Legislature(2023 - 2024)ADAMS 519
02/14/2024 01:30 PM House FINANCE
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| Audio | Topic |
|---|---|
| Start | |
| Presentation: Alaska Permanent Fund; Capital Market Forecast | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
HOUSE FINANCE COMMITTEE
February 14, 2024
1:36 p.m.
1:36:50 PM
CALL TO ORDER
Co-Chair Johnson called the House Finance Committee meeting
to order at 1:36 p.m.
MEMBERS PRESENT
Representative Bryce Edgmon, Co-Chair
Representative Neal Foster, Co-Chair*
Representative DeLena Johnson, Co-Chair
Representative Julie Coulombe
Representative Mike Cronk
Representative Alyse Galvin
Representative Sara Hannan
Representative Andy Josephson
Representative Dan Ortiz
Representative Will Stapp
Representative Frank Tomaszewski
MEMBERS ABSENT
None
ALSO PRESENT
Greg Allen, Chief Executive Officer, Chief Research
Officer, Callan and Associates; Steve Center, Senior Vice
President, Investment Consultant, Callan and Associates.
SUMMARY
PRESENTATION: ALASKA PERMANENT FUND; CAPITAL MARKET
FORECAST
Co-Chair Johnson reviewed the meeting agenda.
^PRESENTATION: ALASKA PERMANENT FUND; CAPITAL MARKET
FORECAST
1:38:14 PM
GREG ALLEN, CHIEF EXECUTIVE OFFICER, CHIEF RESEARCH
OFFICER, CALLAN AND ASSOCIATES, introduced himself and
noted that he had been working for Callan and Associates
since 1988. He had consulted for the Permanent Fund (PF) on
capital markets since 1996 and was a co-consultant for the
fund for two years.
STEVE CENTER, SENIOR VICE PRESIDENT, INVESTMENT CONSULTANT,
CALLAN AND ASSOCIATES, introduced himself and relayed that
he had worked for Callan for almost 14 years and had worked
with the Permanent Fund for the last nine years.
Co-Chair Johnson indicated that Representative Cronk,
Representative Stapp, and Co-Chair Edgmon joined the
meeting.
Mr. Allen introduced the PowerPoint presentation "Callan
Market Outlook, APFC Asset Allocation and Performance
Update" dated February 14, 2024 (copy on file). He
continued on slide 2 and offered an outline of the
presentation:
Outline
?2023 year-end capital market review
?Callan's capital market projection process
?Current economic and capital market environment
?Full-set Callan 2024 capital market projections
?APFC Update
2024 Policy Target Portfolio
Recent Performance Review
?Concluding observations
Mr. Allen skipped to slide 4 titled "Callan Capital Market
Projection Process
Process Overview:
?Callan updates long term capital market projections
each year in January and uses them for the full year
with all clients for strategic planning purposes.
?Projections take into account long term relationships
balanced with current market conditions.
?Consensus expectations (central banks, economists,
asset managers, consultants, etc.) are carefully
considered as an integral part of the process.
?Each number return, risk, correlation for every
asset class must be individually defensible, and the
numbers collectively need to work together as a set to
generate reasonable portfolios during strategic
planning exercises.
?Projections change slowly over time and are not
designed to provide tactical insights.
?Process is executed by Callan's Capital Markets
Research group and projections are peer reviewed by
Callan's Client Policy Review Committee as well as the
hundreds of clients that use them every year.
?Process is battle proven it has evolved and
improved but hasn't fundamentally changed over the
last four decades.
1:42:41 PM
Mr. Allen continued to slide 5 titled "US Equity Rolling
10-Year Returns
Historical Perspective US Large Cap Equity
? Historical 10-year return for US large cap has
averaged 10.55%.
? 2024 projected return for large cap US equities
is 7.50%.
? Historically there have been very few periods
of negative 10-year returns for US equities.
? Current outlook is in lower third of historical
distribution, driven by relatively high
valuations, concentration, and secular decline in
equity risk premium
Mr. Allen elaborated that the chart showed the rolling ten-
year returns for the S&P 500. The fund received its highest
return ever at 20 percent in 1958. In 2008 the market
experienced a negative 10-year return due to the dot com
bubble collapse and the global financial crisis; two major
financial crises in a ten-year period.
Mr. Allen advanced to slide 6 titled "Stock Market Returns
by Calendar Year - Performance in perspective: History of
the U.S. stock market (233 years of returns)." The graphic
broke down returns on the stock market by calendar year. He
pointed out that there had only been two years that were
worse than a negative 40 percent since the market's
inception.
