Legislature(2017 - 2018)HOUSE FINANCE 519
01/22/2018 01:30 PM House FINANCE
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| Audio | Topic |
|---|---|
| Start | |
| Overview: Ak Permanent Fund by Angela Rodell, Ceo | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
HOUSE FINANCE COMMITTEE
January 22, 2018
1:33 p.m.
1:33:10 PM
CALL TO ORDER
Co-Chair Foster called the House Finance Committee meeting
to order at 1:33 p.m.
MEMBERS PRESENT
Representative Neal Foster, Co-Chair
Representative Paul Seaton, Co-Chair
Representative Les Gara, Vice-Chair
Representative Jason Grenn
Representative David Guttenberg
Representative Scott Kawasaki
Representative Dan Ortiz
Representative Lance Pruitt
Representative Steve Thompson
Representative Cathy Tilton
Representative Tammie Wilson
MEMBERS ABSENT
None
ALSO PRESENT
Angela Rodell, Executive Director, Alaska Permanent Fund
Corporation.
PRESENT VIA TELECONFERENCE
None
SUMMARY
OVERVIEW: AK PERMANENT FUND BY ANGELA RODELL, CEO
Co-Chair Foster relayed the agenda for the day and invited
Ms. Rodell to the table.
^OVERVIEW: AK PERMANENT FUND BY ANGELA RODELL, CEO
1:34:08 PM
ANGELA RODELL, EXECUTIVE DIRECTOR, ALASKA PERMANENT FUND
CORPORATION, introduced herself and indicated questions
were welcome. She introduced the PowerPoint presentation:
"Overview: Alaska Permanent Fund."
Ms. Rodell began with slide 2: "The Alaska Constitution."
She reminded members of the establishment of the Alaska
Permanent Fund in the Alaska Constitution. The language
concerning the fund was approved more the forty years prior
in 1976 by a significant margin. She read a portion of the
Alaska Constitution:
Alaska Constitution Article IX, Section 15
Section 15. Alaska Permanent Fund
At least twenty-five percent of all mineral lease
rentals, royalties, royalty sale proceeds, federal
mineral revenue sharing payments and bonuses received
by the state shall be placed in a permanent fund, the
principal of which shall be used only for those
income-producing investments specifically designated
by law as eligible for permanent fund investments. All
income from the permanent fund shall be deposited in
the general fund unless otherwise provided by law.
Ms. Rodell moved to the flow chart on slide 4: "How the
Fund Works." The chart showed the source that flowed into
the principle: royalties, inflation proofing
appropriations, and special appropriations. The principle,
an asset managed by the Alaska Permanent Fund Corporation
(APFC), was constitutionally protected. The resulting
income was deposited into an earnings reserve account
(ERA). The earnings reserve account was comprised of net
investment earnings, statutory net income, realized gains
and losses, and cash flow income (stock dividends, bond
interest, real estate leases, and alternative investment
distributions). The earnings were available for
appropriation under AS 37.13.145(a). Some of the money was
appropriated for AFPC's operating and investment expenses.
The legislature used some of the earnings to inflation
proof the principle, pay the Permanent Fund Dividend, and
pay for some state government needs. She continued that
each investment made by APFC was owned on a pro-rata basis
by the principle and the ERA. The principle was only
entitled to a recovery of the cost basis of an investment.
The earnings reserve account received its cost basis and
any gain that was realized by both the principle and the
ERA.
1:37:53 PM
Ms. Rodell continued to slide 5: "Invested as One Fund."
The Alaska Permanent Fund Corporation invested the assets
under management as one fund. The corporation was
responsible for the investment and management of the fund.
The board of trustees adopted one target asset allocation
for all of the funds under management. Investments were
purchased on a pro-rata basis by the principle and ERA.
Ms. Rodell advanced to slide 6: "Statutory Net Income AS
37.13.140." She explained that the money the corporation
was able to move into the ERA constituted statutory net
income. At the time the Alaska Constitution was originally
adopted, the generally accepted accounting principles
defined income as anything that was realized. However, in
1997, generally accepted accounting principles changed,
adopting a new definition of income. It included realized
and unrealized income. Recognizing the difficulty in
appropriating unrealized gains or unrealized losses, the
legislature adopted a new definition of income, the
statutory net income as presented on the slide:
Statutory Net Income AS 37.13.140
Pursuant to state law (AS 37.13.140), at the end
of each fiscal year APFC calculates and reports
on the net realized gains accounted for during
the fiscal year.
? These net realized gains and investment
income are the funds in the ERA that are
subject to appropriation by a simple majority of
the Alaska Legislature.
? Net realized gains = realized gains accumulated
during the fiscal year (-) minus realized losses
accounted for during the year.
? Unrealized gains earned by Principal are part of
Principal, only until realized at which time they
are transferred to the ERA.
Ms. Rodell pointed to the graph on the right of the slide
which showed that from 2013 to 2017, the state had a fairly
steady statutory net income. In 2018, the corporation was
projecting a statutory net income of $4.4 billion. She
would not be surprised if it was slightly higher. She
provided an example of why it was growing. The market had
been robust for well over a year, and APFC had been
required to do some rebalancing to avoid being overweight
in public equities asset allocations. As the corporation
trimmed down the allocation it was realizing the gains. It
meant that statutory net income increased, and the gain was
deposited into the ERA.
1:41:07 PM
Representative Ortiz was looking at the net income from
2013 through 2018. He wondered if the income was the same
as the annual return of 6.9 percent. Ms. Rodell responded
that it was not. The difference was in the unrealized gain.
When APFC calculated income for accounting purposes,
everything including realized gain, unrealized gain,
realized loss, and unrealized loss. The amount represented
only the net realized gain minus realized loss. It did not
take into account any of the realized gains and losses.
Representative Guttenberg asked about the thought process
behind rebalancing funds. He wondered about the effect of
the money becoming earned income. He asked about the
rebalancing of money available, money going back into the
principle, and money outside of making the Permanent Fund
healthy. Ms. Rodell explained that the only thing that
drove rebalancing efforts was keeping the fund within the
parameters and target asset allocations approved by the
board of trustees. She furthered that the individual
portfolio managers made decisions as to where the money
should come from within their public equity portfolio. For
example, the US domestic equity market had been
particularly robust. The board had approved a tactical
tilt. In other words, the trustees liked what they saw in
emerging markets outside of the US. Some of the investments
were taken out of domestic markets and deployed into other
asset allocations rather than taking the investment pro-
ratably from every manager across public equities.
Ms. Rodell reviewed slide 7: "Assets Under Management in
billions." She noted that in terms of the total assets
under management over the previous 4 years (FY 14 - FY 17)
and in FY 18(unaudited) the principle of the fund remained
steady. As the accounts realized gains, they were moved
into the ERA, which had benefited and grown from the
activities of the fund over 4.5 years.
1:45:19 PM
Ms. Rodell scrolled to slide 8: "Principal." She reminded
members that the principle was built primarily through
royalty deposits, inflation proofing, and special
appropriations. Over the years the legislature had acted to
put additional revenues into the fund. She reported that
approximately $16.5 billion in mineral royalties had been
deposited. Transfers from the ERA for inflation proofing
equaled $16.2 billion. Also, special appropriations had
been made from the ERA and the general fund (GF) in the
amount of $7.1 billion.
