Legislature(1995 - 1996)

03/19/1996 10:00 AM Senate FIN

Audio Topic
* first hearing in first committee of referral
+ 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                 
  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                 
  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                 
  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                 
  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                 
  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.                                            
  The meeting was adjourned at approximately 11:10 a.m.                        

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