Legislature(2003 - 2004)
03/08/2004 08:07 AM House STA
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* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
HB 466-PERMANENT FUND INVESTMENTS Number 0080 CHAIR WEYHRAUCH announced that the first order of business was HOUSE BILL NO. 466, "An Act relating to investments of Alaska permanent fund assets; and providing for an effective date." CHAIR WEYHRAUCH mentioned an amendment regarding allowing the [Alaska Permanent Fund Corporation (APFC)] board to make loans of fund assets to the Alaska Natural Gas Development Authority. He asked Mr. Storer for his feedback. Number 0144 ROBERT D. STORER, Executive Director, Alaska Permanent Fund Corporation (APFC), Department of Revenue, responded as follows: ... The board has not discussed the merits of this issue, so I would just make a couple observations. One is [that], if in fact the amendment were to go through, it would definably be a less liquid asset; but how liquid or how the instrument [would] look ..., I couldn't speak to right now. But one of the things that we discussed, Mr. Chair, was the fact that as we diversify portfolios, we own a lot of stocks. We had discussion weeks ago about ... filling the basket. And we own over 4,000 stocks. And I mention this because, in our publicly traded equity portfolio - very liquid, large company names - our largest holding's probably Pfizer or [General Electric Company], and it's probably around $250 million in value; that's in a $28 billion fund. So, you can see the less liquid the ... investment instrument, the less money one would be willing to commit to. So, it's a practical matter. If it met the prudent investor rule, if it met our diversification criteria, probably the most we would be able to invest in passing those hurdles would be $50 maybe $100 million - tops. We do have other ability to make that type [of] investment, if it's appropriate for the permanent fund, but that would, of course -- the difference being giving us explicit direction to at least consider such an investment. Number 0290 CHAIR WEYHRAUCH asked if the [APFC] makes investments in mortgages. MR. STORER responded that [APFC's] only real mortgage exposure currently is through the publicly traded mortgage-backed security market. He noted that in the 80s, the permanent fund did have a direct mortgage program, perhaps exclusively, through Alaska banks for Alaska mortgages. However, those securities were packaged and sold to the banking industry. Mr. Storer said there are some loans that are made on Alaska property, where the [APFC] has invested. He cited the Frontier Building in Anchorage as an example. He concluded, "So, there are some loans made to real estate assets here in Alaska." Number 0359 CHAIR WEYHRAUCH [moved to adopt] Amendment 1, which read as follows: Page ____, line ____: Insert new bill sections to read: "* Sec.____. AS 37.13.120 is amended by adding a new subsection to read: (q) In addition to investments made under (g) of this section, the board may make loans of fund assets to the Alaska Natural Gas Development Authority for use in developing North Slope natural gas resources and in transporting the natural gas. The amount and terms of each loan made under this subsection shall be established by the board. * Sec.____. AS 41.41 is amended by adding a new section to article 2 to read: Sec. 41.41.205. Loans from permanent fund. The authority may enter into loan agreements with the Alaska Permanent Fund Corporation under AS 37.13.120(q). Money from a loan may be used only to carry out one or more of the purposes listed in AS 41.41.010(a)(1) - (4)." Number 0363 REPRESENTATIVE SEATON objected for discussion purposes. CHAIR WEYHRAUCH explained that the first section of Amendment 1 would allow the [APFC] board to make loans of fund assets to the Alaska Natural Gas Development Authority, while the second section of Amendment 1 would allow the authority to have loan agreements with the [APFC] "only if money so loaned by the fund would meet the fund's fiduciary duties and obligations currently in statute." He indicated that the amendment would provide some "legal comfort" to the authority. He interpreted Mr. Storer's testimony to mean that the [APFC] board has not taken a position for or against [Amendment 1]. He continued: It may be a less ... amount of money that could be available to the fund if it needed those liquid cash assets, but it still would subject any loan application to its own fiduciary needs and its own investment criteria. And I believe that, in making the amendment, what I wanted to do is simply have that pool of funds available to the authority if it can meet the statutory obligations that the fund already has to obtain funds. And that's what's behind the amendment. Number 0558 REPRESENTATIVE LYNN stated that although he understands that the investments in the fund need diversification, he thinks that investing in Alaska is really "investing in ourselves." He said he thinks that "needs to be included in the list of things that [are] possible where the permanent fund can invest in." CHAIR WEYHRAUCH responded