Legislature(2023 - 2024)ADAMS 519
02/10/2023 01:30 PM House FINANCE
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| Audio | Topic |
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| Start | |
| Presentation: Alaska Permanent Fund Corporation | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
| + | TELECONFERENCED | ||
| + | TELECONFERENCED |
HOUSE FINANCE COMMITTEE
February 10, 2023
1:35 p.m.
1:35:11 PM
CALL TO ORDER
Co-Chair Johnson called the House Finance Committee meeting
to order at 1:35 p.m.
MEMBERS PRESENT
Representative Bryce Edgmon, Co-Chair
Representative Neal Foster, Co-Chair
Representative DeLena Johnson, Co-Chair
Representative Mike Cronk
Representative Alyse Galvin
Representative Sara Hannan
Representative Andy Josephson
Representative Dan Ortiz
Representative Will Stapp
Representative Frank Tomaszewski
MEMBERS ABSENT
Representative Julie Coulombe
ALSO PRESENT
Deven Mitchell, Executive Director, Alaska Permanent Fund
Corporation; Jim Parise, Deputy Chief Investment Officer,
Alaska Permanent Fund Corporation.
SUMMARY
PRESENTATION: ALASKA PERMANENT FUND CORPORATION
Co-Chair Johnson reviewed the meeting agenda.
^PRESENTATION: ALASKA PERMANENT FUND CORPORATION
1:36:08 PM
Co-Chair Johnson invited the presenters to the table.
DEVEN MITCHELL, EXECUTIVE DIRECTOR, ALASKA PERMANENT FUND
CORPORATION, introduced himself and staff present. He
shared that he was relatively new to the position and had
been in the job for about three months. He provided detail
about his past work as debt manager and the executive
director of the Alaska Municipal Bond Bank Authority.
Mr. Mitchell introduced a PowerPoint presentation titled
"APFC: House Finance Committee," dated February 10, 2023
(copy on file). There were three components of the
presentation including the Permanent Fund's historical
construct, the enduring financial resource created in the
Permanent Fund, and the intergenerational aspect of the
plan implemented by predecessors. He began on slide 2 and
provided a history of the fund. He detailed that in 1969
the Prudhoe Bay lease sale brought more than $900 million
to the state. He reminded legislators that in the 1960s the
state's budget was around $150 million a year, which was
starkly different than present day. He noted that $900
million had been an extraordinarily large sum of money for
the state to oversee. In 1971, President Richard Nixon
signed the Alaska Native Claims Settlement Act (ANCSA) that
paved the road for the Trans-Alaska Pipeline Authorization
Act and the construction of Trans-Alaska Pipeline System
(TAPS) in the mid-1970s.
Mr. Mitchell believed in part because of the $900 million
that came into the state previously and how quickly it
found its way through the state treasury due to the
significant need of the state, the leaders recognized the
incoming wealth was likely more than the state could spend
prudently at the time. Additionally, the revenue stream was
projected to end by the late 1990s (the Prudhoe Bay curve
went to zero in the late 1990s in projections from the
1970s). Therefore, leaders at the time decided to set aside
a portion of the funds for the benefit of future
generations. He relayed that the constitutional amendment
establishing the Permanent Fund was approved by the
legislature and went to the voters in 1976.
Mr. Mitchell continued to review the history of the fund.
The first deposit of oil royalty revenue was $734,000 in
1977. In 1980 the Alaska Permanent Fund Corporation (APFC)
was established to manage and invest the fund. He noted the
state budget was $4.5 billion in 1981, much of which was
capital. He moved to slide 3 titled "The Permanent Fund"
showing the state's constitutional language pertaining to
the fund. He read from the first portion of the statutory
language:
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...
Mr. Mitchell elaborated that in general, the majority of
the revenue provided into the fund came from royalty
revenue. He noted that the other sources added incremental
value. The state legislature authorized an additional 25
percent to be deposited into the fund by statute. He
explained that the statute had been followed or had
appropriations adopted subsequent to the year they were
due. He highlighted the intergenerational concept of the
fund where a finite resource became an unlimited or
renewable resource.
1:41:36 PM
Mr. Mitchell asked Co-Chair Johnson's preference in terms
of taking questions.
Co-Chair Johnson relayed that members could ask questions
throughout the presentation.
Co-Chair Edgmon looked at slide 3 and stated he believed
the legislature overall had done a pretty good job
regarding its debt service. He noted the fact that the
legislature had been pretty responsible in terms of putting
special appropriations into the Permanent Fund; however, it
tended to get lost in the shuffle. He stated it typically
went unrecognized that the legislature, to a large degree,
played a role in the growth of the fund in terms of
statutory changes and investment policy in addition to
putting additional money into the fund. He stated the
legislature got a bad rap for overspending or
irresponsibility in the budget; however, the record to a
certain extent was much to the contrary - the legislature
had been responsible and fairly forward thinking. The APFC
and legislators had worked together to grow the fund to its
current balance. He highlighted the fund was one of a kind
in the country and possibly Western civilization in terms
of its ability to provide for essential services and an
individual payout to every citizen.
1:44:08 PM
Mr. Mitchell stated the presentation included slides on the
topic. He relayed that the constitutional royalty revenue
deposited into the fund on a nominal basis was around $15
billion. The principal fund balance was currently $52
billion; the difference reflected optional contributions
made by the leadership beginning in 1977 going forward.