Ms. Rodell detailed slide 9: "Inflation Proofing." The
board continued to emphasize the importance of inflation
proofing the principle. In September 2017, at its annual
meeting, board members adopted Resolution 17-01 directing
the corporation to identify and pursue support for
inflation proofing the principle in order to preserve the
purchasing power of the principle account for all
generations as stated in AS 37.13.020. She noted the
contributions over the years as depicted on the slide. She
pointed out there was not an inflation proofing deposit
into the principle in 2010. The appropriation was also not
included in the budget for FY 16, FY 17, or FY 18. She has
included the amount proposed in the governor's budget for
FY 19 to restore the inflation amount. She thought the
amount demonstrated the movement of inflation and how it
has started to pick up. She also thought it reflected how
the rapid size of the fund contributed to how quickly the
corporation could fall behind on the principle account
regarding inflation. The slide also included the estimated
royalty deposits for FY 18 and FY 19 provided by the
Department of Revenue (DOR) Fall Forecast at the 25 percent
amounts.
Vice-Chair Gara referred to the royalty portion. He relayed
that originally 25 percent of all royalties was deposited
into the Permanent Fund. In the 1990s, it was determined
that for the newer fields 50 percent of royalties would go
into the fund. In the early 2000s, when things were going
poorly, a bill was passed that moved the percentage back to
25 of royalties for new fields. However, it did not happen.
He asked about the difference of the "then" newer fields
going from 50 percent to 25 percent. He wondered what would
be left for the general fund on average. Ms. Rodell
responded that APFC did not track information by field or
lease type. The corporation simply received a lump sum from
the Department of Natural Resources (DNR) and used DOR's
forecast. Vice-Chair Gara jokingly asked her to explain why
the corporation did not invest in Bitcoins.
1:49:20 PM
Representative Wilson asked if it was the intent of the
governor to inflation proof the fund in FY 19 to make up
for the prior 3 years or just inflation proof the fund in
the amount of $943 million. Ms. Rodell responded that the
governor had 2 appropriations in his proposed budget; one
for FY 16, FY 17, and FY 18 and one for FY 19.
Representative Wilson asked about the ramifications of
removing the royalty deposits. Ms. Rodell assumed that the
representative meant anything over 25 percent otherwise it
would be a violation of the constitution. She did not know
what the difference would have been had the fund received
the full percentage it had received in the past. She
thought the information could be provided by either DNR or
DOR.
Ms. Rodell discussed slide 10: "Unrealized Gains in
billions." She informed members that the slide showed how
much in unrealized gains had been added to the Permanent
Fund and to the assets under management between the
accounts. Currently, in the principle of the account there
was approximately $40 billion in contributions and $8.7
billion in unrealized gains. She suggested that if APFC
sold and realized every one of the dollars, $8.7 billion
would be transferred to the ERA. She wanted to provide a
sense of how much was due to the pro-rata share being
bought by the principle investments and how it did not
contribute to the amount available to invest by the
principle. She continued that the ERA had $12.6 billion in
realized earnings and $2.7 billion in unrealized gain.
There was a total of about $15.3 billion marked into the
ERA with a nod towards the additional $8.7 billion if it
was sustained and no losses occurred until those dollars
were realized.
1:51:56 PM
Ms. Rodell pointed to actual balances on slide 11: "Fund
Balance FY 18 Q2 and FYE 17." She noted that the balance
sheets we posted on APFC's website monthly. The balances
were unaudited through December 31, 2017 compared to where
the fund started in the fiscal year. She highlighted that
total assets had increased from $60.5 billion to $64.4
billion in 6 months. The majority of the increase came from
preferred and common stock accounts which were part of the
public equity bucket. She noted that the corporation
continued to book for inflation proofing, an amount based
on the statutory formula. Given how the dividend had been
negotiated over the previous couple of cycles, APFC's
auditors had recommended the corporation not book anything
for the dividend as an ongoing liability. She also pointed
out that the realized earnings had increased by about $1
billion along with the unrealized appreciation in
uninvested assets. She noted that in looking at the non-
spendable balances of $40 billion from contributions and
appropriations. It came in a non-spendable form because it
was an unrealized net gain of $8.7 billion. The earnings
reserve account balances could be found under the subtitle,
"Assigned for future appropriations.".
Co-Chair Seaton noted there had been discussion about
inflation proofing and that there was automatic inflation
proofing because of investments. He asked Ms. Rodell to
elaborate on those discussions.
Ms. Rodell suggested returning to the previous slide which
she thought provided the best example of automatic
inflation proofing. She suggested taking the principle as
an example. The growth of $8.7 billion that was coming in
unrealized gain had the concept of inflation attached to
it. There were investments that naturally embedded
inflation in them, such as real estate. If a person were to
buy a piece of property and it grew in value it would be
embedding the notion of inflation over the time period. It
would not be like a fixed income bond that was purchased at
a certain price and it lost value with high inflation. In
looking at the principle, it had increased to $48.7
billion, except the principle of the fund was not entitled
to any of that inflation gain. To make sure that the $40
billion coming directly from the non-renewable resource
that had been preserved for current and future generations
of Alaskans, the state needed to put back some of the gain.
This was done through inflation proofing into the corpus of
the fund.
1:56:48 PM
Co-Chair Seaton mentioned inflation proofing inflation. He
thought that if the unrealized value had increased by $8.7
billion, and the legislature was inflation proofing that
number as well as the invested amount, it would be
inflation proofing inflation even though it was unrealized
gain. He wondered how inflation was being considered in
calculating inflation proofing.
Ms. Rodell reported that the corporation was only
calculating inflation on the $40 billion. It was not
calculating inflation proofing on any unrealized gain.
Vice-Chair Gara referred to page 9. He noted that in
looking at FY 11 through FY 15 there was inflation proofing
and the deposits from the 25 percent royalty were about the
same as inflation proofing. There were additions to the PF
to grow it from the deposits and about the same amount from
inflation proofing. In the prior year the legislature had
indicated it could not afford inflation proofing. However,
the failure to inflation proof had started 2 years prior to
the current majority forming. He wondered if it was
accurate to say that in the prior 3 years the legislature
had not inflation proofed the fund. Ms. Rodell responded
that he was correct.
Vice-Chair Gara asked her if it was her preference to see
the fund inflation proofed. Ms. Rodell responded that
reinjecting some of the wealth the fund had created over
the previous 2 years through the inflation proofing
mechanism was important. She also emphasized that royalty
deposits should not be confused with inflation proofing the
fund. Royalty deposits were the non-renewable resource
coming in and being saved for future generations of
Alaskans. It was not inflation proofing the fund.
Vice-Chair Gara thought everyone would agree that they
wanted to grow the fund. He commented that it was a
conundrum the legislature would have until a fiscal plan
was in place.
Representative Wilson asked if the committee could hear
from DNR about the discrepancy with some of the numbers.
Co-Chair Foster noted there was no one available from DNR
and asked his staff to get a response from the department.
2:00:52 PM
Ms. Rodell scrolled to slide 12: "Changes to Fund Balance."