that there's no clear prohibition on the ability of the Alaska Natural Gas Development Authority "to already apply for funds." [Amendment 1] simply clarifies in statute that the authority may apply "as a source of funds." He explained that there would be no obligation; [Amendment 1] provides "a legal path to do it." Number 0608 REPRESENTATIVE GRUENBERG asked if Amendment 1 would provide any additional authority to [the APFC's existing authority]. MR. STORER stated his assumption that any loan to the authority would be illiquid and below investment grade. He stated, "We do have that authority now through our 5-percent basket clause. If we were given ... explicit direction by statute, then we would not need to apply the basket clause to that investment." REPRESENTATIVE GRUENBERG directed Mr. Storer's attention to the first part of Amendment 1. He asked Mr. Storer if that would "take this out of the basket clause." MR. STORER answered that's correct. REPRESENTATIVE GRUENBERG noted that [part of AS 37.13.120(g)] read as follows: (g) Subject to the limitations contained in this section, the board may invest fund assets at the competitive national market rates or prices that are applicable to each investment only in REPRESENTATIVE GRUENBERG asked, "Would this make this particular loan an exception to that requirement?" MR. STORER answered that the prudent investor rule would still have to be followed. He noted, "We also have other statutes that say ... invest in Alaska if the rate of return is comparable for that same level of risk found elsewhere." He stated that the [APFC] would use those standards in evaluating any investment. He suggested, "The difficulty in this may or may not be to find a comparable investment opportunity to evaluate it, but we would strive to compare this opportunity against other alternatives in our analysis." CHAIR WEYHRAUCH told Representative Gruenberg that it was not his intent to "force the hand of the fund to invest in the authority," but simply to provide legal clarity. REPRESENTATIVE GRUENBERG indicated that the current limit is 5 percent under the basket clause, but [Amendment 1] would allow a loan to the authority in excess of that. He clarified, "It would be in addition to the 5 percent." MR. STORER said that's correct. REPRESENTATIVE GRUENBERG asked how that would affect the present policies of the board, regarding the amount they loan out. MR. STORER responded that that is a difficult question to answer, because he is not certain what "the nature of the loan would look like." He continued as follows: Unless it fell within our real estate policies in some way, it would probably be a stand-alone policy, which would mean that we would have to develop unique criteria and ... qualities to ... identify the investment. If what I stated was true, and ... it was $50 million to $100 million, my assumption [is that] it would be significantly less liquid than other alternatives, perhaps, but that it would ... have a nominal effect on the return. If it was $50 million in a $28 billion portfolio, it would have, probably, a nominal affect - good or bad - on the return for the fund. Number 0965 REPRESENTATIVE SEATON noted that Mr. Storer had previously stated that "it would be below investment grade." He said he is trying to figure out the basis for that. MR. STORER prefaced his response by stating that it is a little difficult [to explain], without evaluating what the specific loan would be. He said investment grade securities typically are publicly traded securities, but they receive a rating from the nationally recognized rating agencies. He gave some examples. He said the [APFC] buys "investment grade," which must be rated as such from Moody's or Standard & Poor's [bond rating agencies]. He stated his assumption that "one would not seek a rating from Moody's or Standard & Poor's, because you're not taking it out on the market." He noted that there's a cost associated to that rating. He added, "You're simply coming to the permanent fund to make an evaluation on its own merit." CHAIR WEYHRAUCH stated his understanding that "this is not the same kind of a structural investment the fund would make; this would be simply the ... legal ability to analyze a loan agreement from the authority to develop whatever the authority believes it needs to get developed, and look to the fund for a potential source of cash, and not obligate either one to invest in it." Number 1061 REPRESENTATIVE SEATON removed his objection [to Amendment 1]. CHAIR WEYHRAUCH announced that, there being no further objection, Amendment 1 was adopted. Number 1094 REPRESENTATIVE GRUENBERG indicated that he had sent a letter containing questions to Mr. Storer. He asked Mr. Storer if he would supply the answers to those questions in writing to the members of the committee. MR. STORER answered yes. In response to a request from Chair Weyhrauch, he agreed to also supply those answers to the House Finance Committee. Number 1151 REPRESENTATIVE GRUENBERG pointed to the language beginning on [page 1, line 14] of the bill, which read as follows: Notwithstanding (g), (h), and (j) of this section or the percentage investment limitations under (i) of this section and so long as doing so satisfies the prudent-investor rule under (a) of this section, the board may invest up to 15 [FIVE] percent of the total assets of the fund in either or a combination of the following: REPRESENTATIVE GRUENBERG, regarding subsections (h) and (j), asked Mr. Storer to describe the meaning and implication of "that." MR. STORER paraphrased subsection (h), which read as follows: (h) The board may enter into future contracts for the sale of investments purchased under (g) of this section, or for the sale of nondomestic currencies, only for the purpose of hedging an existing equivalent ownership position in these investments or as a means of implementing asset allocation strategies. Number 1249 MR. STORER stated that there are some strategies within the hedge fund investment arena, where "you may enter into futures contracts or forward contracts." He stated, "We believe that ... cleaning it up or acknowledging this is consistent with the original intent of the basket clause." He qualified that that does not mean that the [APFC] would accept considerably more risk. He explained, "In fact, going before the board this week, we're recommending a policy that's very conservative, that will have the targeted risk of a bond portfolio, or less." MR. STORER paraphrased subsection (j), which read as follows: (j) The assets of the fund may not be used for the purchase of debt instruments of a corporation or other entity upon which any regular interest payment has been defaulted within five years before purchase, except debt instruments never in default but which have been outstanding for less than five years. MR. STORER continued as follows: This, actually, is a piece of legislation that you saw a lot in the 70s when the permanent fund statutes were created. My prior employer in the 70s and early 80s - the [Los Angeles] County Employees' Retirement System - had that same criteria. Virtually everyone has gone away from that approach. How ... a corporation uses debt is different than how corporations use the bank (indisc.), because courts are a lot different than they were 25 years ago. But, embedded in both, perhaps, hedge funds, but more likely in a private equity portfolio is a subclass called "buyouts." And buyouts are where you go in and invest in a distressed company, and then you financially engineer the company to earn significant returns in the future. And so, this is a case where that would probably apply, within a private equity discipline. Number 1468 REPRESENTATIVE GRUENBERG asked, "But I don't think you're planning on doing that with the permanent fund, are you?" MR. STORER replied as follows: We are ... about to implement a small private equity portfolio. So, embedded in that policy is the potential for investing in a company that may have not paid debt in the last five years. But it's very possible that there's investment-grade debt, that by virtue of upgrades would meet the fund's criteria, but was in some form of distress and managed to work its way out where we could potentially take advantage of that, as well. And there, you have a bond that would be an investment grade rated by national rating agencies and still not be applicable to our fund. Number 1518 REPRESENTATIVE GRUENBERG directed the committee's attention to page 2, line 3. He mentioned that he and Representative Lynn had conversed regarding the percentage. CHAIR WEYHRAUCH questioned whether 15 percent would be an adequate amount. MR. STORER responded that the [APFC] has held a number of discussions with the Department of Law regarding how much the basket clause can be increased. He said, "While not seeking a legal opinion, we're under the impression they're comfortable with increasing the basket clause to 15 percent, but any more might create a look ... at the constitution, which says designated by law." He said the [APFC's] ultimate goal would be to "look like other public funds" and follow the prudent- investor rule. Number 1584 REPRESENTATIVE LYNN suggested that 10 percent would be more conservative than 15 percent, and he asked Mr. Storer how the 15 percent was chosen. MR. STORER responded as follows: Even with the 15 percent constraint, ... by statute and constitution, that would make us one of the most conservatively public funds in the country. So, I've suggested even increasing the limits of 15 percent would still put limitations on the fund. In the [Senate State Affairs Standing Committee], I was asked a question about 10 percent, and the answer is: If we remove the 15 percent down to 10, that would give the fund the flexibility probably over the next couple years to manage the assets in the direction that we would like to go; but we would be back to ask for an extension beyond that point. Keep in mind there's two reasons for this objective. One is the immediate one, which is ... [that] there are limits in equities in using the basket clause, so if ... the strategies are as successful as we hope, we will be forced to arbitrarily liquidate securities, not