Mr. Mitchell advanced to slide 4 titled "Renewable
Financial Resource." He referenced the principal balance of
$52 billion. He noted there were different numbers in the
presentation, some of which was a convention of the
financial and accountancy rules not being aligned with the
statutory construct or rules for accounting for earnings
for example. The fund had received earnings of $82.1
billion. He provided a breakdown of the earnings use
beginning with $18 billion for inflation proofing the
principal and $12.3 billion for special appropriations to
the principal. There was $0.4 billion for the Alaska
Capital Income Account funded through the Amerada Hess
settlement. He explained the settlement came from a court
case related to royalty revenue payments of oil companies
where the judge had ordered any money deposited into the
Permanent Fund as a result of the settlement to be
segregated from the Permanent Fund Dividend (PFD)
calculation because it had been a potential bias to the
jury hearing the case. He elaborated that the money was in
the principal of the Permanent Fund, but it was not
included in the percent of market value (POMV) or dividend
calculation. The payments out of the Earnings Reserve
Account (ERA) for PFDs through FY 18 were $24.4 billion.
The POMV payments out of the ERA from FY 19 through FY 23
were $15.9 billion. He relayed the use of the fund since
the implementation of the POMV had been at a higher level
than it had been historically.
1:47:22 PM
Mr. Mitchell addressed the responsibility of managing and
investing for all generations on slide 6 titled "Investing
for the Long-Term." He stated it was a concept that he may
have ignored more than he should have because he had been
focused on trying to provide a picture of the highest
ability to pay and the best credit he could portray to
rating agencies or investors. He stated that now,
reflecting on the construct of the Permanent Fund and
surrounding statutes, it was about much more than the
ability to pay in the current year; it was about being able
to pay in the current years, 10 years, 20 years, and so on.
The ability to pay at present was based on what the people
had done in the past to set aside the money in order to
have a resource providing for the ongoing transfers to the
state. He noted it was one of the most important concepts
that had come to the forefront for him in his new role.
Mr. Mitchell continued to review slide 6. The statute
specified the fund's goal was to protect principal while
maximizing total return. He elaborated that the fund's
asset allocation was not designed to hit home runs, but to
hit consistent base hits. The corporation had an investment
staff focused on maximizing return in addition to a risk
staff focused on ensuring investments were risk adjusted
and reasonable. He clarified that the fund's investment
performance was not a static target. The corporation
targeted a return that would pay for the POMV transfer of 5
percent in addition to the inflation impacts of the prior
year. He explained the target would be lower in years when
inflation was low whereas the target was much higher in
years when inflation was high. For example, inflation had
been 8 or 9 percent the previous year; therefore, the
targeted return had been 13 or 14 percent versus 7 percent
in years with 2 percent inflation. He added that in order
for the fund to maintain its ability to provide value to
the state, it had to be inflation proofed. Otherwise, a
dollar provided in the present day would not be worth the
same amount in five years due to the eroding impact of
inflation.
1:51:05 PM
Representative Stapp asked about the CPI [Consumer Price
Index] + 5 percent target. It was his understanding the
corporation was adjusting its inflation proofing to the
actualized CPI annually.
Mr. Mitchell replied in essence it was true. There was a
formula in statute defining how the inflation rate was
determined. The amount was based on the prior year's
inflation.
Representative Galvin thought about the board's appetite
metric. She wondered if the current board had given any
directive advocating for or against the POMV budget policy.
She understood the previous board and executive director
had some outward communications regarding budget policy
pertaining to POMV.
Mr. Mitchell answered that the board resolutions supportive
of the POMV concept remained in place and the trustee
papers describing the concerns of the board remained in
place. He stated there was a bit of a disconnect in that
APFC was not mandated to provide a strategy to generate a
POMV payment. The APFC mandate was to keep the principal
safe and maximize return. He elaborated that APFC did not
just ignore the calls coming on the fund, but there was a
bit of tension there. The board did not want make
investment decisions based on a need to transfer monies to
the state. The corporation made investment decisions based
on the ability to maximize returns within its portfolio
benchmarks. The corporation had to manage for the calls
within the template even though it was not specifically
mandated.
Representative Galvin appreciated the answer. She stated it
was sometimes difficult to delineate the line between
investment strategy and budget policy. She would appreciate
it if Mr. Mitchell would share any nuances or policy
directives the legislature should be aware of. She knew it
was something that was strongly voiced.
1:55:04 PM
Mr. Mitchell discussed slide 7 titled "Diversified
Portfolio." He stated that Alaska had a relatively small
gross domestic product (GDP) - in the mid-$50 billion range
- in comparison to other states. The corporation had
investments around the world in over 100 countries and
3,000 distinct entities primarily focused on North America
and the United States to provide revenue back to Alaska. He
highlighted an arrow on the map pointing to Alaska
reflecting $540 million partially managed by a firm located
in Alaska in addition to funds that were part of a private
equity strategy implemented in recent years with some
investments located in Alaska.
Representative Hannan looked at the map on slide 7 and
observed that the United Kingdom had 3 percent of the
portfolio. She asked if there was a particular investment
type the fund made in the U.K.
