Legislature(1993 - 1994)
04/14/1994 08:00 AM House STA
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* first hearing in first committee of referral
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+ teleconferenced
= bill was previously heard/scheduled
HB 375 - PERMANENT FUND INVESTMENTS - LIMITED PARTNERSHIPS CHAIRMAN VEZEY opened HB 375 for discussion. Number 078 CARL BRADY, TRUSTEE, ALASKA PERMANENT FUND CORPORATION (APFC), introduced himself and BILL SCOTT, EXECUTIVE DIRECTOR, APFC, who joined him at the table. He addressed the proposed amendment to HB 375. The amendment reads as follows: *Sec 1. AS.13.120(g) is amended by adding a new paragraph to read: (21) Notwithstanding 37.13.120(i), equity investments may comprise more than five percent of the stock of a corporation only through an interest in a partnership, or ownership in a collective investment vehicle, under the following conditions: (A) the Fund shall not own more than a 60% interest in a partnership or collective investment vehicle; (B) the aggregate investment of the Fund under this paragraph may not exceed five percent of the total investments of the Fund; (C) at no time may the Fund own directly or indirectly, through a corporation, partnership or collective investment vehicle, more than 5% of any entity which has substantial oil and gas operation in the State of Alaska; (D) appropriate policies and procedures for investments under this section shall be reviewed and approved annually by the Board of Trustees. MR. BRADY stated the success of permanent fund's investments is primarily attributed to diversification, or asset allocation; attributing 90 percent of most funds success to asset allocation. He expressed markets do, however, fluctuate. He likened APFC's assets to a pyramid, whereby the further they horizontally diversify in other classes, the more safety brought to the principal of the corporation's assets. MR. BRADY explained APFC is requesting authority to invest into more than five percent of any one individual equity. When the fund had $3 billion, more than five percent of a Fortune 500 company or blue chip stock, would have been a significant amount of money. Five percent of smaller capitalization stocks may only be $8-$10 billion. APFC believes owning more than five of a particular equity would be more beneficial. MR. BRADY addressed alternative investment strategies. There are over 200 of public and private entities that have them. He noted Oregon and Washington have over $1.5 billion each in alternative investments, or with institutional investors. The APFC would limit itself to no more than 60 percent in a partnership with other institutional investors. APFC has been fortunate because the bull market has been very good to its stocks in the past; however, this is no longer the case. APFC is now losing some of its unrealized gains. Therefore, the horizontal horizon of the pyramid needs to be broadened to cover the fluctuations in the market in the future. He noted APFC international and global stocks are working in this way, whereas they are outperforming their U.S. domestic stocks. MR. BRADY commented the language provides there would not be double exposure on oil and gas, for example. APFC would not be purchasing stocks principally dealing with oil and gas in Alaska. APFC will spend a lot of time selecting who it intends to co-invest with. HB 375 is important now. CHAIRMAN VEZEY asked where the proposed amendment goes. REPRESENTATIVE HARLEY OLBERG interjected he believed the amendment was a proposed committee substitute. CHAIRMAN VEZEY inquired if MR. BRADY was suggesting the draft language for the proposed change to a CSHB 375 was to replace all the wording in the existing HB 375. Number 191 BILL SCOTT, EXECUTIVE DIRECTOR, APFC, responded that was correct. He stated the proposed amendment is a replacement of the original language, which accomplishes the same thing. The suggested change describes the investment more clearly. Number 195 CHAIRMAN VEZEY questioned if there was an AS 13.120. Number 200 REPRESENTATIVE OLBERG noticed the "37" was missing from the statute number. The correct statute is AS 13.37.120. Number 203 MR. BRADY stated the original language dealt more with vehicle, as opposed to the investment. Number 206 MR. SCOTT clarified the correct statute is AS 13.37.120. There had been a typing error in the amendment. He noted there would also need to be a new title. He suggested, "An Act relating to equity investments of the permanent fund." Number 208 CHAIRMAN VEZEY commented he did not understand the wording in the original HB 375; however, it would now be replaced. He questioned if the proposed change still dealt with the same subject. Number 222 MR. SCOTT responded the original HB 375 emphasized the vehicle, rather than the investment. He related to limited partnerships and how they got a "bad name" from the tax shelters of the 1980s. This has caused a misunderstanding. The intent of the committee substitute is to clarify what the investment will be. The investment would probably be handled through a "limited