Mr. Allen scrolled to slide 7 titled "U.S. Equity Market:
Key Metrics - S&P 500 Valuation Measures. He explained
that the chart depicted the long-term average market
valuation of price over earnings at 16 percent (16 times
earnings) over 30 years. Currently, the market (December
31, 2023) was at the high end of one standard deviation,
which meant the market was "pricey" and was one reason the
forecasted growth was 7.5 percent.
1:45:44 PM
Mr. Allen examined slide 8 titled "U.S. Equity Market:
Price Relative to History - S&P 500 Index at Inflection
Points and quickly moved to Slide 9 titled "2024 Equity
Market Projections:"
? Projected 10-year annualized geometric returns for
public equity markets are in the 7.5% to 7.7% range.
? APFC portfolio employs all of the underlying equity
markets.
? Diversification results in higher projected return
than any single building block (7.85%).
? Higher standard deviation for non-US markets is
partially due to currency volatility
Mr. Allen summarized that the graph demonstrated that a
diversified portfolio "paid off" with better returns and
lower risk. The PF had a very diversified global equity
portfolio.
Mr. Allen discussed slide 10 titled "Range of Projected
Equity Returns for APFC - 10th through 90th Percentile
? Projected mid-point of range of 10-year annualized
returns for APFC Public Equity portfolio increased
from 7.60% in 2023 to 7.85%
? Projected mid-point for Private Equity portfolio
increased from 8.50% to 8.60%
? Valuation lags for private equity resulted in a
modestly smaller increase in return expectations.
Mr. Allen elucidated that there was a ten percent chance
that returns could be as high as 15.7 percent annualized
over the next 10-years or as low as .23 percent per year,
which was essentially zero. He added that the PF invested
in private equity, which had a higher expected return than
public equity. The PF was gradually moving from public
equity to private equity over the last 10 to 15 years. The
fund could afford the illiquidity of private equity due to
its longevity and in turn it gained higher returns.
Mr. Allen continued on slide 11 titled "US Bonds Rolling
10-Year Returns - Historical Perspective US Fixed
Income
? Historical 10-year return for US bonds has averaged
5.35%.
? 2024 Projection is 5.25%.
? Still no periods historically of negative 10-year
return for US bonds.
? Current outlook is in line with long term historical
average.
? Rising interest rates have created higher return
expectations going forward.
? Consistent cyclical decline in bond returns since
1990.
Mr. Allen pointed to the chart showing the rolling ten-
Year returns on the bond market since its inception. He
noted that the bond market returns peaked at 14 percent in
1990.
1:49:06 PM
Co-Chair Johnson referred to slide 10. She wondered what
was happening when public funds were invested in private
equities. Mr. Allen responded that public funds,
particularly large public funds had been moving into
private equity. He advanced to slide 27 to delineate his
response to the question. He pointed to the gray bar on the
chart showing the range of over 100 large public funds the
and the range of public equity allocations. He expounded
that the public fund with the most public equity had 65
percent of public equity versus the least at 25 percent.
The PF had 34 percent; therefore, relative to large public
funds the PF had a low amount of public equity; 75 percent
of public funds had more public equity. The Permanent Fund
had more in private markets at 42 percent than 72 percent
of public funds. The PF had a high public equity market
exposure because the fund had a longer term time horizon
and was not taking a high percentage of assets each year
unlike most public funds that were paying benefits.
Therefore, the PF could afford illiquidity better than most
other public funds. He turned to slide 28 that contained
the same chart regarding large endowments. He noted that
the endowment funds had moved into private markets much
more than public funds with a median range of over of 60
percent in the private market. He thought of the PF as
existing in between the two roles of a public institution
and an endowment. He concluded that the PF was "relatively
underweight in private markets versus endowments and
relatively overweight in private markets versus public
funds.
Representative Hannan asked if the other public funds were
primarily pension and retirement funds, which was why the
PF was more like an endowment. Mr. Allen answered in the
affirmative.
Mr. Allen concluded slide 11 and highlighted slide 12
titled "Starting Yield Strongly Predicts Forward Returns."
He mentioned that bond markets were easier to predict than
the equity market. The bond market was relatively steady
over a 10-year return. The graph depicted a strong
relationship between starting yields and subsequent 10-Year
returns.
1:54:31 PM
Mr. Allen continued on slide 13 titled "History of Equity
and Bond Yields since 1980 - History of Yield (Income
Return) He reported that the chart showed that bond
yields consistently declined since 1981 through the end of
2021.