JIM PARISE, DEPUTY CHIEF INVESTMENT OFFICER, ALASKA
PERMANENT FUND CORPORATION, answered that there were many
financial partners in the U.K. The fund invested in large
banks, which accounted for a large part of the fund's
index. Additionally, the fund had some real estate holdings
in the U.K. He stated it was a pretty sophisticated
financial system in the U.K.
Co-Chair Johnson remarked there had been a bill that would
require APFC to take the environmental social governance
(ESG) perspective into account when making investments. She
asked how it impacted the way the investments were pursued.
She asked if it was straight out financial.
Mr. Mitchell replied that the less controls placed on
managers making investment decisions the better. He noted
that there were exceptions. He highlighted the current
situation with Russia and explained the fund would not want
to make additional investments there at a time when Russia
was taking actions the world and the U.S. in particular did
not condone. There were cases where it made some sense not
to have investment because of social or other risks. He
shared that he had been on the APFC board for a short
period of time and recalled a presentation from a board
advisor that went through some of the investment/divestment
choices made over the past 20 years based on ESG type
criteria including tobacco, oil companies, and other
industries. The analysis had used CALPERS [the California
retirement system] and indicated the system had foregone a
significant amount of revenue of around $1 billion as a
result of the investment sectors outperforming (in part
perhaps because CALPERS left the sector). He highlighted
that when an investor was no longer an equity participant
in a company, their ability to influence the company was
diminished. He used divestment in oil and gas companies as
an example. He remarked he did not know how the action
could be reconciled when the State of Alaska received a
large portion of its money from the oil and gas industry.
He elaborated that suggesting the state should divest from
the oil and gas industry would have resulted in negative
performance over the past couple of years due to the
outperformance of the sector.
Mr. Mitchell elaborated that APFC had an awareness of the
ESG criteria because it was something the market was
trending towards and ratings agencies had developed a
subsection of their report on ESG criteria. To the extent
it was creating an opportunity, APFC would want to take
advantage of somebody's positioning, but otherwise the APFC
board would not advocate for limiting investment decisions
based on somebody's analysis of ESG criteria.
2:02:09 PM
Mr. Parise expounded that in terms of investments, the
Permanent Fund was a total return fund. He elaborated that
if APFC was told it had to do something else, it would;
however, APFC only looked for the best investment and was
agnostic as to where it came from. He provided a green bond
as an example where ESG had been beneficial to the fund. He
explained that people were willing to take less yield on a
bond because it had the ESG high score. He detailed that
APFC did not buy green bonds, but would sell them. He
believed the purchase of the bonds did stakeholders a
disservice because they were buying based on the value
someone placed on ESG. He reiterated that APFC investment
managers only invested in what made sense for the
portfolio. The fund worked to beat indexes; if its
benchmark did not have any ESG component, the fund would
not invest in ESG.
Mr. Mitchell moved to slide 8 titled "Asset Allocation:
APFC's Investment Policy." The slide showed the progression
of the sophistication of the fund's asset allocation. In
1980 the fund was entirely fixed income and over time the
asset allocation had become much more diverse. He noted
that Mr. Parise would provide details on the various
sectors later in the presentation.
Mr. Mitchell moved to a bar chart showing real return
comprised of 10-year historical lookbacks. The yellow dots
reflected the return objective of CPI + 5. He highlighted
the fund had exceeded its return objective for the past
four 10-year lookbacks, it had failed the mean for the 10
years prior to that, and had met the mean for the 6 years
prior to that. The chart reflected the cyclicality of
markets and the high standard to reach the 5 percent POMV
payout. He noted that based on historical experience there
would be 10-year periods of time where APFC did not achieve
CPI + 5 and it would require a significant amount of
discipline by policy makers and investment staff to ensure
there was a consistency of course during good times and
bad. He explained that for long-term expectations like 30-
year time horizons, the likelihood of hitting a return
objective of CPI + 5 was much higher.
2:05:36 PM
Representative Josephson asked if the graph on slide 9
included the $12 billion in special appropriations over
time. He had seen $8 billion of the special appropriations
deposited during his time with the legislature, once when
there had been an inadvertent failure to veto $4 billion.
He surmised the special appropriations and inflation
proofing had helped achieve long-term objectives.
Mr. Mitchell agreed it had helped the intergenerational
value concept. He noted slide 9 was not oriented towards
the concept; it showed the real return compared to the
inflation objective. The presentation also included a later
slide showing the [special appropriation] deposits over
time.
Mr. Parise addressed slide 10 titled "Fund Performance vs
Benchmarks." He intended to provide a high level overview
of investments made at APFC, how the investment team
thought about things, and what it was trying to achieve. He
relayed the fund had three benchmarks. The first was the
return objective, which APFC tried to achieve through the
asset allocation of the board. The fund used the investment
consultant Callan who talked with the board in coordination
with staff to come up with an asset allocation that was
meant to try to beat the return objective. He clarified it
was not an actual benchmark the investment staff tried to
manage to because there was no index guaranteeing CPI + 5.
The corporation had to come up with a way to stay within
the board's asset allocation and meet the return objective.