partnership" vehicle. If the APFC was able to own more than five percent of a corporation they would be able influence the corporate activities by improving its management and changing policies. These changes would improve the corporation's operating profits, thereby increasing the value of the stock. The APFC expects to gain extra earnings from the investment through the appreciation of the stock. Number 276 MR. BRADY explained co-investors would be investing with managers. He stated these institutional managers would select the stock and involve themselves in the activities MR. SCOTT mentioned. Alternative investments typically return higher rates with greater risk, therfore diligence in the investment is as critical. MR. BRADY referred back to the point of diversification. He stated currently, the fund's unrealized gains, "paper profits," have eroded to nearly $1 billion due to the 9-10 percent reduction in the markets. The intent is to redistribute the money into other areas that have had and continue to have a large degree of success. He noted most investors have this class in their portfolios; however, only a small percent. APFC limited the amendment to propose only five percent of the fund, and no more than 60 percent of the partnership. Number 303 CHAIRMAN VEZEY clarified APFC would like to be able to invest more than five percent in an equity. He inquired why APFC was limiting itself to only 60 percent of a partnership, implying they would not be dealing with less than nine percent of an equity. Number 316 MR. BRADY replied more than five percent of ABC stock. He noted, of the pool of stocks with the institutional investor, APFC would not own more than 60 percent. Number 319 CHAIRMAN VEZEY responded correct. He commented if the APFC had no more than 60 percent interest in a fund, the fund would have to own practically 10 percent of an equity before APFC would have five percent. Number 325 MR. SCOTT answered correct. He said the fund, however, might only buy 20 or 30 percent of a company. They would then have sufficient to influence management and improvement of the total operating characteristics of the company. If APFC owned 60 percent of that fund, they would effectively own 12 percent of a company. He noted the existing statute only allows the APFC to own five percent of a company. This is the reason for the restrictive language in the proposed committee substitute. Number 337 CHAIRMAN VEZEY agreed there was a lot of restrictive language. He inquired if the APFC was interested in expanding its investments to more than five percent of an equity. MR. SCOTT answered as a single investment, no. Number 343 CHAIRMAN VEZEY repeated the intent of the proposed legislation. MR. SCOTT added there are investment managers who specialize in managing these investments daily and they have been extremely successful. APFC would like to share in the success. CHAIRMAN VEZEY stated he was concerned that as returns tend to fall, the managers will tend to take higher risks to keep their returns up to historic levels. Specifically, pension funds. Number 365 MR. SCOTT pointed out "pension funds have no restrictions in their enabling..." Number 367 MR. BRADY explained APFC was not working from a legal list. They are working from a prudent investor list. He felt APFC has a philosophical difference than most investors. It would be very difficult for APFC to be much different from the market place because they are so diversified. APFC has a certain amount of money in "very, very, very conservative cash." On the other hand, APFC has its international/global stocks and real estate. The structure of the change is very similar to their real estate. He pointed out, for the first time in a long time, real estate outperformed all other asset classes this last quarter. Number 383 CHAIRMAN VEZEY referred to the restrictions of the proposal. He clarified the APFC would not invest more than five percent of the fund's assets in the total class. Number 391 MR. SCOTT answered in this type of investment, correct. Number 394 MR. BRADY added over 50 percent is in fixed income, or bonds. Real estate is six-seven percent. Number 396 CHAIRMAN VEZEY clarified in this type of investment, in total, APFC would not exceed five percent. MR. SCOTT replied of the fund, correct. Number 399 CHAIRMAN VEZEY stated the strategy is a diversification of a rather small portion of the portfolio. MR. SCOTT said correct. Number 401 MR. BRADY stated in their Ketchikan meetings last fall, they entered into securities lending as an additional class. This is authorized; however, they had not been doing it. He noted has produced $800,000 to $1 million since it was started a couple months ago. APFC wants to continue diversification as the fund continues to grow at $80-100 million a month in income. Number 416 REPRESENTATIVE OLBERG inquired of the total number of assets the fund has today. MR. SCOTT answered about $15 billion. Number 418 REPRESENTATIVE OLBERG pointed out five percent would exactly be "chunk change" - $750 million. Number 419 MR. BRADY said correct. He added it would