Legislature(1995 - 1996)
03/19/1996 10:00 AM Senate FIN
* first hearing in first committee of referral
= bill was previously heard/scheduled
= 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.