because of the markets ... [or] asset allocations, but because of statute. Increasing from 5 [percent] to 10 [percent] would expand that flexibility over the next couple years. The other reason to go to 15 percent, or even more, ultimately, is just to give future administrators the flexibility to address [the] ever-changing dynamic investment world. Number 1700 CHAIR WEYHRAUCH asked how [the legislature] would know whether 15 percent was the appropriate figure, without specifically asking. He asked if the public would be advised through the [APFC's] annual reports. MR. STORER described the [APFC's] process as a rigorous one. The investment process begins with the asset allocation decision. There are investment policies that develop the standard, which are actually tighter than statutes, and ... they are publicly passed by resolutions, after public debate. Next, the strategies are implemented. MR. STORER indicated that the APFC produces an annual report and reports to the legislature its investment returns quarterly. There is a website listing all [the APFC's] policies and its minutes, once they're adopted. He noted that the APFC posts its returns on a monthly basis, not only by asset class, but also by every discipline and every manager. He added, "And so, one could follow as closely as they wanted to." REPRESENTATIVE LYNN suggested examining "that figure" in two years. Number 1792 REPRESENTATIVE SEATON noted that Mr. Storer had said that "you would be having to get out of investments, not by asset allocation, but by statute." He said, "If we're increasing your flexibility to add some to your asset allocations, I'm not quite understanding how that allocation isn't causing you to redistribute your funds." MR. STORER explained: If the board adopts a recommended asset allocation, we will be very close to our statutory constraint, which means that as the assets appreciate, we will have to reduce our exposure - not because of an asset allocation [decision] ... [or] market decision, but simply because, by virtue of success, we will have reached our statutory limitations, which then will force us to rebalance. Number 1871 REPRESENTATIVE SEATON asked if the current fund allocation - which he said he thinks has total equities of "53 percent, plus or minus 5 percent" - includes the 5 percent basket [clause]. MR. STORER responded, "That's the target, and ... our statutory limit is 55 percent on equities, and we are about 58 percent right now, so we are currently using some of the basket clause that's remaining within our target." He continued as follows: I don't know if they provided a bar chart of how we propose to implement the use of the basket clause, but if you have that before you, you'll see that right now we're not using all of the basket clause, and the only degree we are using it, it's in publicly traded equities. Recommending that we start investing ... 1 percent of our assets in a hedge-fund program - that can be a bit controversial. I'll note that ... early in this presentation ... we're actually going to make it very conservative so it has a targeted risk of below the bond market. And we are in the throes of finalizing our private equity policies; at this board meeting we'll start implementing that strategy. That will take a few years to put to work. So, probably by sometime [in] the next year to year and a half, we will have essentially ... used all of the basket clause, with some cushion for appreciation of the assets. MR. STORER, in response to a question from Representative Seaton, clarified that "theoretically, one could have a maximum exposure to 70 percent in the publicly traded equity market"; however, as a practical matter, he said that won't happen. He revealed that no fund that he has ever overseen has ever invested more than 60 percent in the U.S. equity market. Number 1983 REPRESENTATIVE GRUENBERG offered his understanding that the [Senate State Affairs Standing Committee] "passed it out with a 10 percent, rather than a 15 percent." MR. STORER said that's correct. REPRESENTATIVE GRUENBERG offered his understanding that the history of AS 37.13.120 is that over the last 20-25 years, the legislature has slowly eased the restrictions incrementally. MR. STORER concurred. He mentioned the changes that have occurred over time to allow more investment flexibility to the permanent fund. He continued as follows: In ... July of '83, we funded our first equity manager; that was the product of increased investment flexibility prior to that. And so, the ... legislature has given increased flexibility when we've asked for it, and I believe that the permanent fund has always used that flexibility judiciously. I would note that we were given permission four years ago to use the basket clause, and, in fact, we are only just now beginning to use the basket clause. So, when we are given permission, the history of the permanent fund is that you use that privilege or that authority very judiciously and make informed decisions. Number 2056 REPRESENTATIVE GRUENBERG indicated he wanted Mr. Storer to confirm that the history of the fund was that it had