Legislature(2023 - 2024)ANCH LIO DENALI Rm
06/24/2024 09:00 AM House LEGISLATIVE BUDGET & AUDIT
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| Audio | Topic |
|---|---|
| Start | |
| Approval of Minutes | |
| Alaska Permanent Fund Corporation Update | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
ALASKA STATE LEGISLATURE
LEGISLATIVE BUDGET AND AUDIT COMMITTEE
Anchorage, Alaska
June 24, 2024
9:13 a.m.
MEMBERS PRESENT
Representative Ben Carpenter, Chair
Representative DeLena Johnson (via teleconference)
Representative Sarah Vance (via teleconference)
Representative Frank Tomaszewski (via teleconference)
Representative Andy Josephson
Senator James Kaufman
Senator Scott Kawasaki (via teleconference)
MEMBERS ABSENT
Senator Bert Stedman, Vice Chair
Senator Bill Wielechowski
Senator Lyman Hoffman
Representative Mike Cronk (alternate)
Senator Click Bishop (alternate)
COMMITTEE CALENDARh
APPROVAL OF MINUTES
ALASKA PERMANENT FUND CORPORATION UPDATE
PREVIOUS COMMITTEE ACTION
No previous action to record
WITNESS REGISTER
DEVON MITCHELL, Executive Director
Alaska Permanent Fund Corporation
Juneau, Alaska
POSITION STATEMENT: Co-presented a PowerPoint presentation on
APFC.
MARCUS FRAMPTON, Chief Investment Officer
Alaska Permeant Fund Corporation
Juneau, Alaska
POSITION STATEMENT: Co-presented a PowerPoint presentation on
APFC.
SEBASTIAN VADAKUMCHERRY, Chief Risk & Compliance Officer
Alaska Permanent Fund Corporation
Juneau, Alaska
POSITION STATEMENT: Co-presented a PowerPoint presentation on
APFC.
ACTION NARRATIVE
9:13:51 AM
CHAIR BEN CARPENTER called the Legislative Budget and Audit
Committee meeting to order at 9:13 a.m. Representatives D.
Johnson (via teleconference), Tomaszewski (via teleconference),
Josephson, and Carpenter, and Senators Kaufman and Kawasaki (via
teleconference) were present at the call to order.
Representative Vance (via teleconference) arrived as the meeting
was in progress. Also present were Senators Kiehl (via
teleconference) and Wilson (via teleconference), and
Representative Edgmon (via teleconference).
^APPROVAL OF MINUTES
APPROVAL OF MINUTES
9:14:57 AM
CHAIR CARPENTER announced that the first order of business would
be the approval of minutes.
9:15:06 AM
SENATOR KAUFMAN moved that the Legislative Budget and Audit
Committee approve the minutes for the May 9, 2024, meeting, as
presented. There being no objection, the minutes were approved.
^ALASKA PERMANENT FUND CORPORATION UPDATE
ALASKA PERMANENT FUND CORPORATION UPDATE
9:15:30 AM
CHAIR CARPENTER announced that the next order of business would
be a presentation by Devon Mitchell from the Alaska Permanent
Fund Corporation (APFC).
9:15:47 AM
DEVON MITCHELL, Executive Director, Alaska Permanent Fund
Corporation (APFC), said he wanted to have an opportunity to
address any outstanding issues with the committee and give an
overview of how he perceives APFC, as well as the investment of
the Alaska Permanent Fund.
9:16:57 AM
The committee took a brief at-ease.
9:17:20 AM
MR. MITCHELL directed attention to a PowerPoint presentation on
APFC [hard copy included in the committee packet]. He began on
slide 2 and briefly described the history of Alaska Permanent
Fund ("the Fund"), which was created almost 50 years ago through
a constitutional amendment that dedicated certain royalty
revenues for the benefit of future generations. He continued to
slide 3, "Accountability," and explained that APFC aims to be
accountable to the people through their elected officials and
the oversight of the Legislative Budget & Audit Committee.
APFC's management system aims to protect the Fund from undue
political influence, instead opting to maximize the risk-
adjusted rate of return for the Alaska Permanent Fund's
investment.
