Legislature(2001 - 2002)
02/12/2002 01:41 PM House FIN
| Audio | Topic |
|---|
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
HOUSE FINANCE COMMITTEE
February 12, 2002
1:41 PM
TAPE HFC 02 - 23, Side A
TAPE HFC 02 - 23, Side B
TAPE HFC 02 - 24, Side A
CALL TO ORDER
Co-Chair Mulder called the House Finance Committee meeting
to order at 1:41 PM.
MEMBERS PRESENT
Representative Eldon Mulder, Co-Chair
Representative Bill Williams, Co-Chair
Representative Con Bunde, Vice-Chair
Representative Eric Croft
Representative Richard Foster
Representative John Harris
Representative Bill Hudson
Representative Ken Lancaster
Representative Carl Moses
Representative Jim Whitaker
MEMBERS ABSENT
Representative John Davies
ALSO PRESENT
Jim Sampson, Chair, Board of Trustees, Alaska Permanent Fund
Corporation; Robert D. Storer, Executive Director, Alaska
Permanent Fund Corporation; Allan Moore, Chief Investment
Officer, Alaska Permanent Fund Corporation; Chris Phillips,
Director of Finance, Alaska Permanent Fund Corporation;
Michael O'Leary, Executive Vice-President, Callan
Associates; Robert Maynard, Chief Investment Officer, State
of Idaho Retirement System.
PRESENT VIA TELECONFERENCE
There were no teleconference participants.
GENERAL SUBJECT(S):
Alaska Permanent Fund Corporation
Capital Markets Outlook 2002
The following overview was taken in log note format. Tapes
and handouts will be on file with the House Finance
Committee through the 22nd Legislative Session, contact 465-
2156. After the 22nd Legislative Session they will be
available through the Legislative Library at 465-3808.
LOG SPEAKER DISCUSSION
TAPE HFC 02 - 23 ALASKA PERMANENT FUND CORPORATION
SIDE A CAPITAL MARKETS OUTLOOK 2002
039 JIM SAMPSON, CHAIR, Introduced board members and others.
BOARD OF TRUSTEES,
ALASKA PERMANENT
FUND CORPORATION
301 ROBERT D. STORER, Introduced staff.
EXECUTIVE DIRECTOR,
ALASKA PERMANENT
FUND CORPORATION
339 ALLAN MOORE, Discussed the capital market outlook. He
DIRECTOR OF FINANCE, noted that the Board annually sets an
ALASKA PERMANENT asset allocation policy. The
FUND CORPORATION Corporation's job is to monitor
investments in respect to the policy. If
the markets move beyond the ranges around
their targets they will recommend to the
Board that the portfolio be rebalanced.
519 Mr. Moore Noted that their investments are on
target. As of the end of January 2002,
34.4 percent of the Fund was in domestic
fix income (target 35%) and non-US fixed
income was at 2.5 percent or $600 million
(the target is 2%). He noted that at the
end of January 2002 there was $9.2
billion dollars in domestic stocks or
36.6 percent (target 37 percent).
601 Mr. Moore Explained that corporate bonds are
domestic fix income.
615 Mr. Storer Explained that the portfolio is only in
investment grade bonds. They do not hold
high yield or junk bonds.
628 Mr. Moore Observed that domestic stock is handled
internally. Equity managers are external
professionals that are hired under
contract.
645 Mr. Moore Observed that at the end of January there
was just under $4 billion dollars in non-
US equities or 15.8 percent (the target
is 16 percent). There is a 10 percent
real estate allocation. The actual market
value at the end of January was 10.8
percent or $2.7 billion dollars.
718 Mr. Moore Noted that the markets have been
violently fluctuating. He pointed out
that the numbers are close to their
targets even after the turmoil. They had
an opportunity, as reported in the
quarterly report, to rebalance the Fund.
Stocks had fallen far enough and bonds
had performed well enough that they were
further away from the target than is
prudent. Under less turbulent times the
dividend payout in the fall is so large
that they use that occasion to rebalance.
Selling assets that are not performing
well pays dividends. The gyrations of the
market were such that it needed an
additional rebalancing. The markets have
since behaved close to the targets.