She indicated that the slide reflected the activity of the
corporation for the prior 6 months and for the current
month. She thought it would be evident where money started
coming in. The corporation received interest income of $224
million, dividends of $310 million, and real estate and
other income for a period of 6 months. She suggested that
members should think of these revenues as regularized
income that she expected to see totaling about $711
million. Next, she pointed to the increase or decrease in
the fair value of investments. It spoke to Representative
Ortiz's question about the difference between accounting
income and statutory net income. The Alaska Permanent Fund
Corporation recognized the change in fair value just in 6
months ending December 31, 2017 and the large boost the
bull market had given the public equity portfolio to about
$2.6 billion. She also noted the amounts that had flown out
of the fund for operating expenditures. They were the
corporation's expenditures, expenses having to do with
external management, and other legislative appropriations.
The other legislative appropriations were monies paid to
DNR to collect the corporation's share of royalty, the
Department of Law, and other entities for similar items.
She noted the transfers in and out of the account including
$726 million which paid for the Permanent Fund Dividend.
The fund balance changes could be seen on the slide as
well. The statutory income calculation was reflected in the
box. The corporation made the adjustments for the
unrealized gains (adding back losses and subtracting
gains). The statutory net income for 6 months equaled $2.4
billion.
Representative Pruitt asked about currency and the
associated loss reflected for the year ending
June 30, 2017. He asked if it was because the cash the
state had on hand had been affected by inflationary forces.
He wondered if it had to do with investments outside of the
United States and the exchange in currency values. He asked
her to elaborate.
Ms. Rodell responded that the currency line Representative
Pruitt referred to, was the effect of having investments
outside in currencies other than US denominations. She
relayed that when the value of the dollar was strong, it
tended to widen, and more losses could be seen. Conversely,
when the value of the dollar went down gains or losses
could be seen equivalent to the change in value. She
explained that he was seeing the effect of the global
portfolio. She pointed to the disclosure in the annual
report that relayed the forty or more currencies that the
state was exposed to and the amount each of the exposures
had contributed to or subtracted from the currency line on
the slide.
2:04:52 PM
Ms. Rodell advanced to slide 14: "Board of Trustees." She
relayed that one of the questions the corporation was asked
frequently was how it invested. She relayed that it was up
to the board of trustees:
Board of Trustees
As the fiduciaries, the Trustees have a duty to
Alaskans in assuring that the Fund is managed and
invested in a manner consistent with legislative
findings: AS 37.13.020
? The Permanent Fund should provide a means of
conserving revenue from mineral resources to benefit
all generations of Alaskans.
? The Permanent Fund's goal should be to maintain
safety of principal while maximizing total return.
? The Fund should be used as a savings device managed
to allow the maximum use of disposable income from the
Fund for the purposes designated by law.
Ms. Rodell continued to slide 15: "Investment Oversight":
AS 37.13 .120 Investment Responsibilities Mandates
Use of the Prudent Investment Rule
Board of Trustees
As fiduciaries of the fund, full authority
to make investment decisions.
?Provide authority to invest within set
bands
?Approve target asset allocation
?Adopt investment policy
Chief Executive Office
Assures strategies adopted by the board are
successfully implemented.
Chief Investment Officer
Makes strategic and tactical allocations to
allow the fund to grow in value.
Portfolio Managers
Responsible for the investment and
performance of each asset class.
Ms. Rodell turned to slide 16: "The Portfolio $64.0 Billion
as of FY18 Q2." She read the target allocation percentages
for FY 18 from the pie chart:
The Portfolio $64.0 Billion as of FY 18 Q2
Target Allocation (FY 2018)
39 percent: Public Equities
22 percent: Fixed income plus
Ms. Rodell indicated that the two allocations were the
tradable liquid portions of the Permanent Fund and made up
about 61 percent of the total assets under management.
Ms. Rodell would walk through each of the asset classes and
provide a sense of management, cost, and the amount each of
the portfolio managers were responsible for. She reviewed
public equities on slide 17: "Public Equities $26.1B
audited value as of 6/30/17." She would tie the information
back to the fiscal year audited figures because it was in
the annual report. The corporation had $26.1 billion
dollars on June 30, 2017 in public equities. She provided a
perspective on size: the amount was the entire size of the
fund 10 years prior. The director of public equities
oversaw an internal team of 2 and oversaw 28 external
managers with strategies in US domestic, global, and
international funds. He held quarterly meetings with each
manager, confirmed strategies and performance, and gauged
and adjusted mandates as required. Currently, he was going
through a large rebalancing effort because of the bull
market taking too much of the asset allocation. He was also
responsible for internally managing the tactical portfolio
and provided active oversight of the external portfolio
managers. The stock holdings were liquid-growth,
international equities, global equities, and domestic
equities. The Alaska Permanent Fund Corporation's operating
fund attributable to the public equities portfolio,
including Ms. Rodell's time and overhead, the back office,
and the middle office, was about $2.9 million for the FY 17
budget. The corporation paid external fees of $60.7 million
to external managers along with $3.7 million in performance
fees. They were net of fees.
2:09:45 PM
Representative Pruitt brought up the notion of internal
investment managers versus external investment managers. He
believed there should be a balance of both. There had been
discussion in the previous year about additional funding
for APFC to bring in additional internal investment
managers. He noted that within public equities there were 2
internal employees and 28 external investment managers. He
wondered if Ms. Rodell thought bringing in more internal
investors would save the corporation and the state more
money. He asked how the legislature could help save money
so that APFC had more money to invest.
Ms. Rodell answered that it was an ongoing priority of the
board of trustees to bring managerial assets in-house where
it made sense. She noted how grey the line was between
internal and external management. She opined that it would
never be cost effective or prudent to manage a $26.1
billion public equities portfolio internally solely by
Alaskans in Juneau. She relayed that when she spoke with
some of the external managers, they reported that
technology had allowed them to do much more with fewer
traders. The corporation wanted to rely on "boots-on-the-
ground" information they had access to by being in various
markets - one reason for having a mix of internal and
external management. She had one public equities director
with two people working internally for him. She thought
more could be done internally, but it would be a constant
balance. Not only did the corporation want the flexibility
that internal management provided to shift between
strategies and the lower cost, the corporation wanted to be
very nimble with all of it. She thought the corporation
could do better internally.
Representative Pruitt appreciated the notion of getting to
a balance. He wondered if part of getting to a balance was
the legislature allowing for the appropriation. He wondered
about making recruitment competitive and whether Ms. Rodell
wanted assistance from the legislature.
Ms. Rodell commented that the corporation needed assistance
in a couple of different ways, first of which was funding.
For example, the corporation could hire an external
manager. However, if the corporation were to do direct
investing, she might need a data feed to help an internal
manager with their job. She would have to go through the
procurement process, which was not necessarily flexible.
She thought it was important for the corporation to let the
legislature know what it was doing and how. The next few
slides would provide information about where money was
being targeted.