Mr. Parise explained there were two benchmarks the
investment staff and board looked at. The first was the
passive index made up of 60 percent stocks, 20 percent
bonds, and 10 percent real assets such as real estate and
TIPS [treasury inflation-protected securities]. He
explained if managers did nothing else, the passive index
was what the fund would achieve. The fund managers had
added more sophisticated investments including private
equity, private credit, and infrastructure. The chart
reflected that adding the additional complexity to the
portfolio was worth it over time because the returns beat
the passive index. The second benchmark the fund was
measured against was the performance benchmark that
combined all of the asset classes. Each benchmark within
the asset classes was weighted to the size of the portfolio
and asset classes within the portfolio. The benchmark
indicated whether the managers and chief investment officer
(CIO) were adding any value. The numbers on slide 10 showed
the answer was yes.
Mr. Parise elaborated on slide 10. He explained that the
board provided the asset allocation. For instance,
directing the fund to have 39 percent in equities. The CIO
had a band in which to underweight or overweight equities;
it was the CIO's job to determine what they thought would
happen. He clarified that the managers did not make large
positions/bets versus the benchmark because they were
extremely prudent and did not believe they had a way of
beating the market; however, there were times small
adjustments could be made to the portfolio in an effort to
beat the benchmark. He highlighted that the proudest year
of performance for investment staff was the previous year,
FY 22. He looked at the passive portfolio showing equity
had fallen off a cliff; it had been a nasty year. The fund
beat its performance benchmark and passive benchmark pretty
handily in a down year. He stated it was very easy to get
panicked and make bad decisions when the market was going
down; however, the fund and CIO had a disciplined and
methodical process. He expounded that FY 22 followed a year
where indexes had been up 27 percent and the fund
outperformed by 2 percentage points.
Mr. Parise continued to address slide 10. The chart
included FY 22, 3-year, 5-year, 10-year, and 30-year. He
pointed out that of the past five years the fund had
outperformed three years. In the other two years, the fund
had underperformed by 5 basis points in one year and 70
basis points in the other. However, when the fund won, it
won pretty big. He explained that if there was low hanging
fruit or dislocation in the market, the fund tried to take
advantage of the situation, but it did not occur very
often.
2:12:01 PM
Representative Stapp asked increasing diversification of
the asset allocation (i.e., private equity, private income,
and infrastructure) made it easier for the fund to mitigate
risk.
Mr. Parise agreed diversification across asset classes gave
the fund managers more levers to use. One of the things the
corporation considered when deciding whether to add an
asset class was whether it had the resources, bandwidth,
and a possible edge and that there was not someone out
there that was more sophisticated that would hurt the fund
if it invested in the asset class. The fund took adding an
asset class or securities it had not previously owned
pretty seriously. He explained the fund needed to ensure it
had everything in place and there would not be unintended
consequences of owning the asset.
Mr. Parise advanced to slide 11 titled "Benchmarks -
Internal Fixed Income Example." He described a benchmark as
the standard being measured against. The fixed income
composite benchmark reflected how the overall fixed income
category performed in a given time period. The slide broke
out the underlying [fixed income] assets and portfolios
managed by APFC and compiled them into a total based on
their weighting in the portfolio. He relayed there was a
team of seven fixed income managers at APFC who were each
responsible for different portfolios and were tasked with
beating their benchmark within a risk parameter set by the
board and it generally included what was in the index only.
For example, the corporate bond index was rules-based and
included any bond with an issue size of $350 million or
more that was 18 months or longer and was investment grade.
The fund was allowed to buy any of those bonds and its job
was to select the best bonds to beat the index.
Mr. Parise continued to explain slide 11. The goal for each
of the portfolio components was to outperform its
benchmark. He used the global rates component as an example
and noted it underperformed its benchmark. He detailed that
if global rates was underweighted versus the benchmark and
overweighted a different component, it was still possible
to beat the benchmark. The strategy came down to asset
allocation within fixed income in order to beat the
benchmark. He used the U.S. corporate allocation as another
example and explained that within the allocation, APFC
could decide it wanted to own more banks than utilities. It
could drill down to selecting specific banks, different
investment time periods, specific coupons, etcetera. The
fund managers' job was to figure out the best bonds to
invest in. The selection included a disciplined thought
process and robust portfolio analytics that allowed
managers to dissect the portfolios. The method was not
limited to fixed income and included the fund's equity
program as well. The goal was to grind out performance at
all times and not take big bets.
2:16:28 PM
Representative Hannan asked what TIPS were.
Mr. Parise replied that TIPS are inflation adjusted
treasury securities at the real rate.
Representative Hannan asked if TIPS were credit securities.
Mr. Parise answered that TIPS are not credit securities and
are guaranteed by the federal government. He elaborated
that TIPS were indexed to CPI. The current yield for a
five-year TIP was about 1.36 percent, but the number
adjusts with inflation.
Mr. Parise turned to slide 12 titled "Focus on Increasing
Internal Management." He relayed that over time APFC's
internal management had become more sophisticated. The
fund's asset allocation included public equities, fixed
income, private equity, private income, absolute return
(hedge funds), risk parity, cash, and real estate. The
corporation was working to determine where it could begin
bringing some of the assets under internal management. He
explained that fees alone were not a reason to make the
change. He stated it was not prudent to fire external
managers merely because they had high fees; there was
likely a reason they had high fees. He detailed that APFC
had to know it had the bandwidth, skill, or some sort of
edge that allowed in-house managers to beat a benchmark or
external managers. He elaborated that all fixed income
management had been brought in-house in 2022.