909 Co-Chair Mulder Ask if the goal percentage changed from
the prior year?
920 Mr. Moore Responded that they did not change from
the previous year. Projects generally
change slowly in order to not be
influenced by what is happening in the
short term.
1009 Representative Croft Observed that real estate investments
performed higher than the target.
1112 Mr. Moore Acknowledged that real estate remained
relatively stable and explained that
their real estate allocation includes a
sub allocation to the state investment
trust securities, which performed well in
comparison to other stocks.
1139 Chris Phillips, Provided members with a handout:
Director of Finance, Financial Outlook for the Fund Growth and
Alaska Permanent Income (copy on file). She explained that
Fund Corporation the statistics in the handout were based
on December 31, 2001 numbers.
1224 Ms. Phillips Observed that the total Fund is $24.8
billion dollars: containing principal and
earnings reserve income. They are
invested as one asset pool.
1239 Ms. Phillips Observed that, at the end of December,
there was $21.2 billion dollars in
principal. In December 31, 2000, there
was $20.2 billion dollars in principal.
There has been an increase in principal
of $1 billion dollars. She explained that
$700 million dollars of this was the
result of legislative inflation proofing.
This amount was transferred from the
Earnings Reserve Account to the
principal. The rest of the increase came
from additional mineral revenue.
1299 Ms. Phillips Noted that the Earning Reserve Account
moved from $6 billion dollars [FY00] to
$3.6 billion dollars [FY01]. She
explained that the loss was the result of
inflation proofing, dividends and a $600
million dollar loss in the market.
1402 Vice-Chair Bunde Observed that there was a $3 billion
dollars loss over the past year. The
largest general fund appropriation made
by the state is for the permanent fund
dividend.
1500 Ms. Phillips Clarified that the permanent fund
dividend payout was 1.1 billion dollars.
1509 Ms. Phillips Discussed page 3 of the handout. She
observed that $7.2 billion dollars of the
principal has come from dedicated oil
revenues, $6.9 has come through
legislative inflation proofing and $7.1
from special appropriations by the
legislature. She concluded that 66
percent of the Fund has come from
legislative appropriations.
1604 Ms. Phillips Explained that the Earnings Reserve
Account is divided between realized and
unrealized income. This represents
undistributed accumulated income. She
discussed unrealized income. When an
asset is sold a realized gain or loss is
recorded on the sale. All income ends up
in the Earnings Reserve Account.
1653 Co-Chair Mulder Pointed out that on July 1, 2001 there
was $1.9 billion in realized income and
$200 thousand dollars in unrealized
gains. There has been a gain in the 6-
month time frame.
1830 Co-Chair Mulder Observed that there will be another $700
million dollar transfer for inflation
proofing and close to an $1 billion
dollar payout for dividends. He noted
that funds from the Earnings Reserve
Account pays inflation proofing and
dividends.
1904 Representative Observed that the Earnings Reserve
Whitaker Account is the shock absorber for the
entire fund.
1926 Co-Chair Williams Noted that the legislature has taken this
funding and placed it into the corpus of
the fund. The legislature has added $6.9
for inflation proofing and $7.1 from
special appropriations.
1951 Ms. Phillips Reviewed projects for the next 5 fiscal
years. She observed that if the Fund
continues in its current form that there
is a 50 percent probability that the it
would be $27.7 - $36.6 billion dollars
[after five years]. The median is $31.9
billion dollars for the entire fund in
FY07.
2206 Co-Chair Mulder Observed that the December 2001 OMB
budget forecast was derived from the
median case.
2226 Ms. Phillips Clarified that actual December 31, 2001
values were used in their handout.
2240 Mr. Storer Explained that the numbers were the
median of July 30, 2001. Figures have
been revised down.
2303 Ms. Phillips Pointed out that the principal component
variation is slight. Values are narrow
and predictable. The inflation rate tends
to move in small increments from year to
year. The probable variation for FY02 is
only $1.5 billion dollars.
2424 Co-Chair Mulder Observed that the predicted increase to
the principal is the same amount as the
inflation proofing.
2437 Ms. Phillips Explained that the inflation rate has
come down to 2.83 percent ($600 million
dollars). Mineral revenues are $200
million dollars. The total is $800
thousand dollars.
