FIN) was REPORTED out of Committee with a "do pass" recommendation and with a zero fiscal note by the Senate Finance Committee. HOUSE BILL NO. 156 "An Act relating to investments by the Alaska Permanent Fund Corporation; and providing for an effective date." REPRESENTATIVE GAIL PHILLIPS, sponsor spoke in support of HB 156. The Legislative Budget and Audit Committee is charged with oversight of the Alaska Permanent Fund Corporation. Specific to this legislation, AS 24.20.151 reads "holding these agencies (lending or investment entities) accountable to statutory intent in their performance by recommending, where appropriate, changes in policy to the agencies or changes in legislation to the legislature". On March 23, the Alaska Permanent Fund Corporation presented this legislation to the Committee and the members present agreed unanimously to introduce it, without revision, in both bodies. House Bill 156 modernizes the operations of AS 37.13.120, the statutes that set out the "legal list" of permissible investments of Permanent Fund assets. The revisions requested in this legislation are aimed at providing increased investment flexibility, reduced risk, and hopefully increased returns for the Permanent Fund. House Bill 156 allows the trustees to invest up to 5% of Fund assets to: (1) make or retain greater asset class commitments than currently allowed; and /or (2) invest in individual securities or instruments that are not expressly permitted. However, the legal list approach is maintained and current asset allocations, while modestly expanded, remain in place. The first committee of referral, the House State Affairs Committee, made one amendment to HB 156. On page 6, line 20, the limit on owning domestic and nondomestic entities was raised from 50% to 55%. We think this is timely legislation - as the Finance Committees begins to consider various fiscal plans- making sure we are getting the highest, sustainable, and safest returns from our assets currently entrusted with the Permanent Fund is the first step. I support this legislation as amended in State Affairs. I ask that the House Finance Committee fully review the impact of this amendment with Permanent Fund Corporation Staff. CLARK GRUENING, VICE CHAIR, ALASKA PERMANENT FUND BOARD, JUNEAU testified in support of HB 156. The first deposit to the permanent fund occurred in 1974. It was approximately $734 thousand dollars. There was no structure other than an interim bill, which only allowed the Treasury Division to invest in government security bills. Since then legislators have made pivotal decisions. The initial decision was made to make the fund adhere to a prudent investor standard as opposed to a development bank model. Legislators also decided to add, on a voluntary basis, to the principle. The principle is approximately $18 of the $25 million dollars in the fund. Two-thirds of the principle was voluntarily deposited by the legislature. Another key area of decision has been the continuum of incremental and timely changes to the permissive list. He gave a brief history of the Fund's investment in the stock market. Many similar funds do not have a long permissive list. They only have a pure prudent investor approach. He noted that the Board questioned if they should be guided only by the prudent investment approach. They decided that it made sense to ask for modest improvements. JIM KELLY, LEGISLATIVE LIAISON, ALASKA PERMANENT FUND CORPORATION, JUNEAU provided members with a handout (copy on file). He stressed that the Corporation is asking to modernize the statutes to be responsive to current market opportunities and challenges. The requested change is conservative and maintains the legal list approach. It allows the fund managers to add incremental value and improve the total portfolio risk management. The House State Affairs version increased the equity allocation by 5 percent to 55 percent. He discussed page 2 of the handout, demonstrating the growth of the Fund. He noted that the Fund has been able to take advantage of some of the returns the stocks and higher risk assets have produced. It has earned an average of 17.69 percent annually on every dollar. Mr. Kelly observed that risk can be managed through distribution of income. He estimated that an increase in asset allocations to 60 percent in equities would have earned a 31 percent return on stocks. The permanent fund earned a 9.52 percent on bonds. This is a difference of $2 billion dollars. Mr. Kelly reviewed the distribution of the Fund's investment. He stressed that time is a great protector of assets. He referred to page 4 (chart 8) of the handout. He emphasized that if there is an income distribution policy that is stable and continuos then a long-term investment policy can take advantage of returns from a risk managed portfolio. He referred to page 7 of the handout. He noted that a 48 percent investment in stocks expects a return of 7.75 percent. If assets were invested in an additional 5 percent of equities the rate of return would increase to 7.94 percent. A ten-percent increase in equities could result in an 8.13 percent return. This could be a difference between $67 and $73 billion dollars over the next 20 years. Co-Chair Therriault referred to page 7, lines 1 - 5 of CSHB 156 (STA). He asked for examples of other classes of investments not specifically included in the list. TERRY BROWN, CHIEF INVESTMENT OFFICER, ALASKA PERMANENT FUND CORPORATION, JUNEAU explained that alternative investments include private equity debt, oil or gas, agriculture, high yield bonds, or adventure capital. Co-Chair Therriault noted that outlined equities could be up to 60 percent. Vice-Chair Bunde noted that he is in general support of the legislation. He questioned if there is a danger of over investment. Mr. Brown did not think that there is a danger. He pointed out that there would be a committee process to outsource investments. Investments are not done directly. Ordinarily there would be a manager responsible for selecting and watching the asset. Mr. Gruening maintained that the Board would be cautious. Vice-Chair Bunde pointed out that Alaskan's confidence in government is tied to the Permanent Fund. He stressed that a bad market year would affect the public's confidence. Mr. Kelly reiterated that 8.13 percent is the estimated growth of the Fund for a portfolio that includes 58 percent in equities. Co-Chair Therriault referred to page 6, line 3. He noted that "own" was changed to "acquire". He questioned why the change is needed. Mr. Gruening stated that "acquire" is a more operative word. "Own" can change as the corporation buys its own stocks. RON LORENSON, ATTORNEY, SIMPSON, TILLINGHAST, SORENSEN