2:15:07 PM
Ms. Rodell advanced to slide 18: "Fixed Income Plus $11.7B
audited value as of 6/30/17." She indicated that public
equities represented the corporation's largest asset
allocation of 40 percent. Fixed income plus was the second
largest portfolio. At the end of the fiscal year the
audited value was approximately $11.7 billion. The director
of fixed income plus oversaw a team of four. The
corporation had been handling the asset allocation
internally for more than 20 years. The team actively traded
and assessed the fixed income plus portfolio. She reported
that currently $7.7 billion was internally managed, and
$4.0 billion was managed externally due to a change the
board of trustees made to the asset allocation in 2016. She
pointed out that the portfolio was called, "Fixed Income
Plus" which meant that the corporation added listed
infrastructure and real estate investment trusts (REITS) to
the assets that the team managed. The additions required
more money to be managed externally than in the past. She
indicated the list of assets could be found on the right-
hand side of the slide. The operating expense associated
with the allocation was about $4.8 million and
approximately $10.2 million was paid in external fees.
Ms. Rodell moved to slide 19: "Private Equity and Special
Growth $7.0B audited value as of 6/30/17." She reported
that the private equity and special growth portfolio had an
asset allocation of about $7.0 billion. The director
oversaw a team of two. It was a very labor-intensive asset
allocation. The team was responsible for looking at direct
private equity investments, evaluating and doing due
diligence on co-investments, and working with fund managers
on the monies they managed. The corporation had a $2.9
million allocation for operations and external fees of
$11.5 million along with $182.9 million in net fees. They
were some of the higher fee investments the corporation had
and significantly contributed to returns.
Ms. Rodell advanced to slide 20: "Infrastructure, Private
Credit and Income Opportunities $3.2B audited value as of
6/30/17." The portfolio was very similar to the previous
allocation. The difference was that the infrastructure,
private credit and income opportunities portfolio was
private income as opposed to private growth. Money was
invested in illiquid income structures such as
infrastructure, private credit, and income opportunities.
The director of private income was also responsible for
another portfolio. He had one person on his team that
worked on the asset holdings with an operating budget of
$1.4 million.
2:18:35 PM
Ms. Rodell slide 21: "Absolute Return $2.2B audited value
as of 6/30/17." The director of private income was also the
director of the absolute return portfolio of $2.2 billion.
The asset allocation was also referred to as the "hedge
fund" portfolio. The director was responsible for selecting
each of the funds the corporation invested in. The
portfolio was very illiquid, although the investment
strategies included global, macro, and commodities. She
remarked that the items were counter and cyclical.
Ms. Rodell continued to slide 22: "Real Estate $5.6B
audited value as of 6/30/17." She reported that the real
estate asset class was a fund that had been invested in for
a long time. The fund had $5.6 billion in private real
estate. The director oversaw a team of three along with a
group of external advisors of five. The advisors provided
the property management services needed to ensure that the
properties performed. The fund had 56 properties in the US
and Europe including residential, retail, industrial, and
office properties. The operating budget for the asset class
was $3.8 million plus external management fees.
2:20:07 PM
Ms. Rodell explain the last portfolio on slide 23: "Asset
Allocation and Risk $4.5B audited value as of 6/30/17." She
opined that the asset class was the most challenging to
describe. The asset allocation and risk portfolio comprised
the strategies that the corporation used to overlay the
rest of the portfolio. The director was responsible for
overseeing a team of one, managed all of the cash, and
invested the cash as it came in. The director also
monitored risk factors such as market risk, liquidity, and
any concentrations and inflation. The director was in
charge of the currency overlay program that the board of
trustees approved in the prior year to help mitigate some
of the losses seen on currency. The director was also
responsible for conducting a much more active liquidity
management program to be more fully invested.
2:20:59 PM
Representative Thompson referred back to Ms. Rodell's
comment about the state's cumbersome procurement process.
He asked about the Executive Budget Act and how it would
help save the state money. He asked how it worked with
APFC.
Ms. Rodell responded that getting relief from some of the
procurement requirements had been one of her priorities and
a priority of the board for a couple of years. The
challenge for the corporation was that there were a number
of exceptions to procurement for state agencies to do
things such as procuring professional services. The Alaska
Permanent Fund Corporation did not fall into that set of
exceptions. Rather, the corporation was subject to the
standard procurement procedure which meant it had to go out
to bid for everything non-investment related. She
elaborated that investment related meant directly managing
funds on behalf of and delegating that investment authority
to an external manager. She conveyed that to the extent
that the corporation needed consultants to help with due
diligence on a private equity investment, it might want to
hire someone such as an engineer, biotech doctor, or a
research doctor who could provide intimate knowledge of a
subject. However, the corporation was required to go
through the regular procurement process. She suggested
there were ways the corporation could work with the
legislature to find a way forward with procurement.
Ms. Rodell tried to respond to Representative Thompson's
question regarding the Executive Budget Act. The challenge
was that the management of the fund required an
appropriation. It was clear from constitutional language
that the money from the fund would be used for income-
producing investments. It made no reference to the cost of
making those investments, which was the reason the
corporation believed it needed an appropriation. She
continued that while the Executive Budget Act would give
the corporation some relief, she felt that APFC still
needed an appropriation.
2:24:03 PM
Ms. Rodell reviewed the outcomes for the State of Alaska on
slide 25: "Fiscal Year 2017 Performance as of 6/30/2017:
Realized and Unrealized Gains." The Alaska Permanent Fund
Corporation invested the fund for the long-term. The
corporation's strategies were put in place for long-term
investment horizons. The five-year column was very
important to the corporation because 5 years provided a
sense both up markets and down markets. She explained that
for a 5-year period in FY 17 the return on the fund was
8.85 percent. Compared to a passive index benchmark, the
fund beat the benchmark by 1.7 percent. She suggested
thinking of the passive index benchmark as a portfolio of
index funds with 60 percent allocated to stocks (the fund
was 40 percent to stocks), 20 percent to bonds, 10 percent
to real estate, and 10 percent to treasury inflation proof
securities (TIPS). Basically, it was what a computer would
do without the benefit of active management by the
corporation. The corporation generated an additional 1.7
percent over and above the previous 5 years.
Ms. Rodell continued that the performance benchmark, the
asset allocation and all the individual asset benchmarks
rolled together, returned 8.15 percent. The corporation was
able to generate an additional 70 basis points. It was a
nuance of picking and choosing when and where the
corporation rebalanced the fund. The board of trustees had
a total fund return objective of the consumer price index
(CPI) plus 5 percent. She reported that CPI plus 5 percent
for the previous 5 years would have been 6.32 percent,
which the corporation well exceeded.
Ms. Rodell slide 26: "Asset Class Performance (Realized and
Unrealized Gains)." The chart showed where the returns were
coming from within the fund. She highlighted that domestic
equities of 14.62 percent contributed a much larger portion
than international equities in the public equities
portfolio. In addition, REITS contributed over 8 percent to
the portfolio. The private equity portfolio, with its high
fees, contributed 18.3 percent to the growth of the fund
over 5 years. Infrastructure contributed over 15 percent.
The privet market, illiquid areas of the asset allocation,
contributed greatly to the overall growth of the fund.