Mr. Allen briefly advanced to slide 14 titled "History of
Equity and Bond Yields since 1926 - History of Yield
(Income Return) on Stocks and Bonds." He summarized slide
15 titled "Yield Curve Rose and Inverted in 2022 and 2023 -
Level and Shape of the Yield Curve Drives Fixed Income
Return Projections:"
? After a historic rise in 2022, the Treasury yield
curve continued to rise through the third quarter of
2023.
? Yield curve has been inverted since the middle of
2022.
? Callan's forecasts assume a reversion to an upward
sloping yield curve and a long-term equilibrium across
the curve.
? We expect a large and swift decline for
intermediate- and short-term rates. This drop leads to
capital appreciation for sectors with exposure to
these areas of the curve.
Mr. Allen commented that the yield curve (the yield on
bonds at various maturities) had risen since 2021 and
inverted in 2022; the worst year in the history of bonds.
Mr. Allen moved to slide 16 titled "Spreads Remained Off
2021 Lows but Divergence Emerges
? Spreads widened in 2023 for short-dated credits but
tightened in other sectors.
? Callan forecasts assume spreads revert to longterm
medians over time.
? Wider spreads on the short end contribute to higher
return projections as spreads fall toward equilibrium.
? Tighter spreads in other sectors, particularly long
credit, detract from return projections as spreads
rise toward equilibrium.
Mr. Allen explained that spreads were how much was earned
on a corporate bond versus a treasury bond. The widened
spreads were positive for forward projections on bonds. He
continued to slide 17 titled "Fixed Income Forecasts He
communicated that the chart showed the forecast for the
various areas of the bond market. He pointed to the
aggregate showing that longer term bonds had a higher
return along with higher yield bonds. The chart also showed
that the bond market expectations had risen from the prior
year and had risen substantially since 2022.
Mr. Allen examined slide 18 titled " Range of Projected
Fixed Income Returns for APFC - 10th through 90th
Percentile
? Projected mid-point of range of 10-year annualized
returns for APFC Public Fixed Income portfolio
increased from 4.35% in 2023 to 5.25%
? Projected mid-point for Private
Credit/Infrastructure portfolio increased from 6.90%
to 7.25%
? Changes in yields had a larger impact on the outlook
for public fixed income than for private credit and
infrastructure
Mr. Allen offered that the PF had been moving into private
credit at a similar rate as private equity.
Mr. Allen moved to slide 19 titled "Highlights of 2024
Capital Market Projections
Changes and Observations
?10-year annualized inflation expectation remained
constant at 2.50%.
?Public equity 10-year annualized return projection
increased from 7.60% to 7.85%. Projected standard
deviation (volatility) decreased from 18.50% to
18.15%.
?Public fixed income 10-year annualized return
projection increased from 4.35% to 5.25%. Projected
standard deviation decreased modestly from 4.20% to
4.15%.
?Private real estate projection increased from 5.75%
to 6.00%.
?The projected premium of private equity over public
markets equity declined year-overyear due to the
public markets more fully absorbing valuation
adjustments.
?The projected premium of private credit and
infrastructure over public fixed income also declined
due to similar dynamics in those two asset classes.
?Projected Total Fund return for APFC policy portfolio
increased from 7.25% to 7.60% (more on that next).
Mr. Allen spoke to slide 19 titled "Highlights of 2024
Capital Market Projections - Changes and Observations
?10-year annualized inflation expectation remained
constant at 2.50%.
?Public equity 10-year annualized return projection
increased from 7.60% to 7.85%. Projected standard
deviation (volatility) decreased from 18.50% to
18.15%.
?Public fixed income 10-year annualized return
projection increased from 4.35% to 5.25%. Projected
standard deviation decreased modestly from 4.20% to
4.15%.
?Private real estate projection increased from 5.75%
to 6.00%.
?The projected premium of private equity over public
markets equity declined year-overyear due to the
public markets more fully absorbing valuation
adjustments.
?The projected premium of private credit and
infrastructure over public fixed income also declined
due to similar dynamics in those two asset classes.
?Projected Total Fund return for APFC policy
portfolio increased from 7.25% to 7.60% (more on that
next).
Mr. Allen noted that with inflation constant and the better
outlook for equities and fixed income, the outlook for the
PF to meet its 5 percent real return (actual return minus
inflation) goal was better (higher than the prior years).
1:58:50 PM
Representative Stapp asked what the annualized inflation
target was 4 years prior. Mr. Allen replied that it was 2
percent. He wondered if Callan was using the federal
inflationary target. Mr. Allen answered that they looked at
the federal rate as well as many other indicators and
factors. Representative Stapp asked what a 50 basis point
increase in inflation would do to the projections. Mr.