2447 Co-Chair Mulder Noted that they do not expect future
large gains in the Permanent Fund.
2504 Ms. Phillips Observed that the Earnings Reserve Fund
represents accumulated undistributed
earnings: realized and unrealized
earnings. It will absorb the market
volatility for both the earnings reserve
and principal. As income is collected it
is reinvested. Any volatility is
reflected.
2556 Representative Croft Clarified that figures on pages 6 and 7
assume the statutory amount.
2624 Ms. Phillips Pointed out that the Corporation tried to
communicate that the bull market was
unsustainable. The affect of the bear
market is being demonstrated.
2653 Co-Chair Mulder Questioned when did they see the bear
market and how long is it expected to
last.
2712 Mr. Storer Noted that the bear market started about
2 years ago.
2730 Co-Chair Mulder Constitutionally required deposits from
oil revenues should be approximately $200
million dollars.
2749 Ms. Phillips Noted that $100 million dollars of this
amount had been realized.
2821 Ms. Phillips Explained that there is some volatility
projected in the inflation-proofing rate
of the principal.
2828 Mr. Storer Interjected that there are times when
there would be insufficient income to met
needs for payout and inflation proofing.
Income accrued from prior years may be
used.
2912 Vice-Chair Bunde Observed that inflation proofing can be
looked at from two points of views: (1)
inflation proof for our grandchildren or
(2) not be the miser that dies with all
the money in the bank. He questioned how
they would respond to each point of view.
3016 Mr. Storer Observed that the maximum payout that can
be paid and sustained to meet the entire
obligation for the future generations is
5 percent. A higher percentage would
recognize the current need, but not the
future. If the payout were 3 - 3.5
percent the current generation would
receive less and the future more. It is a
policy decision.
3125 Vice-Chair Bunde Pointed out that it is a dialog that must
be engaged in with the public.
3138 Ms. Phillips Reviewed page 8 of the handout: range of
annual statutory net income. Statutory
net income is the cash received from
dividends, bonds, interest, real estate
and gains or losses on the sale of an
asset. The appreciated asset is not
changed until actually sold. They
expected $1 billion dollars in net income
for this year. Now it looks like $800
million dollars. If they do not receive
$800 million dollars they would have to
dip into the earnings reserve.
3321 Representative Noted that the reserve would have to be
Hudson dipped into, which is currently $3.6
billion dollars. If the payout is greater
than the income the difference will come
from the Reserve Account. He pointed out
that the account was over $6 billion
dollars in FY01.
3421 Ms. Phillips Observed that between FY92 - FY00
statutory net income was $2 - $2.5 a
year. Now it is $1 billion - $800 million
dollars.
3438 Ms. Phillips Reviewed the range of distributed income.
The dividend is calculated at the
Division. The transfer is calculated at
the Corporation and is based on 10.5
percent on the last 5 year's statutory
net income.
3518 Representative Croft Clarified that the distributed income is
the amount that is transferred to be
distributed. It comes before inflation
proofing. The transfer occurs on paper.
It stays invested.
3625 Ms. Phillips Discussed projections of the lump sum
distribution amount, which is lower for
the next few years. It is expected to
come down to between $850 and $1,550 by
FY05.
3809 Representative Asked the percentage of growth.
Lancaster
3816 Ms. Phillips Noted that the current return is expected
at 4 percent. The capital markets in the
future would result in a total return of
7.95 percent and a realized return of
6.60 percent. The population growth used
in the model is 1.5 percent.
3829 Ms. Phillips Observed that their financial statements
are reported on their website along with
other information.
3911 Vice-Chair Bunde Noted that there has been editorials
suggesting that the dividend should be
taxed at 20 percent. He expressed concern
regarding the view of the IRS.
4001 Mr. Storer Observed that the Permanent Fund is not
deemed as taxable since it could be used
for a governmental purpose. If it were
used for another purpose the tax status
could be at risk. He stated that he could
not comment on the tax implications.
4136 Co-Chair Mulder Observed that there has been a protracted
bear market he questioned how long it has
to go before the "other half of the
dividend equation kicks in".
