Legislature(2003 - 2004)
03/04/2004 03:30 PM Senate STA
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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
SB 326-PERMANENT FUND INVESTMENTS
CHAIR GARY STEVENS announced SB 326 to be up for consideration
and asked Mr. Storer to identify himself for the record.
ROBERT STORER, executive director, Alaska Permanent Fund
Corporation, introduced himself and advised members that Ron
Lorenson, outside counsel, was on line to answer questions.
To address the discussion about how the corporation would use
the increased investment flexibility, he distributed a chart
outlining how they would use the basket clause over the next
several years. He said:
We are in the late stages of implementing a private
equity program ... and that takes several years to get
it up to the 3 percent target. Then we're also
recommending a pilot program that will be - we call it
alternative investments - that's the sort of
contemporary term - many people call it hedge funds.
Hedge funds have some notoriety in the sense that they
use a lot of leverage and when they don't work they
get a lot of headlines. This proposal that we are
suggesting will not be that kind of hedge fund. We're
suggesting a pilot program to learn with no more than
1 percent. It will expire within 3 years, but I think
the key is that it is not going to be risky. We're
going to have a targeted, expected risk of equal to or
less than the fixed income market - a bond market.
It's not going to be leveraged up to get excess
returns over the equity market. It'll be structured in
a very conservative manner and we hope to learn from
this program, but it will not be designed as a risky
investment.
One of the problems with where we are right now is
that we are close to our statutory limitations. We
hope we have a wonderful problem, which is what
happens if it all works. If it all works, the fund
will increase - these target allocations will
increase, but we're also going to have a problem,
which means statutes not the markets will define when
we must liquidate the assets.
That, Mr. Chair, is why we're asking for increased
flexibility in the basket clause.
CHAIR GARY STEVENS referred to the new chart and asked for
verification that the traditional asset class [gray bar] is not
part of the basket clause.
MR. STORER said, the blue bar represents the unused portion in
the '03 bar chart. He then pointed out that as the 5 percent is
implemented there would be a 1 percent target to hedge funds and
1.5 to 2 percent in private equities. Moving out to '05, there
will be 3 percent private equity investment and over that time,
the basket clause will essentially be used up on a cost basis so
with appreciation there will be problems.
SENATOR BERT STEDMAN asked Mr. Storer to go over the effects of
the leverage when it moves from 5 to 15 percent.
MR. STORER said he would answer the question at the extreme, but
because they are driven by diversification, the probability of
placing all the eggs in one basket is extremely unlikely. He
continued to say that if they increased risk for dramatically
higher returns they could only use the full 15 percent. He said
he wasn't prepared to suggest they do that, but even that is low
versus some real estate portfolios that are leveraged to 50
percent. "That would probably be the most volatile scenario that
I could think of in terms of using all the investment."
SENATOR STEDMAN used the example of putting $100 down to control
$1,000 of some entity and said, "I assume then that you're
looking at the weighting effect of the $1,000; you're not
counting the $100."
MR. STORER replied that is correct. In that example, they would
use the basket clause and count the leverage and not just the
$100 investment.
SENATOR STEDMAN asked if there is a diversification gain by
targeting a return that would be about equal to the bond market
return.
MR. STORER said that's true, but you can gain diversification in
far more ways than just more equities or more return. The
corporation is working to develop a conservative instrument such
as the targeted risk of a bond market or less as opposed to the
more volatile equity market.
At present the corporation is looking for alternatives to fixed
income, not increasing their equity exposure so the 1 percent
target would reduce the fixed income exposure. They expect to
get some additional incremental return greater than the fixed
income market.
SENATOR STEDMAN asked Mr. Storer to explain the effect that
interest rates have on their bond portfolio.
MR. STORER explained:
The major component of a fixed income security is the
yield of the security and when you buy it, you will
buy that security to yield X. That's a snapshot in
time, but during that whole period you will earn that
yield. Let's just say that the environment is 5
percent so that means that if you earn that security
for life, you get a 5 percent yield. But every time
interest rates change, the price of that security
changes to reflect the changing interest rate
environment. So what will happen in a rising interest
rate environment is we will continue to get that 5
percent yield, but that security that we paid $100 for
will become worth $99 become worth $98 so that
diminishes the value of the investment. Of those two
components, historically the yield has been the
largest contributor of return, but in a lower interest
rate environment you get greater profits from the
principal and in a rising interest rate environment
you will end up losing some principal.
SENATOR STEDMAN opined that the concept is important because
"the impression I'm getting is that you want to broaden out this
asset class and you want to target that bond - roughly the
return you would get in a normal bond environment - and there
probably will not be a normal bond environment coming at you -
and you want to have some diversification for that area to
hopefully give you an incremental, if not a positive rate of
return, at least pushing in that direction."
MR. STORER agreed with the assessment. If interest rates stay
stable or rise they would expect the 1 percent allocation to
have a higher return plus some diversification from a volatility
factor, but part of our goal is to have a higher return than the
bond option.
SENATOR STEDMAN noted that historically returns are yield rate
averaged over the years. He then brought up a previous
discussion regarding reducing the request from 15 percent to 10
percent. If that change were made, he questioned how long it
might be before the corporation would return to the Legislature
and ask for a review of the basket clause limit.
MR. STORER said it would depend on need and the financial
markets, but he estimated that they would be back within two
years.
SENATOR COWDERY asked about the reason for the request.
MR. STORER replied there are two basic reasons for the request.
The immediate one is to address that there are arbitrary
constraints on the successful management of the fund. The
corporation could be forced to liquidate assets because of
statutory constraints rather than due to market conditions. The
other more long-range reason is to create flexibility to meet
the ever-changing financial markets.
CHAIR GARY STEVENS asked Mr. Lorenson whether he had anything to
add.
MR. LORENSON told him that he was listening and available to
answer questions from a legal standpoint.
SENATOR STEDMAN offered an amendment to change the request from
15 percent to 10 percent [page 2, line 3].
CHAIR GARY STEVENS asked if there was any objection to the
amendment and there was none.
He asked for a motion to pass the bill from committee.
SENATOR COWDERY made a motion to move CSSB 326(STA) from
committee with individual recommendations and the attached
fiscal note. There being no objection, it was so ordered.
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