Legislature(1995 - 1996)
03/19/1996 10:00 AM Senate FIN
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* first hearing in first committee of referral
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= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
SENATE BILL NO. 303
An Act relating to management of the budget
reserve fund; and providing for an effective date.
Co-chairman Frank explained that assigning the
Constitutional Budget Reserve, with substantial balances in
excess of current needs, to the permanent fund for
management would increase the rate of return by "maybe 200
basis points or 2 percent." The Governor's long-range plan
also assumes a greater rate of return on the CBR. The
proposed bill represents one way that could be accomplished.
It is offered as a starting point for discussion. He then
asked that staff from the Dept. of Revenue and the Alaska
Permanent Fund speak to the legislation.
ROBERT STORER, Chief Investment Officer, Treasury Division,
Dept. of Revenue, came before committee to speak to present
management of the fund. He noted that much of the
discussion would relate to cash flow and asked that DON
WANIE, Director, Division of Finance, Dept. of
Administration, join him at the table.
In response to a question from Senator Phillips asking if
the administration supports the bill, Mr. Storer cited the
present construction of the constitutional budget reserve,
significant impact on cash flow, and placement of funds
within the permanent fund as areas of concern giving rise to
opposition.
Mr. Storer explained that the CBR is managed to address cash
flows and shortfalls in the general fund. Two
considerations are paramount:
1. Future expenditures
2. Future income into the general fund
These considerations relate not to a one-year time horizon
but a two, three, four-year, somewhat "non-predictive" time
frame. For that reason, the department manages "with
moderate risk." "Risk" relates to "near-term market
volatility" and the chance of fluctuation of valuations in a
portfolio on a year-to-year basis. Over time, investments
can be made in asset classes with higher rates of return,
but there is more volatility. The investor is rewarded for
accepting that volatility by a higher return. Because of
volatility in the equity market, the CBR is managed with
fixed-income securities. The department will not invest
fund assets in securities with more than a five-year
maturity, because of the short-term nature of the fund.
That allows for "about 95 percent of the fixed-income market
returns and about one-third less risk than a bond market."
The permanent fund, much like the state retirement system,
has the luxury of managing for longer time horizons and can
thus have multi-asset-class portfolios. That allows for
investment in domestic and international equities as well as
real estate.
Speaking to the domestic equity market, Mr. Storer noted
that, over time, it should return "about 10 percent."
History also shows that a preponderance of the time those
returns can fall between a positive 28 percent and a
negative 8 percent. Because of that volatility, the
department has been unwilling to accept the incremental
risk.
The department has done a number of things to add income to
the fund. Those actions apply to the general fund as well
as the CBR. Aggregation of assets has allowed for
investment in securities with a higher rate of return, a
little more volatility, but safety of principal to maintain
the purchasing power and value of the fund. The result was
an additional $50 million at the low end and $75 to $100
million over the last few years.
Mr. Storer noted that in the last calendar year, the CBR
returned 10-1/4 percent. Given the nature of the fund, that
is a good return. He referenced FY 93 when the bond market
lost "almost 1-1/2 percent . . . and we managed to earn a
positive 3-1/2 percent"
Mr. Storer reiterated that multi-asset-class portfolios that
should produce a higher rate of return involve near-term
volatility. In considering the proposed legislation, one
must also consider the potential for incurring some losses
in a portfolio that is essentially a cash flow account.
Mr. Wanie next distributed materials (copy on file in the
original Senate Finance Committee file for SB 303),
referenced analysis language indicating Dept. of
Administration opposition to the bill, and explained that
opposition relates to cash flow concerns. The front section
of the operating budget has historically contained language
appropriating moneys from the CBR to the general fund for
the purpose of balancing revenues and expenditures.
Language says that if revenues are not sufficient, the state
can go to the CBR when it needs cash. The state spending
pattern during the first four to five months of the fiscal
year is such that expenditures will exceed revenues
"anywhere from $250 million on the low end to over $350
million on the high end." That creates cash flow problems
for the Dept. of Administration. To meet cash shortfalls
and avoid shutting down payments to vendors, municipalities,
the University, school districts, etc., the department
borrows from the CBR and continues to make payments.