2:27:39 PM
Ms. Rodell turned to slide 27: "Callan's Capital Markets
Forecast as of September 2017." She shared that in
September 2017 the board had heard from [consultant] Callan
Associates on the capital market forecast. She explained
that Callan Associates took the target asset allocation and
their individual asset category outlook, their projected
returns for each of those outlooks, and derive a new
forecasted return for the following 10 years. She
highlighted that the total return went down from 6.95
percent in the prior year to 6. 5 percent for FY 18. The
statutory return increased from 6.2 percent to 6.53 percent
because of the rebalancing activity of taking some of the
gains and feeding the statutory net income number. Also,
inflation had stayed flat in the Callan Associates forecast
at 2.5 percent. She took a pause for questions about how
the corporation invested or what it was doing before moving
to the topic of stress tests.
Representative Wilson understood the difference between the
corpus and the ERA. She was also clear that the fund had
seen gains which went into the ERA. She asked what would
happen if there was a realized loss in the fund corpus. She
wondered if money from the ERA replaced any realized loss.
Ms. Rodell replied "yes and no." She explained that during
the course of a year on a monthly basis the corporation
reconciled realized gains with realized losses. Under
statute, once a year the corporation made a transfer of the
net amount (gains and losses added together) to the ERA.
There was only one time in 38 years, in 2008, the
corporation reversed the transfer moving money from the ERA
to the corpus because of losses. At the time the state
suffered 28 percent in losses. In the other 37 years the
fund experienced net gains.
2:30:37 PM
Representative Wilson spoke to positive performance in the
market in recent months. She asked how the corpus would be
affected by taking out more realized gains. She wondered if
the corpus would be jeopardized at all or whether
everything would balance out in the end.
Ms. Rodell replied that due to the current cushion she
believed it would balance out. She suggested that it was a
strange time, because every time the corporation went to
rebalance, the market kicked up. The circumstance defied
description in several ways. If there was a substantial
fall off, there was a scenario where all of the losses
would wipe out the ERA, but the corpus would remain
somewhat whole. She elaborated that the fund would not
realize those losses but would leave them alone in hopes
that the fund would recuperate.
Representative Wilson asked for the amounts the dividend
would have been, as it was a question her constituents
asked frequently.
Ms. Rodell replied that she could provide Representative
Wilson with what the total transfer amount under the
statutory formula would have been. However, APFC did not
calculate the dividend; it only did a transfer.
Representative Wilson surmised if committee members used
their math skills, they could calculate the dividend
amount. Ms. Rodell agreed.
Representative Ortiz asked about Ms. Rodell's inflation
figure. He referred to slide 27 and asked if the 10-year
previous average annual inflation rate was 2.25 percent.
Ms. Rodell responded in the negative. She explained that it
was the forecasted rate of inflation for the following 10
years that Callan Associates was assuming.
Representative Ortiz asked if Callan Associates had a
record of performance of their prediction of inflation rate
that Ms. Rodell felt comfortable with. He thought the state
had been through a period of relatively low inflation. He
could not see where it would only be 2.25 percent in the
following 10 years. He asked her to comment.
Ms. Rodell suggested looking at slide 25 in the last row
showing the total fund return objective of CPI plus 5
percent. She explained that CPI was considered inflation.
It was a proxy for actual inflation. Since inception the
corporation had returned the total fund return objective of
5 percent plus CPI for a total of 7.67 percent. If the 5
percent was subtracted from the return inflation would be
2.67 percent. For the last 5 years the inflation rate was
and over 3 years it was .92 percent. Inflation had been
low. However, looking forward and looking at what was
happening globally and in the United States, inflation was
starting to increase. She thought it was fair to assume
2.67 percent.
Representative Ortiz assumed that inflation or the rate of
inflation did not necessarily impact the corporation's
strategies of investments.
Ms. Rodell responded affirmatively.
Representative Pruitt referred to an article in the
newspaper about some of the decisions she had to make in
the previous year that affected the 12.89 percentage based
on her need to ensure availability of liquid money. He
asked her to comment on the impact of the total percentage
increase to the fund and how it was impacted by the changes
she had to make.
2:37:06 PM
Ms. Rodell noted that in March 2017 there had been a
general agreement between the bodies about the draw
percentage from the ERA. It was approximately 2.5 billion
or 2.7 billion. The corporation on average tried to hold
about $1 billion in cash for the corporation's own
investment purposes. The amount was based on operating
costs, the need to pay external managers, and what APFC
expected in terms of capital calls from its private equity
managers. The corporation had started targeting a cash
balance of about $3.5 billion, given the narrowing of the
agreement. As the debate continued, the number did not move
for a long time. In June, the debate led to a number closer
to $5 billion, then settled on a total draw of about $725
million. Focusing on just the $2.5 billon or $2.7 billion,
leaving the $1 billion for investments aside, compared to
the $725 million the corporation was holding about $1.7
billion or $1.8 billion in investments in Fixed Income Plus
with returns of 1.5 to 2 percent versus across all the
asset allocations. The corporation could not have the money
in an illiquid asset class because of not being able to
liquidate it. The corporation was unwilling to have the
money in the public equities portfolio because the money
would be needed for state government purposes. She did not
feel like it was a viable option to go to the legislature
to relay that the money was lost in the stock market. She
was not willing to take that risk. As soon as the
corporation had confirmed the $725 million amount the last
week in June, it immediately deployed out and got the money
back to work in the equity and the illiquid asset classes.
Subsequently, the money had been invested.
Ms. Rodell continued that currently the corporation was in
the planning stages using the draw amount outlined in the
governor's budget. Until there was additional clarity, the
corporation would continue operating as if the governor's
draw amount from the ERA was correct.
2:40:43 PM
Representative Pruitt thought she was saying that absent a
long-term stable Percent of Market Value (POMV) plan, the
corporation had to make sure liquid money was available
within a 6-month timeframe. Therefore, the return rate
would be much lower than 1.4 percent. The draw number had
been estimated between $2.5 billion to $5 billion and only
$725 million was actually drawn. He wondered about the lost
opportunity. He asked if the corporation would be able to
eliminate the swings and lost opportunities if a plan was
adopted.
Ms. Rodell answered that he was correct. She added that a
plan also allowed the corporation to fully develop the
corporation's business plan in terms of internal and
external management. She elaborated that it made sense to
manage the private equity portfolio internally because of
the high returns and high costs. However, it would not make
sense to invest in the asset class if the corporation had
to maintain liquidity measures due to uncertainty. From a
business plan perspective certainty allowed for more
choices around where the corporation hired and brought in
external management functions.
2:43:14 PM
Representative Pruitt wanted to understand the parameters
provided to Callahan Associates in terms of stress tests.
He wondered if instructions were provided about modeling
uncertainty.
Ms. Rodell corrected Representative Pruitt that it was
Bridgewater that performed the stress test. She relayed
that the instructions to Bridgewater were to create the new
liability to see what would happened in terms of the asset
allocations and what the expectation for returns might be
in the future.
Representative Pruitt asked if the liability was a POMV
type of model, a $2.6 billion liability. Alternatively, h
wondered if the liability was between $700 million and $5
billion.
Ms. Rodell answered that it was a POMV liability. It would
be as if a statutory framework was put in place to
determine how the funds would be drawn.
Vice-Chair Gara remarked that a few people on the committee
had expressed interest in an amendment that he was having
drafted. He reported hearing from several constituents that
they would be interested in not accepting their Permanent
Fund Dividend check. The money would be left in the ERA.
