Legislature(1999 - 2000)
01/20/2000 08:35 AM Senate FIN
| Audio | Topic |
|---|
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
SENATE FINANCE COMMITTEE
LOG NOTES
1/20/00
GENERAL SUBJECT(S):
Overview:
Capital Markets Outlook 2000
Alaska Permanent Fund Corporation Presentation
JOINT WITH HOUSE FINANCE COMMITTEE
The following overview was taken in log note format. Tapes and
handouts will be on file with the Senate Finance Committee through the
21st Legislative Session, contact 465-4935. After the 21st
Legislative session they will be available through the Legislative
Library at 465-3808.
:
Time Meeting Convened: 8:35 AM
Tape(s): SFC-00 # 5 Side A and Side B
PRESENT:
Representative Mulder
Senator Parnell
Representative Bunde
Senator Torgerson
Representative Austerman
Senator Donley
Representative Davis
Senator Wilken
Representative Foster
Senator P. Kelly
Representative Grussendorf
Senator Green
Representative Phillips
Representative Williams
NOT PRESENT:
Senator Adams
Senator Phillips
Senator Leman
Representative Therriault
Representative Davies
Representative Moses
ALSO PRESENT:
REPRESENTATIVE SHARON CISSNA
REPRESENTATIVE JOHN COGHILL, JR.
CLARK GRUENING, Chair, Alaska Permanent Fund Corporation Board of
Trustees;
JIM KELLY, Director Of Communications, Alaska Permanent Fund
Corporation;
TERRY BROWN, Chief Investment Officer, Alaska Permanent Fund
Corporation;
RANDY SEARS, Manager of Fixed Income Investments, Alaska Permanent
Fund Corporation;
PETER NAOROZ, Manager of Real Estate Investments, Alaska Permanent
Fund Corporation;
MICHAEL BELL, Manager of Equity Investments, Alaska Permanent Fund
Corporation;
CHRIS PHILLIPS, Director of Finance, Alaska Permanent Fund
Corporation
MICHAEL O'LEARY, JR., CFA, Senior Vice-President, Callan Associates;
GREG ALLEN, Vice-President, Callan Associates
LOG
SPEAKER
DISCUSSION
000
CO-CHAIR PARNELL
Introduction
CLARK GRUENING,
CHAIR, ALASKA
PERMANENT FUND
CORPORATION BOARD
OF TRUSTEES
Introduces the trustees present in the
audience.
The board of directors acted upon the
authority given last year by the
legislature to broaden the types of
investments allowed.
The board increased equity allocation from
48 percent to 53 percent. The market was
favorable, which added one billion dollars
to the whole fund.
60
JIM KELLY, DIRECTOR
OF COMMUNICATIONS,
ALASKA PERMANENT
FUND CORPORATION
Handout: How Has the Fund Been Doing?
Listing of consolidated assets of the
permanent fund and breaks the fund down
into categories.
For the last month, the non-U.S. equities
have been performing fantastic at 12
percent. U.S. equities are performing at
almost seven percent.
The fixed income account is not doing as
well this last month and money was lost in
that portfolio.
For the current month, total earnings are
4.37 percent.
Earnings are 9.02 over the last quarter.
For the first six months if the fiscal
year, earnings are 6.95 percent.
Over the last 12 months, the fund earned
10.98 percent.
Over the last three years, the fund earned
14.09 percent.
Handout: How Has the Fund Been Doing?
Alaska Permanent Fund, Consolidated Assets
- Daily Position, 1/18/2000
The progress of the fund is updated daily
on the Internet. The address is
www.apfc.org.
As of January 18, the fund was at cost of
$23.2 billion but at market value of $27.4
billion.
110
MR.GRUENING
Introduced Jim Sampson, trustee
112
MR. KELLY
Introduced Michael O'Leary
121
MICHAEL O'LEARY,
JR., CFA, SENIOR
VICE-PRESIDENT,
CALLAN ASSOCIATES
Handout: Periodic Table of Investment
Returns
Shows in descending order, by calendar
year, the performance of various active
classes segments.