Allen responded that there was about a 54 percent chance
that the Permanent Fund would exceed what it needed to earn
to make the payout on a real basis. A 50 basis point
increase would decrease the chance to 47 percent.
Representative Stapp wanted to highlight the impact of
inflation.
2:01:10 PM
Mr. Allen continued to slide 20 Capital Market Projections
- Summary of Callan's Long-Term Capital Market Projections
for APFC Asset Allocation Model." He offered that the chart
represented the framework for the PF. It showed how the
portfolio had been invested by asset classes. He listed the
asset classes: APFC Public Equities, APFC Public Fixed
Income, Private Equity Private Real Estate, Private
Infrastructure/Credit, Absolute Return (Hedge Funds),
Tactical Opportunities, and Cash Equivalents. The midpoint
of all of the assets projected returns was 7.6 percent.
Representative Ortiz cited absolute return and hedge funds.
He surmised that the two terms did not match up. He asked
for clarity. Mr. Allen answered that hedge funds had a
reputation of being risky but there were different types.
He explained that absolute returns were hedge funds that
attempted to not be overly influenced by the equity
markets. They try to balance their investments by a long/
short equity strategy. He related that the permanent fund
intentionally invested in hedge funds that were hedged. He
pointed out that the hedge fund returns were projected to
be lower than equities. He elaborated that the PF was
looking for a portfolio that included investments
uncorrelated with equity market strategies and strategies
uncorrelated with the bond market. The absolute return
meant that if the market dropped the investment did not and
conversely if it rose the investment did not. These
investments were performing better than bonds but not as
good as equities and the uncorrelated strategy meant it
reduced the overall portfolio risk.
2:04:53 PM
Mr. Allen underlined slide 21 titled "Relationship Between
Expected Return and Volatility
Expected Return Increases with Increased Expected Risk
• For example, investors demand a greater return from
private equity than public equity as compensation for
higher implementation risk and lower liquidity
• Lower correlation asset classes can fall below the
capital markets line and still be efficient components
of a diversified portfolio (e.g. Global ex-US Fixed,
Emerging Market Equity)
Mr. Allen explained that the risk return chart was included
to show that investments that had higher returns were more
volatile or risky and it offered a visual of market
assumptions. The diversified PF portfolio was ranked in the
middle.
Mr. Allen addressed slide 22 titled "Five Percent Expected
Real Returns Over Past 30 Years." He indicated that the
chart showed the increasing PF portfolio complexity and
risk involved to earn a 5 percent real return over time due
to the bond market.
Representative Stapp asked about the drop-off on large cap
equities. Mr. Allen replied that the large cap equity
allocation remained relatively the same between 25 to 35
percent. However, the projections for large cap equities
decreased. He voiced that in the current year the
valuations were high relative to the long term average, but
not too high. He summarized that to the extent that
valuations were high their expectations would be low.
Callan deduced that valuations were one standard deviation
above normal therefore, the expectations were lower than
the long-term average.
2:09:52 PM
Representative Hannan asked what the likelihood was that
the APFC board would accept Callan's recommendations and
direct changes in its investments. Mr. Allen responded that
Callan's clients were not reacting every year to their
projections. He delineated that clients were observing the
general trends and making small changes in the margins. He
summarized that the slide showed that bonds were more
attractive than they used to be, which could alter and slow
down the headlong charge into the risky asset classes like
private equity, private credit, etc. He indicated that the
PF staff did other investigations into market projections
besides Callan's. He noted that the PF staff was in
constant dialogue with the board regarding the appropriate
asset class allocation. The Chief Investment Office (CIO)
made suggestions every year regarding asset class
allocation and changes were usually small. The board had a
five year plan in place and in the prior year they modestly
reduced the allocation of private equity and modestly
increased the allocation of fixed income. He deduced that
it was in recognition of the fact that fixed income yields
were higher and higher risk was unnecessary to earn the
same return. Representative Hannan asked if any of Callan's
guidance to the PF affected any decisions that the
legislature made for things like a bond package or was it
unrelated. Mr. Allen answered that the market was currently
not good for borrowers and would impact different people in
the economy in different ways. Rising interest rates were
good for long-term investors. It was more attractive to
investors and much less attractive to borrowers. Public
finance was involved in both sides of the market in loaning
and borrowing money.