AND LORENSEN LAW FIRM, JUNEAU explained that it is difficult for the Corporation, through its managers, to keep track of the status of a particular holding because more than one manager may acquire the same stock. A situation could occur where a corporation that has been invested in could buy and back and retire some of its own shares, which would increase the percentage of shares owned by the Permanent Fund Corporation. This would require the Permanent Fund Corporation to sell some of its shares to lower the percentage it owns. Co-Chair Therriault questioned if another problem is being created. He pointed out that even if no more than 5 percent was required at any one time the total acquired could be greater. Mr. Gruening observed that of the top ten investments the actual ownership percentage is two-tenths of one percent. Mr. Brown stressed that the top holdings are less than one percent. Representative Williams questioned if the Board is as conservative as it was in its conception. Mr. Gruening stated that the Fund's equity allocation is somewhere in the middle. He stressed that the Board would not be rushing to fill the extra 10 percent at this time. Representative Williams questioned what tools exist to assure that the Board does not move to high risk. Mr. Gruening pointed out that the legislature has continuous oversight and that the Board is audited. He observed that higher equity allocations have great volatility. He maintained that the Fund is not moving in that direction. Co-Chair Mulder observed that the permanent fund is greater than $26 billion dollars. He asked if there are any other comparable funds that have as many restrictions. Mr. Gruening stated that most funds that are of an equal size are more aggressive. Mr. Brown agreed that most funds of equal size are more aggressive. He characterized the Fund as fairly conservative. Co-Chair Mulder questioned if it would be a better course of action to free the hands of the managers. Mr. Gruening stated that it would be an alternative course of action. He emphasized that public involvement makes such a change unlikely. He noted that the legislature is involved in setting the target rate of return and the resulting risk. Co-Chair Mulder spoke in support of the legislation. He observed that there are experts in place to manage the Fund. He spoke in support of maximizing opportunities. Mr. Gruening emphasized that the Board is concerned with risk. Co-Chair Mulder stressed that the legislature has the critical oversight. Vice-Chair Bunde asked if the Corporation's website has a high volume of hits. Mr. Kelly stated that it receives a relatively small number of hits. In response to a question by Vice-Chair Bunde, Mr. Lorenson explained that a split in stocks would not affect the percentage of ownership. (Tape Change, HFC 99 - 111, Side 2) Co-Chair Therriault observed that ownership is under one percent for most holdings. He questioned if there is a problem with approaching the 5 percent. He observed that the new classification of (g)(21) was exempted from the 5 percent. He questioned why a long-standing policy was being changed. Mr. Brown explained that there are cases where they may own more than 5 percent due to buy backs. He clarified that the ownership in the company is not greater than 1 percent. Co-Chair Therriault asked if there are companies that the state owns close to 5 percent of the total stock. MICHEAL BELL, INVESTMENT OFFICERS, ALASKA PERMANENT FUND CORPORATION, JUNEAU stated that in large corporations holdings approach a tenth to two-tenths of a percent. He noted that in small company stocks there have only been one or two cases where holdings have exceeded more than 1 percent. Co-Chair Therriault reiterated his belief that the change is not needed. Mr. Gruening stated that the more important part of the change is in relationship to the ownership of real estate through a single corporation. Co-Chair Therriault stated that he had not heard a compelling reason to change the provision. PETER NAOROZ, MANAGER, REAL ESTATE INVESTMENT, ALASKA PERMANENT FUND CORPORATION explained that property is bought and liability reduced by going through holding companies. He stated that this is used to keep the Fund out of the chain of title. Holding companies are used to reduce risk and lower liability. He did not think that the 5 percent clause was meant to apply to real estate title holding companies. Co-Chair Therriault questioned if there is a way to clarify the provision for the purpose of real estate. Mr. Naoroz stated that they could live with "own". Representatives Phillips pointed out that chart number six should have been labeled "Opportunities Lost". She emphasized the difference that an additional $770 million dollars would have meant to the state. Co-Chair Therriault asked the impact of deleted language on page 4. Mr. Lorenson explained that the deletion addresses the limitations that had been placed on real estate buildings. The language addresses limitations placed by the legislature on real estate investments in the form of buildings. It eliminates the restriction that prohibited the Alaska Permanent Fund Corporation from owning more than 67 percent of a building that is worth more than $150 million dollars. The Corporation has found that co-investors have taken advantage of the limitation in buy-out situations. Corporation counsel recommended the change. The language also removes limitations that prohibit the corporation from buying raw land for the purpose of expanding an existing property. Co-Chair Therriault MOVED to delete "acquire" and insert "own" on page 6, line 3. There being NO OBJECTION, it was so ordered. Mr. Kelly discussed the fiscal note. He noted that the changes made in the House State Affairs Committee would increase the potential earnings by twice the amount. Vice-Chair Bunde MOVED to report CSHB 156 (STA) out of Committee with the accompanying fiscal note. Representative Grussendorf OBJECTED. He pointed out that there would be a greater cost for the active management. He WITHDREW his objection. Representative Williams OBJECTED. He stated that he was not comfortable with the legislation. He expressed concern that the investment be watched carefully and be conservative. He WITHDREW his objection. Co-Chair Therriault stressed that the earnings would not have been as high if the legislature had not made changes. There being NO OBJECTION, CSHB 156 (FIN) was moved from Committee. CSHB 156 (FIN) was REPORTED out of Committee with a "do pass" recommendation and with a fiscal impact note by the Department of Revenue. ADJOURNMENT The meeting adjourned at 9:38 a.m. House Finance Committee 9 4/28/99