CHAIR CARPENTER pointed out that AS 37.13.160 references an
annual post audit and annual operational and performance
evaluation of the Fund's investments and investment programs,
specifically in the purview of the Legislative Budget and Audit
Committee. He stated that the committee needs to assess whether
the audits are needed or not.
MR. MITCHELL explained that the corporation is audited by an
external auditor every year, which is reviewed by the
Legislative Audit Division as part of the state's audit process.
9:21:27 AM
MR. MITCHELL resumed the presentation on slide 4, "Governance,"
noting that certain investment strategies and private market
investments aren't subject to disclosure to the general public
due to the proprietary nature of the investment opportunities.
He said APFC tries to be as transparent as possible; however,
participating with investors in the private market who demand
confidentiality is the cost of doing business. He said APFC
migrated into this space because it's hard to ignore the private
market return potential. He emphasized the importance of
balancing maximum return with the goal of transparency.
9:23:20 AM
MR. MITCHELL continued to slide 5, "Investing for the Long
Term," and reported that the target of the Fund is inflation
plus 5 percent. He said currently, the Fund hits that target on
a 10-year lookback but not a 5-year lookback. In other words,
the consumer price index (CPI) plus 5 percent has been greater
than the returns of the Fund over the last 5 years, but not over
the last 10-year average.
9:25:19 AM
MR. MITCHELL turned to slide 6, "Diversification," which
featured the progression of the portfolio through the years. In
1980, the Alaska Permanent Fund was invested entirely in fixed
income securities. 1990 saw the beginning of diversification
with real estate and public equities, followed by the addition
of private equity and absolute return in 2006. The 2025 target
allocation adds private income and tactical ops to create a
diverse pie of asset classes designed to minimize the impact of
market volatility while maximizing return. He added that the
goal is to shift those pieces of the pie around based on capital
market assumptions that the external advisor provides to target
the maximum risk-adjusted rate of return. He said it's
interesting that Alaska took a non-renewable resource from the
North Slope and made it into a renewable resource that's funded
through the world's economy. As a result, he argued that there
isn't a state with as diverse of a revenue stream.
9:29:00 AM
MR. MITCHELL proceeded to slide 7, "10 Year Annualized Returns,"
which shows 10-year lookbacks of the CPI plus 5 percent return
objective and the difficulty of meeting that target. He
highlighted a period of 11 years [2008-2018] where the return
objective was not met.
9:31:04 AM
MR. MITCHELL turned to slide 9, "Revenue Stability," which
featured two charts. The chart on the left showed the
historical volatility of revenues driven by commodity and oil
prices. The bar chart on the right showed the stability created
by the percent of market value (POMV) transfer. He highlighted
the POMV formula and reported that in FY 25, the draw would be
$3,657.2.
9:32:42 AM
CHAIR CARPENTER asked, to the extent that asset diversification
includes larger amounts of private equity, whether there is a
risk of not being able to meet the reliable revenue sources in
the future.
MR. MITCHELL said yes, that continues to be a concern. He
explained that certain income is classified as unrealized gains
and gave the example of a commercial building that was bought
for $1 million and is now worth $5 million after 10 years,
resulting in $4 million in unrealized gains. Today, the Alaska
Permanent Fund has around $14 billion in unrealized gains, which
was gradually earned. However, those investments have not been
sold, so they are not available to spend. At the same time,
recent years have seen relatively austere realized income. As a
result, in FY 23, the combination of inflation proofing and POMV
transfer was $5 billion more than the realized statutory net
income (SNI). He suspected that FY 24 would be smaller, but
similar.
9:38:16 AM
MR. MITCHELL resumed the presentation on slide 10, "Producing
Income," and highlighted the chart on the right, which showed
the past 6 years of SNI. FY 24 is shaping up to be a median of
the 6 years at $3.7 billion. The chart on the left showed the
progression of the Fund with realized earnings and total return.
He noted that APFC's portfolio is structured towards total
return. He reiterated that realized return and total return can
vary significantly from year to year, which challenges one of
the Fund's great strengths, the stability factor.