Mr. Wanie asked if the department would continue to have
access to cash from the CBR if custody is turned over to the
permanent fund corporation. If access remains available,
the next question is, "How quickly can the permanent fund
corporation respond?" At the present time, when the state
runs into a cash crisis, the department "can kind of predict
it, but all of a sudden we're at a situation where we're at
a threshold and we need to borrow cash . . . ." If that
opportunity is not preserved when the CBR moves to the
permanent fund corporation, what would the alternatives be?
Co-chairman Frank voiced his intent that the state would
retain ability to manage cash flow through loans from the
CBR to the general fund. There should be no policy problem.
In response to a question from Co-chairman Frank, Mr. Wanie
explained that state revenues are "generally somewhat even."
However, the first three or four months of the fiscal year
are peak periods for all agencies. That is when employment
is at its highest, construction projects are undertaken, and
there is "an awful lot of activity." Much more cash goes
out the door than comes in. The state attempts to spread
disbursements to municipalities across the year to preserve
cash.
Co-chairman Frank acknowledged that the Dept. of
Administration raised good questions. He then asked that
staff from the permanent fund corporation respond.
Senator Rieger inquired regarding the asset allocation of
the CBR at the present time. Mr. Storer said it is entirely
in fixed income securities--predominantly treasury and high-
grade corporate bonds. The risk profile has been expanded
by investment in "some intermediate securities."
Approximately 30 percent of that portfolio has maturities in
a three-to-five-year time horizon. That is the area that
provides a 95 percent incremental return without the risk.
There are currently no equities in the portfolio. Senator
Rieger asked if the remaining 70 percent is in fixed-income
investments of less than three years. Mr. Storer concurred.
Senator Rieger asked if the department would invest in
equities if the time frame was eight to ten years. Mr.
Storer responded, "Unequivocally." He voiced his opinion
that to successfully invest in equities, a five-year time
horizon is needed. That allows opportunity to smooth out
market volatility. If the department knew some element of
the portfolio could not be touched for eight years, more
risk could be taken. Senator Rieger referenced projections
which show a substantial balance ten years hence, depending
upon the type of investment. Mr. Storer agreed, saying that
could be done if there is "some sort of explicit guarantee
that we can eliminate this non-predictive event . . . ."
Senator Rieger acknowledged the fiduciary relationship of
the department to the fund and further acknowledged that it
would be uncomfortable for staff to undertake additional
risk investments without "some kind of release from the
Legislature." He then suggested that Legislative assumption
of risk should be a sufficient directive. Mr. Storer
agreed.
Co-chairman Frank voiced his assumption that a good portion
of the 10 percent return resulted from an increase in the
price of bonds and securities held by the state. Mr. Storer
concurred. He added that by creating a pool--"almost a
mutual fund environment"--the department was able to incur
more risk (longer-dated securities) which provided potential
for greater capital gains. Department evaluation of the
market and price increases also helped. Co-chairman Frank
then suggested that should the market turn, the state could
experience no return or a loss with the same risk profile.
Mr. Storer agreed that for near-term investments that is
potentially correct. With a three to four-year time
horizon, there is an emphasis toward safety of principal.
There would be an income flow. Mr. Storer emphasized that
the nature of the single-asset-class portfolio allows the
state to become more conservative if the market dictates.
Co-chairman Frank asked if a greater return could be
achieved if $1.8 of the $2.2 billion CBRF was placed within
the substantially larger permanent fund and $400 million
left to deal with cash flow. Mr. Storer explained that
since the department manages 18 different portfolios, it has
the capability to construct a portfolio to fit the
requirements of a large fund. The problem is the non-
predictive element. If continuity of the fund could be
predicted over a longer time horizon, assets could be
differently invested. Co-chairman Frank acknowledged that
should the price of oil significantly decrease, the state
might have to substantially draw upon the CBRF. That might
mean that securities would have to be liquidated at an
inopportune time. Because the permanent fund is
substantially larger, it would be in a better position to
liquidate short-term securities that would naturally be
turning over. It appears as though that would be of
benefit.
Co-chairman Halford advised of need for members to attend
the Senate floor session and suggested that discussion of SB
303 continue at the next meeting.
ADJOURNMENT
The meeting was adjourned at approximately 11:10 a.m.
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