4206 Mr. Storer Observed models for the next 2 years did
not show the Earnings Reserve Fund
kicking in.
4249 Co-Chair Mulder Observed that a graph was developed in
1999 showing the "do nothing" course on
the dividend. He recalled that the
dividend would drop to about $400
dollars. He asked if the drop would occur
sooner since no action had been taken.
4357 Mr. Storer Agreed and explained that the time frame
would be shortened since the bear market
has lessened the fund. As assets are
liquidated to met funding needs the
impact is for dramatically lower
dividends in the out years.
4507 Co-Chair Mulder Noted that to drive the payouts some of
the assets are liquidated. The net assets
continue to dwindle. He asked for a model
with standard assumptions.
TAPE HFC 02 - 23,
Side B
4618 Representative Observed that there is nowhere to go
Hudson except into the Earnings Reserve Fund
unless a 15 - 20 percent income tax was
enacted. He noted that the median range
on page 9 that would go into the
dividends. He observed that legislation,
which split the income to pay 50 percent
to the state government, would reduce the
dividend amount by half.
4236 Ms. Phillips Observed that the range of distributed
income is calculated before inflation
proofing. If the amount is not sufficient
to cover inflation proofing and dividends
they would use the Earnings Reserve,
which they anticipate doing in the
current year.
4202 Representative Stressed that with a billion dollar
Hudson shortage the state will have to choose
between funding education, roads or
dividends.
4054 Co-Chair Mulder Noted that the governor's income tax
would be 20 percent.
4034 Representative Clarified that the Governor's proposal is
Hudson 20 percent of the federal tax paid, not
the adjusted gross income. He pointed out
that it would be half the level of taxes
previously collected by the state.
4011 MICHAEL O'LEARY, Discussed the 2002 Capital Market
EXECUTIVE VICE-Outlook. Observed that 2000-2001 have
PRESIDENT, CALLAN been a remarkable (and painful) run for
ASSOCIATES the U.S. Technology and dot-com bubble
burst. The NASDAQ decline has been one of
the worst on record. The Fed has been
accommodating especially after the
terrorist attacks, ensuing war, and
broken confidence. The NASDAQ is off
57.2%. The Fed cut interest rates 11
times (4.75%), the steepest cut in
history. Interest rates are near a 40-
year low. Much-touted federal surplus
sighted in fiscal 2000, only to disappear
again in the current fiscal year.
3629 Mr. O'Leary Explained that the U.S. economy
officially peaked in March 2001, thus
entering recession in the second quarter
of the year. Observed that Christmas may
have been merrier than expected, and data
suggest a fourth quarter growth rate near
zero. The recession may already be
technically over. The consumer has spent
a lot of money during the recession.
3532 Mr. O'Leary Observed that the slow down has occurred
around the world and that the world is
looking to the U.S. to lead them out.
3455 Mr. O'Leary Reviewed Page 7 of his handout: 2002
Capital Market Outlook (copy on file.) In
the real economy the recession has not
appeared particularly severe.
Unemployment rates have not been out of
line with the past but are expected to
rise.
3352 Representative Asked if the unemployment rate reflects
Lancaster adequately the results of layoffs from
9/11/01.
3327 Mr. O'Leary Felt that the rate could be off due to a
lack of filling by discouraged people.
3259 Mr. O'Leary Observed that there has been a stronger
banking system and a more balanced real
estate markets. There were also a
stronger fiscal and monetary policy
response.
3134 Co-Chair Mulder Noted that confidence has returned.
3055 Mr. O'Leary Agreed that confidence is returning but
pointed out that the downturn was strong.
He thought that the uncertainty from
ENRON has affected investor confidence.
2952 Vice-Chair Bunde Asked why there was an inverse
relationship between savings and wealth
or income.
2919 Mr. O'Leary Explained problems, which occur in
measuring savings. Homes and retirement
assets can continue to grow through
appreciation.
2848 Mr. O'Leary Pointed out that consumer debt is high.
Consumers have taken advantage of
refinancing and low interest rates.
2808 Co-Chair Mulder Noted that those that have stretched
their resources in order to continue
their standard of living will have slowed
recovery because their options would be
more limited. He concluded that the
ability for an accelerated recovery is
reduced.