The way the law was currently written, if they did not
apply, the money would go to everyone else's dividend
rather than the ERA. Also, if a person applied for the PFD
and gave it back to the state, he wondered if they would be
taxed on it or whether it would be tax deductible. He
suggested that some people wanted a clean way of returning
the funds to the ERA. He had worked with Legislative Legal
Services and thought they were okay with the language. He
had also talked with the attorney general's office about
the taxability issue. He wondered if he should be working
with Ms. Rodell on the issue or if she would differ to the
Department of Law. Ms. Rodell responded that the
corporation would defer to the Department of Law.
2:46:26 PM
Ms. Rodell continued to slide 29: "What are the stress
tests?" She indicated that the chairman's office had
requested that the corporation review the stress tests.
They were stress tests conducted in the previous fall at
the request of the board chair, Bridgewater, one of the
corporation's partners in portfolio management, was asked
to develop and present stress test scenario analyses to the
board of trustees. In the past, the board of trustees had
been very direct in not weighing in on the debate as to
whether to use the ERA. The analyses were designed to gain
information in understanding what impacts could affect the
fund in the event a draw was enacted. The analyses
demonstrated the effect of stressful conditions on the fund
assuming two draws. One draw scenario was to draw 5.25
percent in years 1-2, and 5 percent in years 3-10. This
draw was, in essence, Senate Bill 26 [Legislation passed in
2018 - Short title: Appropriation Limit and Permanent Fund:
Dividend Earnings] in conference committee. A second
scenario assumed a 5.25 percent draw in years 1-2, and 4.5
percent in years 3-10. The second scenario recognized the
existing environment and a long-term ongoing plan. The
analyses estimated the returns required to achieve assumed
draw outcomes. Bridgewater compared the return hurdles to
the range of returns implied by forward looking
assumptions, Callan estimates, and historical returns
adjusted for current cash rates. She relayed there had been
times in history where cash rates had been considerably
higher than the 1.3 percent or 1.4 percent environment of
the current day.
Co-Chair Seaton asked if the numbers were based on the
previous 10-year assumption of 5.95 percent or the
currently adopted board assumption of .5 percent less. Ms.
Rodell explained that Bridgewater assumed the asset
allocation that had been approved by the board, the target
allocation of 39 percent public equities. Callan's return
forecast for the individual asset classes were also being
assumed.
Co-Chair Seaton suggested that on slide 27 there was an
average of either 6.95 percent or 6.5 percent of an overall
return to the fund. He asked what the stress test was based
on. Ms. Rodell responded that it was 6.5 percent taking
into account the standard deviation which could be seen on
the right column on slide 27. The standard deviation was a
measure of volatility. She highlighted the deviation of
18.55 percent for global equities which had a projected
return of 7.0 percent. The standard deviation indicated
that the range of outcome for global equities could be 7.0
percent or as high as 25 percent over a 10-year period. It
could also be as low as 11 percent over the 10-year period.
2:50:58 PM
Ms. Rodell advanced to slide 28: "APFC Stress Tests." She
reported that Bridgewater made 3 observations:
• Total returns for savers are likely to be historically
low over the next decade.
Ms. Rodell noted that it was no surprise that the total
returns would be historically low because inflation had
been low for a significant amount of time and 10-year
treasury rates (subtracting inflation of 2.25 percent)
would be negative for 10 years. The savings rate was
expected to be low over the following 10-year period. She
continued to review Bridgewater's observations:
• Forecasting future returns is inherently imprecise;
however, there is confidence that low cash rates will
be a drag on all assets for the medium term.
• This development presents a significant challenge to
investors whose spending plans are based on higher
expected returns than are now likely.
Vice-Chair Gara asked Ms. Rodell to return to slide 29. He
noted that drawing 5.25 percent to the value of the fund
was not really 5.25 percent but rather 5.25 percent of some
portion of the previous 6 years. In prior years, the fund
was worth less. He suggested that 5.25 percent was really
closer to 4.75 percent of the value of the fund, and 5
percent was closer to 4.5 percent. He asked her to explain
the numbers and whether the Callan estimates were based on
the previous 5 of 6 years. He wondered if they were talking
about a percentage of the current value of the fund. Ms.
Rodell replied that the POMV calculated draw of 5.25
percent stepping down to either 5 percent or 4.5 percent
was calculated on the average fund value of 5 out of the
previous 6 years. There was a 1-year lag. It took into
account the years where the fund balances were lower. There
was a lower effective draw than the rate of 5.25 percent or
5 percent.
Vice-Chair Gara clarified that when she stated 5.25 percent
under the methodology that was discussed the previous year,
it was actually less than 5 percent, closer to 4.5 percent.
He wondered if the recommendations from the consultants
were based on 5 out of the previous 6 years or on a true
percentage of the current value of the fund. b Ms. Rodell
answered, as a matter of clarification, that the consultant
was not making a recommendation. The consultant was hired
to help understand what affect the percentages would have
on the ability of the fund to grow over time and to deliver
on draw amounts. In calculating the amount of the draw over
a 5-year smoothing period, the draw money would be coming
out of the fund that would no longer be available for
investment purposes. Depending on various economic
conditions, it would have an overall long-term affect on
the fund. The board's goal was to understand the range of
potential effects and what earnings were necessary to keep
the fund in its status quo.
Vice-Chair Gara asked if the numbers in the following
slides were based on 5 of the prior 6 years. Ms. Rodell
answered in the affirmative. The numbers were based on an
average. She added that while the effective rate was lower
because of the growth of the fund balance over 5 years, if
the fund rate were to decline in the subsequent 5 years,
the effective rate would rise above 5 percent.
2:55:40 PM
Ms. Rodell continued to slide 31: "Methodology." She
relayed that there were two stress tests conducted. The
first was to make payments according to a distribution plan
until the ERA was exhausted. The consultant used the
audited balances from June 30, 2017 as the starting point.
The earnings reserve account balance of $13 billion was
used as the starting buffer. The first stress test was
conservative with respect to potential distributions and
represented a lower boundary of distributions.
Ms. Rodell explained the second stress test, which was to
continue to make the payments until the overall economic
surplus was exhausted - the amount of the ERA plus the
unrealized gains. The second test recognized that the
unrealized gains acted as an additional buffer. The stress
test was less conservative because it allowed continued
distributions even after the ERA balance was zero.
Representative Pruitt asked if inflation proofing was
included in the stress test. Ms. Rodell responded that it
did not make the assumption that the legislature restored
inflation proofing for the prior 3 years. However, it
assumed the state would make inflation payments equal to
2.25 percent after the draw was made. There was a waterfall
effect: A Percent of Market Value draw would be made prior
to an inflation draw.
Representative Pruitt wanted to make sure there was a
calculation for money going from the ERA, therefore,
requiring the ERA to make up the amount to keep the ERA at
its present level. Ms. Rodell responded, "Correct."
Representative Ortiz asked about the starting point of the
stress test being the balance of the ERA on June 30, 2017.
Ms. Rodell responded positively.
Representative Ortiz asked if the outcome of the test would
be significantly impacted if it were to be conducted again
based on the ERA balance on December 31, 2017. Ms. Rodell
did not think the outcome would be impacted substantially.