9:40:36 AM
CHAIR CARPENTER asked whether APFC is experiencing a downward
trend in realized return from its inception.
MR. MITCHELL acknowledged that there appears to be a downward
trend. He explained that markets have become more sophisticated
over time, so what might have been possible in the past, might
not be possible today. There are also fixed income trends that
have more recently created additional challenges for portfolio
construction. He resumed the presentation on slide 11, which
showed the composition of the Fund. He reported that as of May
31, the Fund's total value is $80.2 billion with the non-
spendable Principal portion amounting to $56.9 billion. He
noted that the unrealized gains are allocated between the
Principal and the Earnings Reserve Account (ERA). The FY 25
POMV transfer is $3.7 billion; the current FY 24 inflation
proofing is $1.4 billion, which is transferred at the end of the
fiscal year on June 30; and the uncommitted, realized earnings
that are available for appropriation is $3.9 billion.
CHAIR CARPENTER sought questions from committee members.
9:45:27 AM
REPRESENTATIVE JOSEPHSON said the press had reported that the
Fund ran a substantial risk of not being able to complete the 5
percent draw. He asked whether the simple answer is to draw
less than 5 percent rather than a statutory reform. In
addition, he questioned whether APFC had ever formally
recommended drawing less than 5 percent.
MR. MITCHELL said he was not at APFC when the transition to a
POMV draw occurred. He added that at this time, there is no
recommendation by the Board of Trustees to adjust the rate.
9:48:25 AM
SENATOR KAUFMAN pondered a sustainable percentage for the draw
and asked whether APFC runs projections that show inflation
adjusted draws over time.
MR. MITCHELL answered yes, APFC has publicly available
projections on their website that are adjusted monthly, and
projections based on Callan's assumptions, which he likened to
oil price projections. In addition, modeling on the ERA's
durability had been performed in various scenarios, each with a
probability of breaking the ERA due to a lack of realized
earnings over the next 10 years. He noted that the Board of
Trustees has advocated for a constitutional amendment that would
resolve a number of issues by creating one fund with a defined
draw. This would eliminate the concern about one generation of
Alaskans taking more than their "fair share" and the concern
that there wouldn't be enough to spend.
9:53:24 AM
SENATOR KAUFMAN commented on risk management and opined that the
Fund's current structure impedes the ability to manage for total
return. He shared his belief that cash flow constraints would
go away if the Fund was conjoined with a constitutional
amendment. If the constitutional constraints of having the ERA
and the corpus were removed, he asked whether the cash would
flow appropriately with the current asset allocation.
MR. MITCHELL acknowledged that there are no statutory directives
to provide for liquidity. As asset classes increase in value,
he explained that bands around the target allocations trigger
divestment in that asset class to maintain a balance and bring
in realized gains. He added that private market exposure leads
to less ability to rebalance due to illiquidity. An asset class
might fit in well with the portfolio construction to meet a
maximum adjusted rate of return without providing consistent
cash flow.
9:58:29 AM
CHAIR CARPENTER inquired about asset allocation and its impact
on unrealized gains. He referenced AS 37.13.020, which states
that the Alaska Permanent Fund should be used as a savings
device managed to allow for the maximum use of disposable income
from the fund for purposes designated by law. He questioned
whether disposable income and uncommitted, realized earnings fit
within the same category, and asked where disposable income
would come from if it was not uncommitted, realized earnings.
MR. MITCHELL said the interpretation adopted by the Board of
Trustees is to maximize the risk-adjusted rate of return, which
ultimately provides for disposition, but not necessarily on a
year-by-year basis. He highlighted a difference in the
interpretation of AS 37.13.030, in that APFC perceives it as a
directive to maximize return and is agnostic on whether its
liquid or illiquid.
CHAIR CARPENTER asked what portion of the unrealized gains would
be liquidated to meet the statutory requirement in a single
account structure if there was not enough money for a 5 percent
draw.
10:04:21 AM
MR. MITCHELL said in a one fund construct, that conversation
would be "water under the bridge" and not as germane, because a
constitutionalized draw based on a certain formula would
supersede the significance of how the money got there and how
its categorized.