Mr. Parise elaborated on slide 12. He relayed that APFC had
brought some of its private equity portfolio under in-house
management in 2013. The fund would not bring the entire
asset class under internal management. He noted that
private equity involved investing in private companies. He
expounded that the investment was extremely labor
intensive, time sensitive, and required analytics and "an
army" of analysts to decide what was a good investment. The
fund could do co-investments in private equity where it
hired a manager to buy numerous companies. He explained the
external manager may see a company it wanted to invest in
that exceeded its $100 million fund. Under the scenario,
the manager may only be able to contribute $20 million and
may ask APFC if it would be willing to invest $100 million.
He furthered that on top of the due diligence performed on
the asset by the external manager, APFC would do its own
review in addition to getting advice from its third-party
consultant and would then decide whether or not to co-
invest. He explained there was no fee and no carry in the
co-investment, meaning it diluted the overall fee APFC paid
to the external manager. He noted that the term "carry"
meant that typically when a private equity manager
performed well, APFC had to pay them year after year. Under
the co-investment scenario, there was no carry fee.
Additionally, it enabled APFC to move the portfolio around.
For example, if the proposed investment was in a software
company and APFC's private equity portfolio was underweight
in software, the investment enabled APFC to put a
considerable amount of money in software immediately.
2:20:37 PM
Co-Chair Edgmon recalled a recent conversation where the
committee had been told that every barrel of oil was not
equal in terms of valuation, whether it came from state or
federal land, and other factors. He thought of the notion
that every dollar in the ERA was not necessarily created
equal in the sense of unrealized and realized gains and
other. He believed the topic was worthy of discussion at
some point. He stated there were some profound implications
in having a given amount in the ERA, while much of the
funding was tied up and much was in a more available liquid
state. He spoke about oil price volatility in the coming
years and considered it may be necessary to get into
understanding the topic more. He thought it was fascinating
to know there was so much going on behind the scenes at
APFC in the fund management. He thanked Mr. Parise for the
detail and noted it was an incredibly important point and
one that many did not understand.
2:22:42 PM
Representative Ortiz asked when the ERA had been created.
Mr. Mitchell answered it had to have been the early 1980s
before 1983. He noted the first PFD had been a $1,000 [per
person] transfer out of the general fund. He would follow
up.
Representative Ortiz asked about a scenario where the split
fund was eliminated and replaced with one combined fund the
fixed POMV model could draw from. He asked if it would
impact the fund's portfolio in a good or bad way.
Mr. Parise replied from the perspective of investors they
did not care about the ERA. He elaborated it was not
discussed or thought about by fund managers. The investors
managed for total return versus the benchmarks.
Mr. Mitchell responded, "For the rest of us, yes, it would
be very helpful." He referred back to his explanation of
tension that existed because APFC had a specific mandate in
its statutes that ignored the needs of the state, but as
good residents, APFC wanted to be cognizant of the state's
needs and expectations of the legislature and others to
provide on an annual basis. He explained that Mr. Parise
was investing without regard to that need; however, the CIO
through coordination with the chief financial officer (CFO)
was setting money aside to meet the state's cash calls
based on a schedule worked out with the Treasury Division
[within DOR].
2:25:37 PM
Mr. Parise agreed. He confirmed that when the investment
managers knew there was cash needed, they managed for that
need. He clarified that investors were not managing for an
ERA, they were managing against the benchmarks. When
managers knew funding was needed, they moved the portfolio
around and many times it was used as an opportunity to
rebalance the portfolio. For example, if managers knew $400
million was going to the state, they moved things around to
make refinements to the portfolio.
Representative Ortiz stated that theoretically the
legislature could draw the entire amount in the ERA if it
was crazy enough to do so. He thought the absence of that
potential could provide more freedom for APFC to be more
profits or earnings driven.
Mr. Parise agreed that on the margins it was likely true;
however, the fund had enough to sell and enough liquidity
to do what it needed.
Representative Hannan referenced slide 8 regarding APFC's
asset allocations. She observed that at one point the asset
allocations APFC managers were allowed to make was driven
by specific policy. She asked if the asset allocations were
driven by a policy set by the board. She observed that APFC
currently invested in all asset classes. She asked if there
was policy that specified how much of the portfolio was
invested in each asset class. For example, no more than 10
percent in real estate and no more than 20 percent in
bonds. Alternatively, she wondered if the asset allocation
policy decisions were no longer driving the allocations.
2:28:15 PM
Mr. Parise answered that the board set the asset
allocations with bands, which gave fund managers the
freedom to move where it saw fit.
Mr. Mitchell added that the board set the allocation on an
annual basis.
Mr. Parise turned to slide 13 titled "APFC Performance
Relative to Large Public Funds." He highlighted that APFC
performance had been in the top decile in the last year,
last three years, and last five years. He noted the
performance was compared to some large funds with higher
allocations to private equity, meaning they had riskier
portfolios. He elaborated that APFC's success had been with
less risk than some of the largest public funds such as
CALPERS and CALSTRS [California State Teachers' Retirement
System]. The numbers indicated that the fund's performance
had been doing very well over the past few years with a
consistent, disciplined process.