2:15:00 PM
Mr. Center addressed Representative Stapp question
regarding the projected decline in large cap equities. He
reminded the committee that the data was based on a
hypothetical portfolio optimized for a 5 percent real
return. He noted that in the current higher interest
environment it was possible to invest in fixed income and
achieve the 5 percent real return at less risk declining
from 17 percent to 11 percent.
Mr. Allen added that bonds were more attractive currently
than large cap equities.
Representative Stapp wondered how asset allocation changes
affected the statutory net income and the balance of the
fund. Mr. Allen responded that he had built a model of the
PF in 1998 that Callan had been using ever since. He
explained that as the PF had moved increasingly into
private market investments and out of bonds, there was less
yield. The money was locked up longer and it took longer to
realize returns, which diminished statutory net income as a
percent of the size of the fund. As bond yields increase,
statutory net income will rise; fixed income was 20 percent
of the fund and therefore, the yield will rise on 20
percent of the portfolio. He expounded that private equity
(16 percent of the portfolio) realized returns by selling
investments and the realized gains became statutory net
income. Beginning in 2023, private equity gains realization
decreased. He concluded that private equity gains moving
into statutory net income was cyclical. Statutory net
income had become less predictable for the reasons he
outlined.
2:19:33 PM
Co-Chair Johnson referred to slide 22 and inflation rates.
She wondered why inflation kept rising. Mr. Allen answered
that Callan had a team of economists analyzing the
situation. He believed that the major news outlets were
inflammatory in regard to inflation. He elaborated that in
periods of high inflation the goal of the PF was to try to
maintain the purchasing power of the corpus. There was an
inflation proofing appropriation from the Earnings Reserve
Account each year to cover the prior year's inflation. He
shared that Callan's prediction for inflation was 2.5
percent on average for the next 10-years based on a variety
of factors.
Mr. Allen continued on slide 23 titled "Actual Returns
versus Callan Projections - Historical Comparison: Actual
Returns vs. Callan Capital Markets Projections Portfolio
(60% Equity, 30% Fixed, 10% Real Estate)
? Our projections have generally been within one
standard deviation of the future actual return.
? The glaring exceptions are the 10-year periods ended
in 2008 and 2009 which contained not one but two major
collapses in the equity market: the Dot-Com Bubble in
2001-02 and the Global Financial Crisis in 2008.
Mr. Allen pointed to the chart and the orange line that
showed the prediction of what would happen over ten year
intervals, the blue line was what actually happened, and
the green lines represented plus or minus one standard
deviation.
2:24:34 PM
Mr. Allen turned to slide 26 titled "APFC FY 2024 Total
Fund Policy Target - Target Asset Allocation
?The Alaska Permanent Fund remains broadly diversified
across all major public and private institutional
asset classes
?Roughly 58% allocated to public market investments
(publicly traded equities and fixed income) and 42% to
private markets
?Exposures to private equity, private infrastructure
and private credit have been methodically increasing
over the last decade at the expense of public equity,
fixed income and real assets
Co-Chair Johnson asked why the uptick in inflation from
2.25 percent to 2.5 percent was predicted between 2022 to
2024. Mr. Center confirmed the question and replied that
Callan was projecting inflation over a ten year period on
average. He believed that the Federal Reserve was committed
to achieving its 10-year target of 2 percent inflation.
However, given it was currently over 3 percent it would be
difficult to achieve. He reported that inflation was
declining but not rapidly.
Mr. Allen continued on slide 26. He discussed the target
asset allocation for the PF. He recalled that private
markets were comprised of Private Equity 16 percent; Real
Estate 10 percent; Private Infrastructure/Credit 9 percent;
and Absolute Return 7 percent and were the illiquid
markets. The APFC Public Fixed Income was 20 percent;
Public Equities 34 percent; Cash 2 percent; Tactical
Opportunities 2 percent (S&P 500); were the liquid assets.
Mr. Allen advanced to slide 27 titled "APFC FY 2024 Target
versus Large Public Funds - Target Asset Allocation
Comparison
? Low Public Equity Lower allocation to public
equities than 76% of Public Funds. Median is 45%,
APFC is 34%.
? Median Public Fixed Income Slightly below median
allocation to public fixed income. Median is 22%,
APFC is 20%.
? High Private Markets Higher allocation to private
markets than 72% of Public Funds. Median is 31%,
APFC is 42%
? Low Growth Assets Slightly below median allocation
to Growth Assets Median is 69%, APFC is 65%
Mr. Allen noted that he spoke to the slide earlier in the
presentation. He reiterated that the PF's allocation to
growth assets was close to the average of other public
funds and when compared to endowments it was conservative
with a lower allocation to growth assets and private
markets and a higher allocation of public equity.