2:59:03 PM
Ms. Rodell scrolled to slide 32: "Assumptions":
Draws
• Scenario 1:
Distributions are Calculated as 5.25% of the 5-
Year Average of the Total Fund Size in years 1-2,
and 5.00% in years 3-10.
• Scenario 2:
Distributions are Calculated as 5.25% of the 5-
Year Average of the Total Fund Size in years 1-2,
and 4.50% in years 3-10.
Distributions
• Limited by either the size of the ERA (Stress
Test 1) or the ERA plus current unrealized gains
(Stress Test 2).
• Prioritized over inflation proofing payments
partial payments allowed.
• ERA can be drawn to zero, but never have a
negative balance.
Inflation Proofing
• Assessed on the Principal Fund Balance, excluding
any unrealized gains.
• 2.25% Annual Inflation (unless otherwise noted).
Ms. Rodell walked through the first scenario on slides 33:
"Scenario 1: 5.25 percent years 1-2 and 5.00 percent years
3-10" and slide 34: "Required Return (5.25 percent to 5.00
percent Scenario)." She noted that Bridgewater could not
model APFC's rebalancing efforts because the corporation
did not conduct hard daily rebalancing. Rebalancing was
left up to the discretion of the corporation's internal
managers. She reported that Bridgewater asked what type of
return would be needed to make distributions, inflation
proof, and maintain $13 billion in the ERA and $7 billion
in unrealized gains. In other words, what would it take to
keep the fund whole year-after-year. An annual return of
6.3 percent would be necessary. She conveyed that if
drawing into the ERA was allowed without tapping into the
unrealized gains portion, an annual return of 4.5 percent
would be required. In 10 years the $13 billion in the ERA
would be drawn down, but there would still be $7 billion
left in unrealized gains. If the unrealized gains of $7
billion were tapped into, an annual return of 3.3 percent
would be necessary.
Ms. Rodell continued that when volatility, the standard
deviation, was applied the probability of achieving an
annual return of 6.3 percent (making all distributions
including inflation proofing), was 52 percent. The
probability of falling short was 48 percent in at least 1
out of 10 years.
Representative Wilson referred to Ms. Rodell's note, "The
probabilities shown above assume all distributions are made
in full." She asked if she was talking about the dividend
or the distribution based on a percentage of what would be
withdrawn. Ms. Rodell responded that she was not talking
about how the money would be used, but about the amount
that would be taken.
Representative Pruitt asked if the stress test was using
the previous 10 years which included 2008 and 2009. Ms.
Rodell replied that it was the test time she was
highlighting in the current day. She mentioned that the
board had seen a number of different tests which were
available on APFC's website. She would point out some of
the lines on the chart on the following slide. She
highlighted just one because it reflected a recent 10-year
period.
3:04:16 PM
Representative Pruitt believed the board had changed the
manner in which the fund's investments fell from the 2008-
2009 timeframe. He mentioned a 30 percent drop. He asked
Ms. Rodell to describe how the corporation currently
invested versus in the previous timeframe. He asked if the
fund would be in a position of incurring a downturn similar
to the past.
Ms. Rodell responded that the target asset allocation
changed as a result of a number of things. She elaborated
that in 2005 or 2006 the legislature removed the required
list of investments and gave the board of trustees the full
gamut of possibilities. Adjustments had started being made
when the downturn hit. She thought it was important to
recognize that the test was using the fund's current asset
allocation which had a smaller allocation for public
equities than 10 years prior. The corporation had attempted
to mitigate some of the risk and volatility by having
certain private market investments. The corporation had
taken a number of mitigation steps which were recognized in
the analysis. The analysis assumed the target asset
allocation stayed static and that no adjustments were made
by the board of trustees as a result of what might be
happening currently. There were too many variables for
anyone to model.
Ms. Rodell finished her presentation of slide 34. She
reiterated that there was a 48 percent chance of not
maintaining a surplus balance of $13 billion. There was a
30 percent chance of not maintaining the $7 billion in
unrealized gains. Also, there was a 20 percent chance of
going further downward without maintaining a return
percentage of 3.3.
3:07:18 PM
Ms. Rodell moved to slide 35: "Stress Test Example: 2007-
2016 (5.25 percent to 5.00 percent Scenario)." She reported
that Callan had collected investment data regarding how
investments had behaved over the last 100 years. They had
created proxies for investment types that had not been in
existence 100 years prior. They had done a significant
amount of research on the subject. They had adjusted the
cash rates, as there had been periods over the 100 years
where the cash rate was considerably higher than 1.3
percent. Each of the grey lines on the chart represented a
distinct 10-year period beginning in January 1925. She
highlighted the number of scenarios where performance was
positive over the following 10-years - a period where there
were no extended periods of negative returns. There might
be high returns versus lower ones. She believed the chart
provided a sense of the spread of all the different stress
scenarios in 10-year increments. It could be stagflation,
the oil embargo of the 1970s, the tech crisis, and other
things.
Ms. Rodell pointed to the highlighted line on the chart
which represented the most recent 10-year period. The
financial crisis and its recovery occurred from 2007 to
2016. The rolling 5-year average fund size was used as the
starting point for 2018 and noted in the left column. She
reported that 2007 investment results were applied in that
period with a target distribution of 5.25 percent. The
portfolio would have returned 2.0 percent based on current
asset allocations. There would have been an actual
distribution based on a calculation of $2.7 billion, 100
percent of the requested distribution. The fund total under
management would have grown to $58.6 billion, the ERA would
have been $10.4 billion (a recognition of gains), and the
accumulative distribution would have been $2.7 billion. She
moved across the chart and pointed to a portfolio return of
minus 30 percent in 2019. She relayed that the portfolio
distribution would still be allowed out of the ERA in the
amount of $2.9 billion calculated on 5 of the prior 6 years
because of a small amount remaining in the ERA. The
distribution combined with the losses would take the ERA to
zero and would have eaten into the economic surplus by $3.9
billion.
Ms. Rodell continued that the financial recovery could be
seen in the out years. In 10 years, when the legislature
would be ready to do another 10-year plan, there would be a
back-up fund in the amount of $64.2 billion, accumulated
distributions would accrue to the amount of $22.6 billion,
and an inflation proofing payment of $2.6 billion would be
missed. Through the financial recovery the fund would have
recouped the unrealized losses in the principle. She
emphasized that there might be years in which the
distribution could not be made, but recuperation would be
possible and actual distributions could be made in the size
requested. She encouraged members to contact her for
additional scenarios.
Ms. Rodell moved to the scenario on slide 36: "Scenario 2:
5.25 percent years 1-2 and 4.50 percent years 3-10" and
slide 37: "Required Return (5.25 percent to 4.5 percent
Scenario)." She noted with the draw at 4.5 percent it
lowered the required returns. In order to maintain $13
billion in the ERA the annual would shift from 6.3 percent
to 5.9 percent. If the draw had to go through the ERA, the
annual return would need to be 4.1 percent. She thought it
was intuitive because in taking less, less would have to be
earned to maintain the minimum balances. She commented that
the odds of maintaining the balance in the ERA would be 56
percent (or 44 percent odds that the fund would fall
short). The odds were slightly better in maintaining the
balances with a lower 4.5 percent distribution.