Mr. Parise moved to slide 14 titled "Tenured and Seasoned
Investment Leadership." The slide showed investment
managers and leadership who had been managing the APFC
portfolios for a long time.
Representative Josephson asked if the people listed on
slide 14 were the individuals who needed to arrive in the
office at 4:00 a.m.
Mr. Parise answered, "That's me." He relayed that generally
everyone was at work around 6:00 a.m. or 7:00 a.m. He noted
that private market managers did not necessarily need to
come in as early, but public markets (stocks and bonds)
managers had to be there when the market opened.
Mr. Mitchell addressed slide 16 titled "Financial Resource
for Alaska." The slide addressed the state's reliance on
the revenue stream from the POMV and APFC's work to be a
good citizen by providing the predictable stream of revenue
even though it was not necessarily the mandates provided by
statutes. He elaborated that Mr. Parise had a mission
driven job and needed to be able to ignore the noise of
suggestions that something happen with the ERA. He
explained Mr. Parise should not spend his energy worrying
about the scenario and considering how he would get out of
positions to provide extra cash. The goal was for
predictableness and reliability. The fiduciaries for the
fund were the Board of Trustees and they were responsible
for setting the asset allocation. The asset allocation
included bands, meaning that as allocations could go up and
down in value without automatically being out of
compliance. The investment policy was revisited annually
and had a three-year prospective outlook that could evolve
from year to year.
Mr. Mitchell discussed state revenue on slide 17. The slide
included a bar chart showing the importance of the revenue
flowing from the POMV. He explained that when the POMV was
instituted in FY 19 it had a hugely calming effect on the
state's finances and credit ratings. He noted there were
considerably larger UGF revenues from petroleum revenue in
FY 14, whereas FY 15 through FY 18 had been rough years for
the state with large draws on the CBR Fund. There had not
been many options people could agree upon and the POMV
became a solution that worked from the perspective of
meeting the state's needs while ensuring the fund met the
statutory and constitutional mandates of maintaining the
intergenerational value. The transfers in FY 20 and FY 21
were the largest component of state revenue in those years.
He added that even in FY 22, petroleum revenue accounted
for the largest single revenue source. He highlighted the
predictability of the POMV on a year to year basis. He
stated that the FY 23 payment was in process with about
half yet to be transferred. He explained that the FY 24
payment was already known because the POMV calculation was
5 percent of the average of the last five complete fiscal
years.
2:34:42 PM
Mr. Mitchell turned to a bar chart on slide 18 and
discussed principal contributions and intergenerational
benefit. He believed the chart illustrated the sacrifice of
the 45 or so past generations of Alaskans to provide the
resource now existing in the Permanent Fund. He detailed
that in each of the years shown, the money could have been
used for schools, capital projects, or other. He
highlighted 1986 and 1987 when the bottom had fallen out of
the Alaskan economy, there were still savings put away for
the state's future. He remarked it was extraordinary to
have the dedicated and statutory royalty revenues, the
deposits from the ERA and general fund, the Amerada Hess
settlement money, inflation proofing from the ERA, and
special deposits from the ERA in 2020 and 2022. He noted
the bar for 2023 was not yet complete. He added there was a
makeup in 2023 of contributions from the state to provide
for the statutory royalty revenues of some of the past
years that had not received full contributions during the
2016 to 2018 timeframe.
2:36:22 PM
Mr. Mitchell addressed the ERA with a graph on slide 19. He
pointed to the red line showing the net impact of
contributions and withdrawals [from FY 14 to FY 22]; the
line generally ascended and became choppier. He looked at
the blue bar in FY 22 [FY 20] reflecting statutory net
income money into the ERA and the brown bar reflecting the
POMV transfer out. He noted the POMV transfer out was about
equal to the statutory net income but adding the outflow of
inflation proofing and special appropriations resulted in a
dip in value. There was an increase in FY 21 with the bull
market resulting in a 29 percent return for the fund. In FY
22, there was an outflow as the POMV and inflation proofing
exceeded statutory net income for the year.
Mr. Mitchell relayed that statutory net income in the
current year was surprisingly low; it was driven entirely
by markets. He highlighted it had gone from $3.5 billion in
FY 14 to $2.9 billion in FY 15 and $2.2 billion in FY 16.
The decrease had been followed by a run of fairly
extraordinary statutory net income at $6.3 billion in FY
18, $3.3 billion in FY 19, $3.1 billion in FY 20, and $7.6
billion in FY 21. He noted the bull market in 2021 resulted
in the high number in FY 21 with some residual impact in FY
22 resulting in statutory net income of $4.5 billion. He
explained that FY 23 would be closer to $2 billion. He
explained the $2 billion would essentially replace the $6.3
billion in the statutory formula for the PFD. He elaborated
that if the $2 billion trend continued into the future it
would have a stark impact on the formula.
Mr. Mitchell discussed the effective POMV rate shown on the
bottom line of a table on slide 19. He explained that the
fund had been ascending in value. He detailed when there
was an increasing fund value and a historical average was
taken, it meant less than 5 percent would be taken from the
present day balance; therefore, the POMV draw had been less
than 5 percent of the current fund balances. He highlighted
the 4.04 percent POMV draw in FY 22 and 4.52 percent POMV
draw in FY 20. He relayed the opposite would be true for a
trend of fund declines; the draws would be much higher than
5 percent.