Mr. Allen continued to slide 28 titled "APFC FY 2024 Target
versus Large Endowment/Foundations - Target Asset
Allocation Comparison:"
? High Public Equity Higher allocation to public
equities than 68% of E&F's. Median is 30%, APFC is
34%.
? High Public Fixed Income Higher allocation to
public fixed income than 70% of E&F's. Median is
11%, APFC is 20%.
? Low Private Markets Lower allocation to private
markets than 72% of E&F's. Median is 63%, APFC is
42%
? Low Growth Assets Slightly below median allocation
to Growth Assets Median is 68%, APFC is 65%
Mr. Allen moved to slide 29 titled "APFC FY 2024 Total Fund
Policy Target - Projected Return and Standard Deviation:"
?Projected median 10-year annualized return of 7.60%
is roughly 35 basis points higher than last year.
?Inflation expectation remained the same at 2.50%.
?Projected median 10-year annualized real return of
5.10% is an increase of roughly 35 basis points
relative to last year.
?Projected standard deviation of 12.65% is 50 basis
points lower than last year.
?Percent probability of exceeding 7.5% annualized
return over 10-year horizon is estimated to be 51%.
?Percent probability of exceeding 7.1% (median
effective real payout) is estimated to be roughly 54%.
Mr. Allen briefly introduced slide 30 titled "Constrained
Efficient Frontier Analysis (50% Private Assets)
? Efficient frontier with 50% private markets
constraint.
? Strategic Policy target portfolio is slightly below
the constrained efficient frontier due to 2% cash
allocation and private markets allocation of 42%.
? 75/25 Equity/Fixed portfolio is pure public markets
portfolio with slightly lower expected return and
higher risk.
? APFC Policy Target has a roughly 35 basis point
projected return premium over 66/34 public markets
(portfolio with same projected risk).
Mr. Allen advanced to slide 31 titled "Range of Projected
Returns - 10th through 90th Percentile:"
? Projections are ranges not point estimates
? Point estimates are impossible to forecast
? Forecasting ranges is a more realistic goal
? Range forecasts can supply reasonable estimates for
probabilities of exceeding a threshold return
? Projected probability of 2023 Target Mix exceeding
7.5% annualized return over 10-years is roughly 48%
Mr. Allen summarized that the slide showed that
diversification took the good and bad extremes out of the
equation to help realize the targeted returns.
2:30:21 PM
Mr. Allen continued to slide 32 titled "Range of Projected
Returns over Various Time Periods - 10th through 90th
Percentile:"
? POMV spending rule is equal to 5% of the average
ending market value for the first five of the trailing
six years
? Given expected positive returns, this translates to
an effective payout (relative to the most recent
market value) of roughly 4.6%
? Adding 2.5% inflation to 4.6% yields a target
threshold return of 7.1%
? Projected probability of 2024 Target Mix exceeding
7.1% annualized return over 10-years is roughly 54%
Mr. Allen moved to slide 33 titled "Concluding Observations
- Callan's 2023 Capital Market Projections
?No change in inflation expectation of 2.50%
?Public equity return projections were increased
modestly
?Public fixed income return projections increased
significantly
?Yield expectations up across the board
?Private market return expectations also increased but
by smaller percentage
?APFC Policy Target is well diversified and lies close
to the efficient frontier for portfolios with a target
of 50% private markets
?Expected nominal and real return for APFC portfolio
increased relative to last year
?APFC Policy Target has lower projected risk and
higher expected return relative to a public markets
portfolio with a 75% allocation to Global Equity and
25% allocation to US Fixed Income.
?The projected probability of exceeding the effective
POMV annual payout of 4.6% (of current market value,
5% of trailing average) increased to over 54%.
Representative Coulombe asked for the definition of a
geometric return. Mr. Allen answered that the geometric
return was the best measure of the actual return on a
portfolio. He delineated that there were two types of
returns; arithmetic return (average), and geometric return
(a different way of calculating and average that took
volatility into account.) He exemplified that if $100 was
invested and 50 percent was lost $50 was left. Therefore,
100 percent on $50.00 must be earned to return to the
$100.00 amount. Volatility or losses lowers the average
return because the losses decrease the investment more than
a similar gain returns the initial investment amount. He
concluded that the more volatility the larger the
difference between an arithmetic average and geometric
average. Callan always used the geometric average.