CHAIR CARPENTER contended that the conversation is germane
because decisions on asset classification appear to be more
focused on growing the total value of the Fund than realized
earnings. Without the ERA, he posited that the 5 percent draw
would be pulled from the corpus to meet the statutory
requirement, and questioned whether that money would come from
royalties or money that the legislature had set aside. He asked
whether a performance audit is necessary to assess whether
actions taken by the Board of Trustees are meeting the
legislature's intended purpose of the fund.
MR. MITCHELL said with the existing construct today, there could
be a draw if there was an insufficient amount of realized income
in the ERA because the money would come from either unrealized
gains or the Principal.
CHAIR CARPENTER added, "Hence the need for an ERA if the people
want to protect their fund." Without an ERA, the balance of the
Fund would be the only place to pull from.
MR. MITCHELL said shifting the Fund's structure to one account
would instantly add $14 billion of available earnings for
expenditure to a theoretical ERA balance. With one fund, if
there was a need to start drawing from what was historically
classified as the Principal, he asked how that would compare to
where the Fund is currently and whether some sort of buffer
would be needed in the constitutional construct.
10:09:46 AM
SENATOR KAUFMAN opined that the legislature should consider
avoiding overlapping protective layers. If the Principal and
the ERA were conjoined and managed for total return while
providing for the draw, there would be a safe shot at achieving
that cash flow through interest rather than growth expectations,
he said. He suggested that the Fund's current structure could
be tweaked for revenue to avoid the sequence of return risk that
causes an asset to be sold before its ready. Furthermore, he
shared his belief that restructuring the Fund while protecting
its value and providing for the anticipated draw would be
doable.
CHAIR CARPENTER reiterated that per statute, the Fund's goal
should be to maintain safety of the Principal while maximizing
total return. Further, the fund should be used as a savings
device to allow the maximum use of disposable income. He
questioned whether the Fund is being managed appropriately if
what's being presented are uncommitted, unrealized earnings that
aren't enough to meet the statutory 5 percent draw. He asked
how a single account structure would change that.
MR. MITCHELL said it's a matter of how one thinks about earnings
versus Principal. He shared his belief that additional thought
could be put towards ensuring that the suggested path is viable
and in alignment with historic goals.
10:14:09 AM
MR. MITCHELL resumed the presentation on slide 12, "The
Permanent Fund's Two Accounts," which charted the composition of
the Principal and the ERA. He explained that the coming year's
POMV transfer, as well as the current year's inflation proofing,
has been reserved and identified on July 1 to ensure to the
legislature that its available. He noted that $3.8 billion had
been segregated for the FY 26 POMV, and for the first time, the
$3.9 billion in realized earnings is insufficient to cover the
draw plus FY 25 inflation proofing. Consequently, that future
appropriation would rely on FY 25 earnings to make those
transfers.
10:17:46 AM
REPRESENTATIVE JOSEPHSON asked whether the need for additional
realized earnings would come organically or whether investors
would pivot to account for a 5 percent need.
MR. MITCHELL acknowledged that the statutory framework for
providing for disposable income could be explored.
Theoretically, the investments in unrealized gains can be sold
and bought back to realize those earnings; however, it would be
a one-time opportunity and there would be a cost. Furthermore,
the majority of unrealized gains are in the private market where
there's not the same ability to churn portfolio. In addition,
large commercial real estate holdings take at least one or two
years to divest, and there are time restrictions on divesting
from hedge fund portfolios. At this point, APFC operates as if
it would not churn portfolios solely for the POMV draw unless
there were a statutory mandate. Otherwise, there would be an
inability to provide for the transfer. Nonetheless, he
cautioned against being "alarmist," as there are many
opportunities to make adjustments to eliminate this perceived
cliff.
CHAIR CARPENTER said he's fully aware that this is not a black
and white issue. He questioned the long-term plan for the Fund,
and asked whether the goal is to grow the Fund to some arbitrary
number for a purpose that's not well defined in statute, or
whether the purpose is what's stated in statute.