Representative Stapp asked if there were failure mechanisms
in the current POMV formula. He asked if it would create a
problem with the POMV draw if there were several years of
declines in the fund combined with high inflation.
Mr. Mitchell responded that the scenario would create a
problem and there was no safety feature. He elaborated that
the principal of the fund was protected by the [state]
constitution and could not be spent. The ERA housed the
realized earnings of the fund (i.e., interest income,
dividends, rentals, and realized gains), which could be
spent. He explained if there was a period of low statutory
net income years combined with high inflation, there was a
significant probability of insufficiency in the ERA. He
informed members that the Legislative Finance Division
(LFD) had created a probabilistic model that had recently
been presented in the Senate Finance Committee. The
division had not pulled all the levers on the model; it
included a static inflation assumption based on Callan's
inflation projections, which were relatively low at 2.5
percent. He explained that a higher inflation level in the
next couple of years would have a much more drastic impact
on the durability of the ERA. The model also included a 5.1
percent statutory net income variable, whereas the actual
current fiscal year number was about half of that amount.
He believed the LFD presentation had 10 percent probability
of an insufficient balance in 2027. He explained that a
worse case scenario would pull that number forward to 2025
and the legislature would be faced with struggling over how
to provide the 2026 POMV.
2:42:26 PM
Co-Chair Johnson asked for the projected ERA balance at the
end of FY 23.
Mr. Mitchell turned to slide 20 and shared that the ERA
balance was currently $13.5 billion from a financial
statement perspective. He relayed there were a number of
nuances that made the balance much more austere. First,
there was a $4.2 billion inflation proofing transfer
scheduled to be made from the ERA at the end of FY 23.
Additionally, the FY 24 POMV payment was $3.5 billion.
Theoretically, the combined $7.7 billion would be
transferred out of the ERA on July 1, 2023. It was certain
the $4.2 billion would be transferred at that time in
addition to a portion of the $3.5 billion. The $3.8 billion
available for appropriation included the $1 billion in
realized statutory net income in FY 23; if there was an
additional $1 billion it would bring the number to $4.8
billion.
Mr. Mitchell looked at the $2 billion in unrealized gains
associated with the ERA on slide 20. He explained that
unrealized gains were divided between the two accounts
[principal and ERA] on a pro rata basis, meaning balance
was key to where the unrealized gains resided. He
elaborated that as the inflation proofing transferred to
the fund principal and the POMV draw was made for the
state's use, about $1.4 billion of the $2 billion would
move to the unrealized gains in the principal. The
remaining amount would move to principal if the last $3.8
billion was spent. He relayed it was more of a cushion than
a number to be relied on for purposes of the balance. He
clarified that if the gains were realized they would flow
into the ERA. He noted that some of the asset allocations
such as private equity and real estate were less liquid
than public market securities or equites. He detailed that
money was anticipated to be in a private equity transaction
for ten years. Typically, money was invested in the first
two to four years, some money started to come back in the
following few years, and investors began to exit in the
last seven to ten years. He explained it was a long play
that did not lend itself to much nimbleness on the ability
to realize unrealized gains.
Mr. Mitchell shared that APFC did not know what the future
held and they were optimistic things played out better than
the scenario he had just described. However, there was
potential that at the end of the fiscal year there was a
$4.8 billion balance that would be mostly used to cover the
FY 25 POMV draw and inflation proofing.
2:46:30 PM
Representative Stapp saw a potential risk if there was a
relatively bad year combined with high inflation. He
thought the 10 percent [probability of an insufficient
balance] scenario may be very bad if the state could not
have a POMV draw because the funds were allocated for
inflation proofing. He asked if Mr. Mitchell had an
estimate on how realistic the scenario was.
Mr. Mitchell answered in the negative. He stated the
corporation was not making bets on the market, it was
implementing strategies. He explained that APFC could
project ranges for the next six months to 1.5 years that it
hoped to be within, but they could not predict exactly what
would happen.
Representative Stapp made clarifying remarks about his
statement. He noted that APFC was doing a great job.
2:48:12 PM
Representative Josephson remarked that as the fund corpus
grew, the amount of inflation proofing grew. He asked if
there would ever be a time when APFC would advise against
fully funding inflation proofing. He stated his
understanding that inflation proofing was subject to
appropriation by the legislature. He noted the legislature
had been very good about making the payment historically,
but he believed it was almost advisory.
Mr. Mitchell answered there were very strong beliefs
surrounding the topic. Additionally, there were papers and
a resolution around the ERA variability. He believed there
was a recommendation for a minimum balance of four times
the POMV payment and that there should be consideration of
foregoing inflation proofing during times of low earnings
with the expectation of making up the funds when earnings
improved. He noted that discipline was very difficult. He
relayed it would always be the corporation's prerogative
that inflation proofing should be pursued and enacted to
the extent it did not lead to an inability to pay. He
explained it maintained the compact with past and future
generations. He remarked that in some ways the fall set the
stage for a discussion about adjusting the two account
system to a one account system. The presentation included a
couple of slides on the topic.