be very difficult for the APFC to get anywhere near that amount of money at the onset. The asset allocation targets are hard to meet with the income flowing at the rate that it is. The targets cannot be met as fast as the revenue is coming in. APFC needs percentages to make everything add up to 100 in their totals. Number 428 CHAIRMAN VEZEY read subparagraph (C) of the amendment and said it was complicated. He stated APFC's opportunity to participate with a venture capital firm, who was going to do an exploration well in Alaska, would be almost nonexistent. Number 437 MR. BRADY responded APFC would not participate in the deal if the firm had an oil and gas producer in Alaska in the fund. APFC might end up with more than five percent and they feel it would be doubling their exposure, noting their core source is royalty revenue. He noted, as royalty revenue goes down, presumably the value of their stock would follow. Number 444 CHAIRMAN VEZEY felt this contradicted the intent of investing the state's wealth back into Alaska. MR. BRADY agreed, in that regard. Referring to this asset class, APFC owns a considerable amount of stocks with oil and gas operations in Alaska in their domestic equity portfolio. He believed ARCO, Exxon and Union Oil are stocks in that portfolio; however, they are not even near five percent. Number 456 CHAIRMAN VEZEY referred to mining and timber also. He stated by APFC standards, five percent of AMEX Gold would not be a major investment. He guessed $400-500 million. Number 461 REPRESENTATIVE G. DAVIS corrected gold and timber are not oil and gas. Number 462 CHAIRMAN VEZEY clarified subparagraph (C) is limited to oil and gas. He questioned why APFC would want to restrict its opportunities to invest in Alaska. He appreciated, however, the prudent investor attitude about investing in oil and gas prospects in Alaska. Number 472 MR. BRADY stated he believed the primary purpose was not to let it go. They do not want to invest in stocks which they are already getting their core source of income from. They fear if the price of oil were to go down the value of the stock would follow. This is a safety concern. Number 479 CHAIRMAN VEZEY commented he did not believe it was true that royalty was the APFC's core source of income anymore. MR. SCOTT answered not anymore. Number 482 CHAIRMAN VEZEY added oil has been converted into another form of wealth. MR. BRADY stated their investment income is superceding the royalty income now. Number 484 REPRESENTATIVE OLBERG questioned if royalties were not still the single largest source of income. Number 486 MR. SCOTT answered no, not for the APFC. He said their bottom line is more in a couple of months than they receive all year from royalties. He said CHAIRMAN VEZEY was correct. Number 490 REPRESENTATIVE OLBERG commented he was more concerned with how the APFC invests, not where. He has never felt the APFC "had a special charge" to invest in Alaska. The quality of investments is much more important than the geographic location. Number 495 CHAIRMAN VEZEY replied he had trouble putting into statute that APFC would basically stay out of oil and gas operations in Alaska. MR. SCOTT responded only with respect to this vehicle. Number 501 MR. BRADY said they could provide lists of stocks doing business in Alaska that are domicile elsewhere, but their revenue comes from Alaska. Number 503 CHAIRMAN VEZEY stated HB 375 would involve APFC with a managing partner that had a substantial equity interest and effective management influence. He questioned if this much restriction needed to be in statute. Are the Board of Trustees trusted enough to not have it in statute? Number 517 MR. BRADY replied that was a good point. Their debate on HB 375 resulted in the conservatism. He noted they have a very good board; however, trustees do come and go. Number 528 REPRESENTATIVE BETTYE DAVIS referred to subparagraph (C) of the proposed change. She asked if (C) could be deleted, thereby having it done in regulations rather than in statute. She noted the proposed amendment is supposed to be a committee substitute to the original HB 375. Subparagraph (C) does not have to be included. Number 535 MR. SCOTT commented the deletion would not affect the intent of the legislation. Number 537 CHAIRMAN VEZEY questioned why HB 375 had a $200,000 fiscal note. MR. SCOTT answered consultants and advisors will need to be hired to screen any investment of this type made by the APFC. They approach each investment with due caution, therefore an independent analysis will be done. Number 552 CHAIRMAN VEZEY said he was still trying to learn how the APFC accounts to the legislature. Number 556 MR. SCOTT responded the legislature approves their budget just as it does for other departments. Number 557 CHAIRMAN VEZEY pointed out there are general moneys and program receipts. Number 559 MR. SCOTT clarified they are funded by program receipts. APFC expects the expense impact would be far offset by potential gains. Number 568 CHAIRMAN VEZEY asked if the APFC would be objectionable to the deletion of subparagraph (C). Number 