2756 Mr. O'Leary If consumers had entrenched and increased
savings, then when the economy improved
they would have the power to accelerate
recovery. The recovery will turn on
consumer income growing and the
confidence to spend.
2635 Mr. O'Leary Reviewed page 14: Inflation Will
Decelerate as the Economy Softens. He
observed that from FY00 to FY01, core
inflation, which does not contain the
volatile items, rose. Energy costs are
contained in the CPI, but not in the
core.
2511 Mr. O'Leary He explained that a long-range estimate
for inflation is developed when the
capital market forecast is developed.
Last year they estimated 3.25 percent.
This year the estimate has been reduced
to 2.9 percent, because they did not
expect the terrorist attack and a greater
weakness in the economy.
2411 Mr. O'Leary Clarified that the CPI is a federal
government statistic that encompasses the
entire U.S. He observed that 1999 was the
last full year of the bull market. He
reviewed the fall of stock prices since
1999. Smaller companies did better than
large companies. He concluded that there
was an overvaluation in the mega
companies, especially in high growth
areas. The NASDAQ had more extreme motion
up and down.
2223 Co-Chair Mulder Questioned the break point for small cap
companies.
2211 Mr. O'Leary Explained that the size of the market
value of the company is used for
determining the category.
2120 Mr. O'Leary Pointed out that much of the bull market
trend made it into the big companies. He
stressed the importance of being well
diversified.
1950 Co-Chair Mulder Questioned if most of Alaska's public
trade companies are small cap.
1934 Mr. Storer Noted that there are several large
companies in the state of Alaska.
1854 Mr. O'Leary Reviewed page 24. He noted that it shows
the yield to maturity for a bond index.
The index is a good indication of the
yield. He explained that the assumption
is that bonds will be held to maturity
and that the income would be reinvested
at the same rate. The yield at the
beginning of 2001 was 6.25 percent; at
9/11/01 they were at 5.60; and after
9/11/01 they plummeted to 4.75 [11/7/01].
Interest rates for a bond portfolio were
below 5 percent. They have returned to
the 9/10/01 level.
1550 Mr. O'Leary Reviewed page 25. He noted that the 5-
year return rate was 20 percent between
1981 and 1986. Through the 90's bonds
returned less than 10 percent per year
and more recently less than 8 percent.
The expected bond return for the next
five years is 5.575 percent, which is
less than it has earned over the previous
five years. This is a third of the
portfolio.
1306 Mr. O'Leary Noted that the SP 500 is projected at a 9
percent return. Last year it was 8.9
percent. The inflation number was
reduced. The bond return expectation has
been reduced. We are closer to recovery.
The market has substantially declined.
1134 Mr. O'Leary He noted that they developed three sets
of estimates based on asset classes
(contained on page 29).
945 Mr. O'Leary Reviewed page 30. He noted that the
return versus risk ratio has increased.
801 Mr. O'Leary Discussed page 31. He noted that nothing
is targeted for short-term investments.
The rate of return is 7.95 percent, which
is lower than what was expected last year
because of the low bond rate of return.
621 Mr. O'Leary Reviewed mixes of investment options on
page 32. He concluded that there is no
reason for a substantial change in
policy.
505 Mr. Storer Observed that inflation is also lower.
The real rate of return is the same as in
prior years [5 percent].
433 Mr. O'Leary If more than 5 percent of the value of
the portfolio is spent it is difficult to
maintain the purchase power of the
corpus.
408 Co-Chair Mulder Summarized that the computer model does
not do a good job with the subjective
factors.
338 Mr. O'Leary Pointed out that the results have always
been within the range. He stressed that
there is an equal possibility that
anything in the range could happen.
Overtime the range narrows because the
probability of having subsequent bad
years over many years is reduced. He
stressed that the bear market was within
the range of possibilities.
154 Co-Chair Mulder Acknowledged that the money that was lost
in real value translated to the risk
factor. He stressed that there is a
subjective art to forecasts other than
computer analysis.
105 Mr. O'Leary Agreed that computer models suggest a
level of precision that does not exist.
TAPE HFC 02 - 24,
Side A
005 Representative Noted that bonds and real estate are
Whitaker providing a lower rate of return. He
asked why real estate was affected.