Representative Ortiz asked that if the fund would transfer
to a single endowment structure, would it impact the
performance of the fund overall. Mr. Allen responded that
it was a significant issue. He relayed that the APFC was
managing the fund for the highest return per unit of risk
and did not pay attention to the two account structure. He
indicated that returns would be sacrificed if investments
were made just to generate income for the ERA. However,
with the new structure of withdrawing the 5 percent of the
previous five year average market value (percent of market
value POMV), the ERA was likely to come under some pressure
over the next ten years especially if large inflation
proofing adjustments were made. He summarized that anything
withdrawn from the ERA had the dual effect of making the
principle larger and the ERA smaller and unrealized gains
were allocated between the ERA and the principal based on
the ratio of the two. He predicted that the issue would
become a "big deal".
2:36:04 PM
Mr. Allen continued that a pure endowment model could
easily afford the 5 percent POMV. In a real endowment
model, the 5 percent would decrease more gradually if the
market was down in some years of the five year average. He
characterized the two account structure as a cliff
structure. He relayed a personal antidote regarding the
issue. He currently felt that getting rid of the two
account system would stabilize the revenue source.
Representative Ortiz asked if there would be any downside
to getting rid of the two structure system. Mr. Allen
responded that there was a concern that the ERA protected
the principal. He exemplified that the legislature could
increase the POMV to 10 percent or more in a one structure
model because the POMV was not in the Constitution. He
pointed out that it would take a Constitutional Amendment
to change the two account structure. He would also
recommend constitutionalizing the 5 percent spending limit
and eliminating the two account structure. He did not see
any downside with the 5 percent/5 year average withdrawal
in a one account structure. He viewed that the downside
would be if the two account structure was eliminated was if
the spending limit was not also constitutionalized.
2:41:32 PM
Representative Tomaszewski asked what the fund would do if
the United States dollar lost its reserve currency status.
Mr. Allen was unable to answer the question.
Representative Coulombe cited slide 29 and referenced the
projected standard deviation of 12.65 percent. She thought
that the projections were around 6 percent. She asked for
clarity. Mr. Allen answered that 12.65 percent was the
standard deviation for the portfolio. He recalled that it
had decreased from approximately 13.1 percent in the prior
year. The decrease came from the fact that some funds were
moved out of private equity and fixed income increased. He
noted that generally speaking, it was a lower risk
portfolio than in the prior year.
2:44:42 PM
Mr. Center returned to slide 3 to remind the committee of
how things ended up in 2023. Slide 3 was titled "Public
Markets Surge in 4Q, Following Decline in 3Q
Stocks have recovered losses of 2022; bonds still have
ground to make up.
S&P 500 soared 11.7% in 4Q23
? Loss through first three quarters of 2022 was
23.9%; the rebound in the following five quarters
brought the index back to a positive return of
1.7% over the past two years.
Fixed income recovered in 4Q, up 6.8% after a sharp
loss of 3.2% in 3Q
? The Bloomberg Aggregate was on track for
another negative year through 3Q; softening Fed
language on rates and a dot plot that showed cuts
on the horizon in 4Q turned the market around.
? CPI-U declined in 4Q compared to 3Q, though up
3.4% year-over-year; the index is still 10%
higher than it was at the start of 2022.
Economic data defied expectations of recession in 2023
- GDP growth came in at 2.1% in 1Q, 2.2% in 2Q,
and jumped to a stunning 4.9% in 3Q. Preliminary
4Q forecasts have GDP over 2%.
? Job market remains solid, providing support to
Fed efforts to fight inflation.
Mr. Center interpreted the data from the chart on the
slide. He elaborated that the US equity markets were
positive and had increased by 4 percent. The global equity
markets were also positive and developed market stocks were
up about 18 percent while emerging markets had increased by
10 percent in the prior year. The fixed income markets had
the best fourth quarter since 1989, an increase of over 6
percent. He shared some concerns in the private markets;
private equity had slowed. However, the final numbers were
not available until mid-April of 2024. It was anticipated
that the numbers would be flat to negative. In addition,
the real estate market had decreased by 9 percent in the
third quarter. He concluded that the private market was
"suffering." He noted that the PF had a significant amount
of investment in the private markets, which would drive the
performance differences depicted in the following slides
for large public funds and endowments.
Co-Chair Johnson asked about leases expiring on open real
estate and what to expect in the future. Mr. Center replied
that "there was a wave coming over the next three years on
both expiring leases and refinancing on institutional real
estate." He reported that "a lot" of debt on institutional
real estate debt was coming due that was financed by
private debt and banks and it would need to be refinanced
at 7 percent to 8 percent interest versus the original 2
percent interest. That would change the valuation of the
real estate that was also experiencing high vacancy and
soon to be higher borrowing costs. Co-Chair Johnson
wondered how long it would take for the situation to
develop. Mr. Center ascertained that it would take
approximately 3 years before the bottom would happen. He
discussed some upsides to the real estate market.