been "slowly loosened to provide you with flexibility." MR. STORER answered that's correct. He directed the committee's attention to page 4 of "that initial presentation" that shows how the asset allocation of the permanent fund has changed over time, beginning with the pure bond fund in the late 70s and early 80s. He offered his understanding that in 1980, the fund didn't hold a bond with a maturity greater than 2 years. The asset allocation has been incrementally increased over time in various asset classes. He stated, "The history of the permanent fund is one of caution and conservatism." Number 2127 REPRESENTATIVE LYNN [moved to adopt] Amendment 2, which read as follows: Page 2, line 3 Delete "15" Insert "10" CHAIR WEYHRAUCH objected. REPRESENTATIVE LYNN reiterated his previous comment that it is a conservative fund and he thinks that [changing to 10 percent] follows the history of incremental changes. He stated that he has no problem with [the idea of] revisiting the issue in the future. He concluded, "So, I would recommend also, to go along with the other body, that we change it to 10 percent." Number 2188 REPRESENTATIVE BERKOWITZ said, "We revisit this thing all the time." He explained the reason why is that putting a specific number in statute is inherently not a conservative method of investment, because any specific number is a deviation from the reasonably prudent investor rule; it takes away the flexibility that a reasonably prudent investor would normally exercise. He offered his understanding that the statutes that govern private investments are in Title 13, and he noted that in those statutes there are no numerical restrictions on the amount or type of investment - they just outline the prudent-investor rule. He stated that it's only in Title 37 that false conditions are imposed on the [APFC] that are restrictive in a way that works against reasonably prudent investment. Number 2200 REPRESENTATIVE BERKOWITZ spoke against Amendment 2. He said, "I think the more we can do to expand the basket, the more we allow the fund the flexibility to get closer and closer to what a reasonably prudent investor would truly do, instead of restricting, based on some arbitrary number." Number 2220 RONALD W. LORENSEN, Attorney at Law, Simpson, Tillinghast, Sorensen & Longenbaugh, P.C., opined that Mr. Storer had accurately and succinctly described the issue regarding the basket clause. He suggested that there may be a potential maximum size that the basket clause could not exceed, but [that size] is yet to be determined. He indicated that the Department of Law seemed comfortable with the notion that the 15 percent hasn't "pushed that limit." MR. LORENSEN referred to the aforementioned comments made by Representative Berkowitz regarding the prudent-investor rule. He said, "Certainly it's the way I know the board ... and also ... the investment staff looks at the issue, is that any limitations that are expressed actually operate to reduce flexibility that would otherwise be available under the prudent investor rule, as stated in subsection (a)." Number 2278 REPRESENTATIVE SEATON stated his concern that "we" are the gate keepers of the fund, as well, and, although Mr. Storer is saying that he wouldn't be at 70 percent of equities for any fund he managed, that's what would be allowed "with this." Regarding [Amendment 2], he stated the following: If they haven't used the 3 percent of the basket clause to this point in time, after several years, I think the 5 percent - or a doubling of the basket clause - has been ample opportunity to look at a number of different investment ways and let's us come back to the ways. I mean, we're talking about future markets here, which are ... a little bit outside of what we normally think the permanent fund would normally be investing in and what we historically said we wanted to invest in. And we are talking about $2.7 billion of available money in that 10 percent. Number 2327 REPRESENTATIVE COGHILL noted that it had already been stated that the 15 percent is still a limit on flexibility. He said the [APFC] has shown it has a steady handed management style. He stated, "I think to be fearful that they would step outside - especially since they're still under the auspice of the prudent- investor rule - speaks to giving them the 15 percent." He concluded that he has no problem with the 15 percent. Number 2366 REPRESENTATIVE BERKOWITZ stated that when the legislature puts numbers into statutes affecting the permanent fund, in essence it's substituting its judgment for that of the fund managers, which is a bad step to take. He said he realizes that the statutory restrictions already exist. TAPE 04-31, SIDE B Number 2381 REPRESENTATIVE BERKOWITZ [suggested] stripping out the numbers and going straight to the reasonable prudent-investor rule. He said, "We hire professional managers to manage the fund; we ought to let the professionals do their job." He expressed that one of the government trends he finds problematic is the micro- management of people hired. He reiterated that he would take all the numbers out; however, notwithstanding