Representative Josephson considered the past supplemental
appropriations [into the fund principal] that had been
sizeable. He asked if the past appropriations could
effectively be considered as "credit" towards inflation
proofing, enabling the legislature to suspend a year of
inflation proofing. He asked if the description and words
assigned to the actions taken mattered.
Mr. Mitchell answered there were strong beliefs about that
as well. He aligned his views with the views of the APFC
Board of Trustees. He defaulted to inflation proofing as a
primary tenet of the compact of the Permanent Fund. He
elaborated it should be given every consideration and the
potential of not appropriating should not be taken lightly,
despite past special appropriations. He highlighted special
appropriations made in 1986 or 1987 from the general fund
to the Permanent Fund. He stated it had not been designed
as inflation proofing; it had been designed as an
additional deposit to the fund. He thought it mattered how
the appropriations were made when considering their
purpose. He stated the fund had been growing, not merely
maintained, over the years. He explained that it was a
matter of considering whether it was the intent of a given
legislature to grow the fund for the future or maintain the
fund for the future. He stated the concepts were two
distinct things.
2:52:51 PM
Mr. Mitchell highlighted an illustration on slide 21
showing the complexity of the two account system [the ERA
and fund principal]. He reviewed the illustration showing
money coming into the principal from royalty revenue, which
was constitutionally protected. He detailed that invested
income flowed to the ERA as it was realized. He highlighted
the concept of unrealized gains, which were part of the
financial and accounting world and not currently
incorporated into statute. He remarked on unrealized gains
that resided in the two funds and could cause confusion
about the real fund balance. He relayed there was a tension
between maintaining an adequate balance and not having a
balance that became too excessive and was relied upon
beyond the ongoing ability of the fund to provide for each
generation's needs with the POMV. He characterized the two
fund structure as overly complex, which created many
headaches for the CFO and people in general who were trying
to understand how the Permanent Fund worked, how money
flowed in the accounts, and what the balance was.
Mr. Mitchell turned to slide 23 showing a simplified system
that APFC would advocate for where contributions came into
the Permanent Fund and the fund paid out a historical POMV.
He explained the structure was more in line with a classic
endowment. The simplified structure eliminated the worry
for those making decisions about whether they were doing
the right thing for their generation that some future
generation would take as theirs or whether they were taking
what some past generation set aside in part for the present
generation, but not all. The simplified system eliminated
the tension associated with the balancing act between the
ERA and keeping the other aforementioned considerations in
mind. The change meant there would be a predictable payout.
He recognized it was a heavy lift that would require a
constitutional amendment. The board had been advocating for
the change since 2003.
Mr. Mitchell looked briefly at slide 22 pertaining to the
POMV. The slide highlighted the APFC board resolutions from
2003 and 2004 advocating for an amendment to the
constitution:
Percent of Market Value (POMV)
• Supporting a constitutional amendment to limit the
annual Fund payout to not more than a 5% POMV
averaged over a period of 5 years.
• Implementation of a constitutional POMV spending
limit for the Fund, has the accompanying benefit of
assuring permanent inflation proofing of the Fund.
Mr. Mitchell highlighted other board resolutions on slide
24 that could all be found on the APFC website. He stated
there had been significant thought put in by the board,
consultants, and staff to set the framework for how the
fund operated and trying to live up to the standards of
those who created it. Slide 25 showed an example of the
corporation's homepage and documents that could be found on
the website.
2:56:47 PM
Representative Hannan looked at slide 23 and asked for
verification that Mr. Mitchell had stated that the APFC
board had advocated since 2003 for a model that eliminated
the ERA and included an endowment fund only.
Mr. Mitchell agreed.
Representative Hannan asked if the idea had ever gotten
political traction at the legislature.
Mr. Mitchell answered there had been effort and it was a
very difficult discussion. He relayed that a joint
resolution was required for a constitutional amendment. He
recalled former Representative Jonathan Kreiss-Tompkins
advocated for the structure shift, but he did not know how
much traction the effort had received. He stated that in
some ways being able to see the floor of the ERA at present
gave some additional weight to the conversation about the
shortcomings of the current structure and what would happen
if there were not sufficient realized earnings in the ERA
to provide for the POMV. He stated it would be a dire
situation. He thought perhaps people may be willing to
reconsider the potential of making a run at the change. He
considered that legislators in the future may look back and
think about being present when the change was made. He
thought of legislators who had been present when the
Permanent Fund had been created and considered the historic
nature of the times. He explained that the change [to a
single fund system] would ensure the discipline of the past
was maintained in perpetuity.
2:59:37 PM
Representative Stapp thanked Mr. Mitchell for reminding
legislators for the incredible weight of their decisions.
Co-Chair Johnson requested [asset allocation] percentages
on the smaller pie charts on slide 8. She thanked the
presenters and reviewed the schedule for the following
meeting.
ADJOURNMENT
3:01:01 PM
The meeting was adjourned at 3:00 p.m.
| Document Name | Date/Time | Subjects |
|---|---|---|
| APFC - HFIN 021023 Presentation_Final.pdf |
HFIN 2/10/2023 1:30:00 PM |
|
| APFC Follow Up to HFIN mtg 021023 022223_.pdf |
HFIN 2/10/2023 1:30:00 PM |