Ms. Rodell advanced to slide 38: "Stress Test Example:
2007-2016 (5.25 percent to 4.50 percent Scenario)." She
highlighted a similar hit to the ERA where nothing would be
available for 2020 or 2021. However, in the current
scenario, the total fund would increase to $74.2 and the
cumulative draw distributions would be lower at $21
billion.
3:13:58 PM
Representative Pruitt suggested that in both examples there
was a zero percent payout. He mentioned the dire situation
in 2018 and reflected in 2019. He asked if the same
challenge would exist no matter the distribution. He
thought that because of the dramatic drop, there would
likely be a zero-percentage available. He asked her to
comment on his observations. Ms. Rodell responded that
Representative Pruitt was correct that the draw amount
would not have likely mattered. In that year, there was a
30 percent loss. She used $60 billion as an example. She
calculated a 30 percent loss on $60 billion which equaled
$18 billion. She pointed to the negative number in the
unrealized gain amount minus 3.9 percent. It was a
recognition of taking from an economic surplus.
Representative Pruitt suggested that if the state was
moving in the direction of being dependent on the Permanent
Fund, there was the need to recognize that a dramatic shift
could put the state back in the same situation where it did
not have money available, without having a damaging affect
on the corpus. He argued that the state still had the
challenge of managing the budget long-term.
Senator
Ms. Rodell indicated that the stress test maintained the
target asset allocation, and the corporation managed the
fund in a certain way mandated in statute. It did not
account for the possibility of the corporation being
directed to bifurcate the asset allocation in any way and
manage the ERA, for example, under a different allocation
than the corpus of the fund. She suggested that assuming
everything was equal, the corporation would continue to do
everything the way it had always done. The stress tests
were designed to give members a sense of what might happen.
In the current case, the returns were adjusted, and the
money was made back. However, there would be a year or two
where the fund would be unable to make a distribution
because the corporation did not do forced realization of
gains. It begged the question about the possibility of the
trustees realizing the gains and making the draw happen.
However, it was not what the corporation had been asked to
do. She highlighted that if the corporation acted in the
way it had always acted under the same principles it always
acted under, it was possible that the corporation would not
be able to make a distribution. She wanted to provide this
information for the legislature as it moved forward putting
a plan together. She reported that she had heard from
members of the general public that if the corporation made
6.5 percent there would be an excess of 1.5 percent which
would be fine. Her point was that the fund did not make 6.5
percent statically. The fund made 6.5 percent over a
10-year period, and within that timeframe a significant
number of things happened. One year the fund might make
minus 30 percent and the next year it might make 27.9 - a
swing of 50 percent. It averaged out to a 6.5 percent
return over a 10-year period. The board of trustees, with
the help of the stress tests, were trying to delve into
what boundaries were necessary for discussing the use of
the ERA going forward.
3:19:58 PM
Ms. Rodell reviewed slide 39: "Summary Comparison." She
summarized that the required return was 6.3 percent or 5.9
percent depending on the distribution percentage in years
3-10. The probability of falling short fell 4 percent
through the two scenarios. In terms of expected 10-year
outcomes based on the Callen capital market estimates the
cumulative distribution would be roughly $30 billion. The
fund size would have stayed and continued to grow to about
$75 billion to $78 billion. The ending of the ERA would be
between $14 billion to $17 billion. She relayed that the
6.3 percent would not be going into the ERA. There would
also be an economic surplus. The gains would continue to
accumulate to between $21 billion to $24 billion. There
would not be any missed inflation proofing dollars. She
made herself available for questions.
3:21:30 PM
Co-Chair Seaton appreciated the stress test because things
were not static. He asked about when the corporation
decided to put more cash in the previous year because there
was a variable amount and the state lost money and
investment. He recalled Ms. Rodell wanted to go to cash
because she anticipated the money getting lost in the stock
market. He suggested that in her forward looking investment
strategy she was not secure enough to say that the returns
would not fall. He thought she made a rational decision to
have liquid assets available. She did not know how the
stock market or other assets would perform. He asked if his
rendition was correct.
Ms. Rodell responded that because of having to come up with
a certain amount of cash on July 1 and not know how the
markets would perform, it was better to maintain safety of
that portion of the fund from which the cash would be
drawn. She knew she would be expected to deliver a portion
of revenue for state government purposes.
Co-Chair Seaton asked if there was an expectation that the
draw would be instantaneous, and all of the cash would be
needed at once. He wondered if something was in statute
that would require the transfer to be made on July 1.
Ms. Rodell responded that there was nothing in statute that
provided direction on this issue. The corporation was
operating under the same knowledge as it had before.
Previously the majority of cash was taken in by DOR in the
first part. The corporation had always transferred the
amounts needed for the dividend in August and September to
be distributed in October. It was possible that the
corporation could have worked with DOR to time out the
distributions once the corporation knew the amounts. She
continued that whether the corporation needed the cash in 3
months on July 1, 6 months on September 1, or 9 months on
January 1, the short time horizon meant that the
corporation had to maintain the safety of being able to
access cash. The corporation could have put the money in
longer duration fixed income. The return would have been
greater than 1.4 percent but would not have reached 12.89
percent. It was an opportunity cost.
Representative Pruitt provided a hypothetical scenario. He
asked what the cost would have been to the state to
liquidate an additional $2 billion that would have been
needed. He asked how much more than $2 billion would have
had to be liquidated.
Ms. Rodell answered that the corporation would have had to
start realizing gains because of being in a bull market.
She explained that when the corporation realized gains
currently, it reinvested immediately. Part of the job of
the director of asset allocation and risk management was to
sometimes hold cash rather than deploying it. The director
would have been looking forward to seeing what was expected
in current income and not deploying it into the asset
allocation. The director also worked with the portfolio
managers for public equities and fixed income plus to
determine how to best accumulate the additional $1.2
billion.
3:28:36 PM
Vice-Chair Gara conveyed that the lesson he was getting
from the discussion was the longer the state waited and
looked over the fiscal cliff, the fewer options it would
have. He and Representative Thompson had suggested a
temporary dividend amount of $1500 that could be reformed
later. Several people did not support the idea and no
changes had been made. Many people at the legislature
wanted things to happen but there were not enough votes to
make thing happen. He stated that the lower draw, the less
the state would have for services and a dividend. Ms.
Rodell agreed.
Co-Chair Foster reviewed the agenda for the following day
and encouraged Ms. Rodell to provide any additional
information she deemed necessary.
ADJOURNMENT
3:31:57 PM
The meeting was adjourned at 3:31 p.m.
| Document Name | Date/Time | Subjects |
|---|---|---|
| 20180122_House Finance Committee_Final v.pdf |
HFIN 1/22/2018 1:30:00 PM |
HFC - APFC Overview |
| APFC Bridgewater Stress Test.pdf |
HFIN 1/22/2018 1:30:00 PM |
Follow up HFIN-APFC Overview |
| APFC Bridgewater Stress Test (Reduced Distributions).pdf |
HFIN 1/22/2018 1:30:00 PM |
Follow up HFIN-APFC Overview |
| APFC - Response DNR Permanent Fund Deposits.pdf |
HFIN 1/22/2018 1:30:00 PM |
HFIN APFC Overview Response |