10:22:49 AM
MR. MITCHELL said a target has not been identified by the Board
of Trustees. Nonetheless, he said there have been discussions
about celebrating when the fund hits $100 billion. He continued
the presentation on slide 13, "What Portion of the Fund is
Available for Appropriation?" He reiterated that within the
ERA, $3.9 billion of uncommitted, realized earnings are
available for future use. These earnings can be appropriated to
support the FY 26 POMV draw and the FY 25 inflation proofing.
If the amount is insufficient to provide for the POMV draw as
well as inflation proofing, APFC would come to the legislature
and suggest that appropriations be modified to accommodate the
deficiency. He shared his belief that the POMV draw would be
funded before inflation proofing. He turned to slide 14,
"Looking Ahead Projection Beginning of Fiscal Year 2025,"
which listed the projected amounts in the Principal and ERA. He
reiterated that with a $3.8 billion POMV draw to the General
Fund (GF) in FY 26, only $400 million would be available to
provide for the $1 billion appropriated for FY 25 inflation
proofing, resulting in a shortfall of $600 million. Mr.
Mitchell briefly highlighted the last bullet point on slide 15,
"Revenue Stability," reiterating that with a total return
portfolio, the focus is not on an asset allocation that was
envisioned when the statutory framework was constructed. He
addressed the Trustees' Paper Volume 10 on slide 16, which
outlined various reforms to mitigate the risk of depleting the
ERA, including suspending inflation proofing; realizing gains in
public markets to ensure that there is sufficient SNI to provide
for transfers; and collapsing the two funds into one, which has
been the perspective of the board for more than 20 years.
10:29:24 AM
REPRESENTATIVE JOSEPHSON asked Mr. Mitchell to share his
analysis of what would be missing without a constitutional
endowment versus the statutory approach.
MR. MITCHELL answered, "Durability." He stated that statutory
changes are laudable as well, and encouraged the legislature to
consider those; however, the risks of overdrawing and inflation
proofing remain on the table.
10:31:19 AM
MARCUS FRAMPTON, Chief Investment Officer, Alaska Permeant Fund
Corporation (APFC), returned to slide 10 and commented on the
slight downward trend of realized earnings, which he attributed
several different factors, including yield on the portfolio, as
well as volatility as the fund moves away from fixed income.
10:35:21 AM
MR. FRAMPTON jumped to slide 19, "Target Asset Allocation - FY
2025 Vs. FY 2024." He acknowledged the low ability to predict
where the asset classes will go in the next year, but an
estimate over the next 10-year horizon is necessary to build a
portfolio that is expected to earn the target of inflation (CPI)
plus 5 percent. He reviewed the changes in each asset class
from FY 24 to FY 25, indicating that all changes combined result
in approximately .001 of a percent higher on expected return.
10:38:35 AM
SEBASTIAN VADAKUMCHERRY, Chief Risk & Compliance Officer, Alaska
Permanent Fund Corporation (APFC), turned to slide 20, "Risk
Metrics," and explained that the board has instilled a target
risk, or the maximum level of risk that can be taken to achieve
the target return. Risk numbers were computed for the FY 25
target asset allocation as per the board approved risk appetite
policy. On all three dimensions Value at Risk (VaR), stress
drawdown levels, and liquidity the proposed 2025 allocations
were within the risk tolerance portfolio.
CHAIR CARPENTER asked whether a risk analysis for each asset
class could be provided to the committee.
MR. VADAKUMCHERRY offered to follow up with the requested
information.
10:41:35 AM
MR. FRAMPTON continued to slide 21, "Long-term Investment
Performance Exceeds Relevant Benchmarks." He explained that
fiscal year to date, it's been a difficult year with the total
Fund performing at 5.4 percent versus the 6.3 percent
performance benchmark. He noted that private market performance
is best scrutinized over a long-term lens, and while the Fund is
underperforming by 2 or 3 percent against the benchmark this
fiscal year, the Fund's 10-year private equity performance is
one of the best among large state funds. The real return
objective, or CPI plus 5, is underperforming on all three
analyses (fiscal year to date, 3-year lookback, and 5-year
lookback); however, most institutional portfolios have
underperformed on that marker given the level of inflation in
the country.