573 MR. BRADY said he did not believe so. They put subparagraph (C) in for two reasons. First, so APFC would carefully watch to not double their exposure. Second, it made APFC more politically comfortable because it clarified the proposal came from the board itself, and not the Administration. He stated there had been questions as to whether alternative investments would include water pipelines, etc... He answered no. Sub-paragraph (C) would dispel any concerns. (REPRESENTATIVE OLBERG left the meeting at 8:38 a.m.) Number 593 REPRESENTATIVE G. DAVIS asked if there was similar language in present statute in other areas where the APFC is limited. MR. SCOTT answered their only limitation in real estate is that it must be within the U.S. Other than that, not really. Number 598 MR. BRADY mentioned institutional grade and code. Number 600 REPRESENTATIVE G. DAVIS commented he thought it might be policy that certain percentages were to be invested in certain areas. He inquired if this was in statute or policy. Number 602 MR. BRADY clarified within institutional grade there is residential, industrial, commercial, etc... He noted certain things are not done because they do not think it is wise. Number 606 CHAIRMAN VEZEY inquired if there was a companion bill in the Senate. MR. BRADY answered yes, SB 244 moved out of Senate State Affairs yesterday. Number 610 REPRESENTATIVE B. DAVIS asked if the bill that passed the Senate State Affairs Committee was the new committee substitute. MR. BRADY affirmed REPRESENTATIVE B. DAVIS. Number 618 CHAIRMAN VEZEY asked if there was a motion to adopt the committee substitute, version E to HB 375. Number 619 REPRESENTATIVE B. DAVIS so moved, and noted that she wanted to delete subsection (C), page 1. CHAIRMAN VEZEY asked the committee secretary to call the roll. IN FAVOR: REPRESENTATIVES VEZEY, KOTT, B. DAVIS, G. DAVIS. ABSENT: REPRESENTATIVES ULMER, SANDERS, OLBERG. MOTION PASSED Number 627 REPRESENTATIVE KOTT clarified the committee substitute to HB 375, less subsection (C) had been adopted. Number 630 REPRESENTATIVE B. DAVIS asked what the title change would be. MR. SCOTT suggested the title be, "An Act relating to equity investments of the permanent fund." CHAIRMAN VEZEY asked why this title would be suggested. MR. SCOTT answered the title on the original HB 375 does not quite fit; therefore, the new title would simplify the description of the intent. He noted the original title emphasized limited partnerships which was not the thrust of the bill. Number 644 CHAIRMAN VEZEY said CSHB 375 would be held in committee so legal services could prepare a title. He advised it was very late in the legislative process and the actual chance of CSHB 375 passing this session was slim. Number 658 DAVID GOTTSTEIN, PRESIDENT, DYNAMIC RESEARCH GROUP, supported CSHB 375. He noted the permanent fund had expanded its scope of investments over the years. He felt the great market Alaska had been experiencing for the last 10-12 years was coming to an end. Therefore, from a risk management perspective, they would have to become even smarter to accomplish smaller returns because interests rates are not as high. He felt CSHB 375 would allow APFC to expand, while acting prudently. He concurred with MR. SCOTT that it is not necessarily appropriate to get bogged down in the vehicle. Making sure the investment is good and priced right is the most important. CSHB 375 would allow premium returns while managing the risk appropriately with partners. Number 683 RALPH SEEKINS, CHAIRMAN, BOARD OF TRUSTEES, supported CSHB 375. He clarified APFC was not trying to get more sophisticated, rather more profitable. He said the oil and gas restriction was a political limitation. TAPE 94-47, SIDE B Number 000 MR. SEEKINS estimated some of the restrictions presently on the APFC has cost the people of the state of Alaska between $300-400 million. He noted the APFC is restricted by law to a very small portion of the universe of corporate securities as an example. APFC is limited to AA or better, of the five percent, in the A category. There are certain good investments which the APFC cannot buy. He explained the only way "to own those A stocks is to be that five percent, or have an AA move down." MR. SEEKINS stated part of his mandate on the Board of Trustees is to return the best possible return for the people of the state of Alaska. He felt if they did get this additional class available to them, they would not fill it very quickly because they would be looking for the prudent investment. He noted if ten packages were bought, eight may be bad. Therefore, this is where the political risk comes in. Those two would be put on the front page even if a "killing" was made on the other eight. APFC wants to balance this problem. MR. SEEKINS expressed APFC felt without moving farther to the upper right on the risk factor, they can move farther up on the profit factor. They are seeking a balance. APFC is also not trying to put the legislature farther out on the "political limb" than it already is.
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