that, he opined that 15 percent is far preferable to 5 or 10 [percent]. Number 2343 REPRESENTATIVE GRUENBERG said that most Alaskans consider the permanent fund to be theirs and do not want the legislature changing "anything with the fund" unless it's done carefully and conservatively. He indicated that because of the history of conservative management of the fund, not only by the [APFC] but by the elected legislators as well, the public confidence in that management remains high. Representative Gruenberg said that adopting Amendment 1, and thereby allowing the investment in the gas pipeline, will effect significant change in the way the fund is being managed. He emphasized the importance of keeping the public's confidence, which he explained is why he is in support of [Amendment 2]. Number 2234 REPRESENTATIVE BERKOWITZ said the question is, in essence, "Who do you want making your investment decisions: the legislature, or the [APFC]?" He reiterated that he would choose the latter. He posited that including Amendment 1 in this discussion is a "red herring," because the decision whether or not to make investments in the natural gas pipeline will be based on a reasonably prudent investor analysis. He stated that he was sorry he missed discussion regarding Amendment 1, because if the [APFC] is going to make investments, it will do so based on its own analysis of what's in the fund's best interest. He reiterated his opinion regarding leaving the job to the professionals. Number 2180 REPRESENTATIVE SEATON clarified: Our investors didn't tell us 15 percent was where they wanted to go; they wanted to have all limits off. And they say that 15 percent is the maximum that they think they could go, without violating the constitution. ... In a prudent-investor rule, ... there are funds all around that are 100 percent invested in equities, and that can be prudent investing, depending on the type of fund. So, the [prudent-investor rule] doesn't necessarily fix the diversification you have; you can have a very diverse stock portfolio and it is fully managed for stocks and equities. So, the idea that we're fixed at 55 percent or that a prudent investor is only going to be 55- or only going to be 60-percent invested in stocks - that's not the case. Number 2142 REPRESENTATIVE LYNN stated, "One of our principal jobs here is to oversee what is going on in departments and functions that professionals manage." REPRESENTATIVE BERKOWITZ brought attention to AS 13.36.235, which read as follows: Sec. 13.36.235. Diversification. A trustee shall diversify the investments of the trust unless the trustee reasonably determines that, because of special circumstances, the purposes of the trust are better served without diversifying. REPRESENTATIVE BERKOWITZ said the idea that the [APFC] would want to invest 100 percent in equities, real estate, bonds, or any other type of asset, flies in the face of the legal description of what a reasonably prudent investor would do. He listed some of the other components of what a reasonably prudent investor is required to take into account as follows: general economic conditions, expected tax consequences, the role that each investment plays with the overall trust portfolio, expected total return, other resources of the beneficiary, the need for liquidity, and the special relationship or special value to the beneficiary. Representative Berkowitz stated that the prudent- investor rule guards strongly against the notion that the fund's monies could or would be inducted in a single place. He concluded, "To the extent that this committee might have any concerns that we might wind up with 100 percent in equities, I think that that would not be ... the course that a prudent investor would follow. And I think that, again, it's sort of a phantom concern." Number 2025 REPRESENTATIVE GRUENBERG noted that the [prudent-investor rule] for the fund is in subsections (a) through (c) of AS 37.13.120. He said it largely mirrors what Representative Berkowitz just said, but "they have their own mini prudent-investment standard right in this statute." Number 2009 CHAIR WEYHRAUCH reminded the committee that earlier testimony had revealed that 15 percent would still make the fund one of the most conservatively managed in the country. The other reason to go to 15 percent is because it gives more ability [to the APFC] to invest to benefit the fund. He said he hasn't heard any reason for the 10 percent, other than to go incrementally up to the 15 percent. He explained that's why he will vote against [Amendment 2]. Number 1970 A roll call vote was taken. Representatives Seaton, Lynn, and Gruenberg voted in favor of Amendment 2. Representatives Coghill, Berkowitz, and Weyhrauch voted against it. Therefore, Amendment 2 failed by a vote of 3-3. Number 1934 REPRESENTATIVE GRUENBERG moved [to report HB 466, as amended, out of committee with individual recommendations and the accompanying fiscal note.] There being no objection, CSHB 466(STA) was reported out of the House State Affairs Standing Committee.
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