10:48:50 AM
MR. MITCHELL concluded the presentation on slide 22, "Consistent
Discipline," which highlighted the following three components:
honoring the past, stewardship, and providing stability. He
emphasized the corporation's desire to adhere its conduct and
performance to the highest standards and provide that value to
the state of Alaska.
CHAIR CARPENTER referred to a recent issue with the Board of
Trustees, which lead to an open investigation within the
corporation. He asked why the release of information as a
matter of public record is being investigated.
MR. MITCHELL said the concern is that the information wasn't
released through the proper channels. He explained that emails
were provided to someone outside the corporation in an
inappropriate fashion. He reported that APFC spends 98 percent
of its budget on protection from the outside in, as opposed to
inside out, which makes this event unprecedented. Consequently,
ensuring that confidential information stays within the
organization has been one aspect of APFC's discussions.
10:53:37 AM
CHAIR CARPENTER suggested that the public sharing of information
by employees may be evidence of conflict. With regard to
legislative oversight, he asked whether there is evidence that a
performance audit should be conducted to assure Alaskans that
this conflict isn't negatively impacting the ability to manage
the Fund. He asked whether there has been an increase in
internal conflict that has led to delayed responses or
negatively impacted the corporation's ability to follow
statutory requirements.
MR. MITCHELL shared his belief that the staff's professionalism
and dedication to duty has not been impacted. In his role, he
said he encouraged staff to focus on their job despite "outside
noise" and to continue doing the best they can for the state of
Alaska.
10:58:29 AM
REPRESENTATIVE JOSEPHSON said Mr. Mitchell has his trust and
faith, but he would not refer to this situation as "noise" due
to an accumulation of issues, like the dispute over the
Anchorage office and the email leak which lead to questions
about investment decisions outside the norm and the decision to
invest money in state. He said what he wants most is "the
typical historic story about the permanent fund doing its work,
hopefully building towards that $100 billion" even if those
stories are mundane. He acknowledged the need to protect
internal communications; however, these are important things
that the public needs to hear about because there is legitimate
concern.
MR. MITCHELL agreed that it would be nice to be boring. He said
APFC staff strives towards putting their heads down and doing
their job.
11:01:35 AM
REPRESENTATIVE D. JOHNSON shared her understanding that the
Board of Trustee's intent is to maintain the Anchorage office
and disregard the legislature's intent not to fund the Anchorage
office.
MR. MITCHELL confirmed that the board had determined that the
Anchorage office is an important component of the operation. He
shared his understanding that despite the appropriation
language, there is flexibility to continue to fund that office.
REPRESENTATIVE D. JOHNSON clarified that the legislature does
not want offices established anywhere without legislative
approval. She asked whether there is any intent to establish
offices elsewhere in the continental U.S.
MR. MITCHELL answered not at this time. He acknowledged that
there have been discussions about offices in other locations
closer to financial centers; however, he said APFC would need to
ensure that a physical office would bring added value.
REPRESENTATIVE D. JOHNSON emphasized that the only time to have
that conversation is in front of the House or Senate Finance
Committee during the budget process. She encouraged APFC to
maintain a strong relationship with the legislature.
11:06:14 AM
CHAIR CARPENTER said with regard to the emails, he agreed with
Representative [Josephson] that the series of events paints a
different picture. He said he looked forward to seeing what the
governor does with the budget and how that impacts the Anchorage
office. He reiterated that the Legislative Budget and Audit
Committee has a responsibility to Alaskans to provide oversight
for the corporation and thanked Mr. Mitchell for his willingness
to have a conversation in that light.
11:07:26 AM
ADJOURNMENT
There being no further business before the committee, the
Legislative Budget and Audit Committee meeting was adjourned at
11:07 a.m.
| Document Name | Date/Time | Subjects |
|---|---|---|
| 202406_LBA Committee.pdf |
JBUD 6/24/2024 9:00:00 AM |
APFC Presentation |