2:50:29 PM
Mr. Center continued on slide 35 titled : APFC Total Fund
Historical Returns - Total Fund versus Total Fund Targets:"
Total Fund is ahead of benchmark (APFC Total Fund
Target) for all time periods other than the most
recent year
?Total Fund trails the CPI + 5% objective over the
last three years over the 10 and period
?While the Total Fund protected well on the downside
in 2022, it failed to capture the market snap-back in
2023
Mr. Center indicated that the benchmark index was designed
to closely mimic the way that the PF was being invested. He
characterized it as a strong way to track the overall
performance of the PF relative to how it was invested over
time. He cautioned that it should not be expected to get
CPI (Consumer Price Index) plus five percent each year.
However, it should over a 5 to 10-year time horizon. The
fund lagged its total fund target by about 2.2 percent for
the calendar year that was driven by it being "underweight"
in the public equity market and slightly "overweight" to
the private equity market relative to its target. The two
asset classes sightly underperformed its benchmarks for the
calendar year. However, the PF had outperformed its
benchmark over the twenty year time period by between .5
parent and .7 percent and performed at 7.3 percent over the
time period.
Mr. Allen interjected that in the early part of the 20 year
period the fund was heavily invested in bonds and gradually
diversified which increased the probability of reaching its
benchmarks. Mr. Center added that the fund outperformed its
benchmark even when the markets were negative.
Mr. Center continued to slide 36 titled "APFC Total Fund
Cumulative Return vs CPI + 5% - Total Fund versus Return
Objective:"
• Chart shows the path of Total Fund returns versus the
long-term return objective of CPIU + 5%
?Over the long term the Total Fund has fallen
slightly behind the objective
?The volatility of an investment strategy that can
keep pace with this objective over the long term
will result in periods underperformance
Mr. Center summarized the chart depicting that the PF had
generally kept pace with the CPI plus 5 percent "fairly
well."
2:54:35 PM
Mr. Center advanced to slide 37 titled "APFC Total Fund
Ranking versus Large Public Funds - Total Fund versus Large
Public Fund Peer Group:"
?Total Fund ranks very competitively versus large
public funds over longer time periods
?Underperformance over the last year was significant
due to higher public equity allocations in larger
public funds
?Over the last year, the APFC public and private
equity portfolios have underperformed their respective
benchmarks
Mr. Center delineated that the median large public funds
plan returned roughly 12.3 percent while the PF returned
about 8.4 percent in the prior year driven by public equity
market increases. However, the PF performed above median
than the average large public fund and was ahead of its
benchmark over any time period over the last 20 years.
Mr. Center continued to slide 38 titled "APFC Total Fund
Ranking versus Large Endowment Funds - Total Fund versus
Large Endowment/Foundation Fund Peer Group:"
?Total Fund ranks closer to median versus Large
Endowment and Foundation universe
?This is because the APFC asset allocation target has
evolved to look increasingly like that of a large
endowment
?Endowments typically employ large allocations to
private markets investments that have not experienced
the same price appreciation in 2023 of public markets
investments
Mr. Center noted that the PF portfolio had looked more like
an endowment for the last 8 to 9 years.
Mr. Center continued on slide 39 titled "Concluding
Observations - Performance Review
?Total Fund has outperformed performance benchmark
over most long-term periods ended December 31, 2023.
?Total Fund has underperformed the long-term
performance objective of CPI +5% over short-term
periods, but modestly outperformed over longer-term
periods.
?Total Fund performance has been competitive with that
of large public pension funds and large endowments and
foundations over most longer-term time periods ended
December 31, 2023.
?Asset allocation of Total Fund looked more like that
of a large public fund up until about 7 years ago.
?Asset allocation of Total Fund has evolved to look
more like a large endowment and should perform
increasingly in line with that peer group over time.
Mr. Center concluded the presentation.
2:58:47 PM
Co-Chair Johnson reviewed the following day's agenda.
ADJOURNMENT
2:59:29 PM
The meeting was adjourned at 2:59 p.m.
| Document Name | Date/Time | Subjects |
|---|---|---|
| HFIN -Callan Presentation - APF Forecast 02142024.FINAL.pdf |
HFIN 2/14/2024 1:30:00 PM |