011 Mr. O'Leary Explained that real estate values reflect
low bond expectations. People price to
earn a premium in relation to bonds. It
is a tougher environment.
424 ROBERT MAYNARD, Stated that projections are accurate over
CHIEF INVESTMENT a 5-year period. Accuracy increases with
OFFICER, STATE OF longer time periods.
IDAHO RETIREMENT
SYSTEM
809 JERROLD MITCHELL, Referred to Page 32. He observed that
CHIEF INVESTMENT number 4 is the same asset allocation
OFFICER, STATE OF used by the state of Massachusetts.
MASSACHUSETTS
822 ALLAN BUFFERD, Spoke to the question of inflation
TREASURE, proofing a $25 billion dollar fund. He
MASSACHUSETTS observed that with a 3 percent inflation
INSTITUTE OF rate, in 24 years you would need $50
TECHONOLOGY billion dollars to have the same
purchasing power. If inflation protection
is not provided the purchasing power
would be cut in half in a relatively
short time. He explained that volatility
is 11 percent. The range of return could
be -3 to +20 and would be observed 65
percent of the time.
1110 Co-Chair Mulder Explained that the Fund would only be $14
billion dollars if there had not been
legislative appropriations.
1210 Mr. Bufferd Stressed that the question is political
in regards to the people's expectations.
1245 Vice-Chair Bunde Asked if the parents should sacrifice so
that the children don't have to work.
1339 Representative Questioned the advantage of using percent
Hudson of market value.
1412 Mr. O'Leary Explained that a reasonable level of
maximum expenditures and consistency of
distributions, and discipline in the
process would be the benefit of a percent
of distribution policy.
1517 Representative Questioned the opportunity to invest for
Hudson higher return.
1543 Mr. Mitchell Noted that the percent of market value
does not prevent taking a three year
average to smooth the amount. He stressed
that the major advantage is greater
transparency to what the fund is doing
and why. It is easier to relate
investment policy to spending priorities
of the legislature and for the
legislature to track what is going on and
have better projections.
1728 Mr. Bufferd Explained that the current structure,
which is based on the concept of trust
law for the definition of income, drives
a behavior pattern in terms of generating
income for the payout requirement. There
is a tendency to invest where there are
dividend and interest payments and to
take realized gains. The total return
approach does not care about the
character of appreciation in the fund.
The measure is in terms of the totality
of the fund.
1837 Co-Chair Mulder Asked what happens to the future of the
dividend if we do nothing. He questioned
if no action toward increasing revenues
and closing the fiscal gap would result
in a dramatic affect to permanent fund
dividends within 3 - 4 years.
1918 Mr. Storer Responded that it would draw down on the
fund to the point where there would be no
dividend. The Fund would be drawn down to
the principal within 4 - 8 years.
2025 Representative Croft Noted that there is a tendency to use the
capital market forecast as a function of
price earnings as opposed to the
underlying value or what the economy is
doing. He questioned if it is a function
of the 401K markets.
2057 Mr. O'Leary Explained that supply is a function of
demand. The level of household investment
in the stock market increased
dramatically in the 90's. The height of
equity investment in retirement
contribution plan was reached
simultaneously with the market peak. Many
people did not derive the benefit of the
strong market but invested at the top.
2223 Mr. Bufferd Noted that prices move only when there is
another buyer. The market fell and
institutionalized investors returned.
2322 Co-Chair Williams Noted that the legislature has been
working on a fiscal plan since 1998. He
observed that there are those that do not
think there is a problem.
2553 Mr. Bufferd Stressed that the use of the earnings of
the Permanent Fund after inflation
proofing is clearly a decision of the
state of Alaska.
2689 Mr. Maynard Noted that the state of Alaska was been
in similar position in 1985. He stressed
that given the asset allocation of the
Fund; there cannot be an expectation to
make more than 5 percent above inflation
over a 5 - 10 period. Decisions that
would use above 5% should be considered
as dipping into the purchasing power of
the Fund for future generations.
ADJOURNMENT The meeting was adjourned at 3:45 PM
| Document Name | Date/Time | Subjects |
|---|