Handout: Presentation to the Alaska State
Legislature, Callan Capital Market
Projections
Page 2: Background
Every year Callan and Associates develops
five-year projections of return, risk and
the interaction of active class with
another.
We never make heroic assumptions, always
long-term estimates to assist in long-range
strategic planning.
The permanent fund's money managers make
more significant judgements with regard to
the outlook for interest rates and stock
prices on a shorter-term basis.
We are actually forecasting a range that is
captured by the risk statistic.
Our stock forecast will always be within
that range. If it's on the lower end of the
range it is because of devaluation, if at
higher than because of we determine stocks
are undervalued.
Don't see significant changes from year to
year. Gross national income will only grow
at seven or eight percent over the long-
term. You can't expect corporate stocks to
grow much faster than that.
Page 3: Critical Concepts and Beliefs
The concepts underlying the process are
also taught at the University of Alaska and
other learning institutions. The concept is
that higher returns can only be achieved by
accepting greater volatility, that
diversification is essential to reducing
that risk. We also believe that market
timing does not work.
We would be less well off than we are today
Page 3: The Current Economic Environment
The economy is coming off its forth-
straight year of growth greater than three
percent and will set a record in March for
the longest expansion in US history.
Inflation and unemployment are low. We see
a global recovery. Asia is showing strong
signs of recovery. Europe is also in
recovery. Oil prices shocked us all by
doubling in price.
On the negative side, but not
unanticipated, interest rates are much
higher than a year ago. The good news is
that's largely behind us. As we look
forward five years, our bond return
projection is much higher than last year.
The Y2K bug was a source of concerns, but
we survived that.
Greatest threat to the outlook is that
growth stays too high. It could lead to
inflationary problems or cause the federal
government to crack down.
Page 5: We Have a Point of View,
(hmmm...this looks familiar)
This is similar to last year's assessment.
We expect some slowing in the economy but
no recession. The Asian financial crisis
has stabilized and beginning to recover.
The value of dollar in the international
marketplace has peaked. While inflation is
low, and we expect to remain low, is
rising.
Last year I said our five-year projection
for inflation was three percent but it has
increased. We expect inflation to be 3.25
percent.
All those inputs just shade our projections
at the margins.
249
Page 6: Current Capital Markets Refuse to
Conform to Theory
This shows the rate of return in 1999.
266
Page 7: The 90's vs. The 80's, What a
Difference a Quarter Makes
In both decades the total return from stock
market was phenomenal.
80s value outperformed growth. 90s growth
outperformed value.
292
Page 8: Inflation Matters to Capital
Markets, Long-Term Inflation Patterns
In the 1970s, inflation was a problem.
That's why interest rates were high and
stock returns were poor.
We've had tremendous deflation and now it
has stabilized.
310
Page 9: Rolling 5 Year Return for S&P 500
(1926-Present)
This is the quarterly return of the
Standard and Poor (S&P) 500 since 1990.
There are only four down quarters in a
decade.
The last data point is the September
quarter. In the December quarter, the S&P
500 was up 14.88 percent.
Page 10: Quarterly Returns Over Current
Bull Market
This graph explains how people think about
market decline.
For ten years whenever there has been a
downturn the reaction was viewed as a
buying opportunity immediately proven
right.
Page 11: Fundamentals Are Also Included,
(although we're starting to wonder)
326
Page 12: Large Cap Domestic Equity, S&P 500
5-Year Returns vs. Lagged Earnings/Price
(1954-1999)
I showed you this graph last year. The
market has gone up and earnings have grown
but not nearly as fast.
Page 13: Large Cap Domestic Equity, S&P 500
Earnings Yield vs. 10 Year Treasury Yield,
and, Ratio of S&P 500 Earnings Yield and 10
Year Treasury Yield
There is a good relationship between the
earnings and treasury yields expressed as a
ratio.
354
Base of evaluation it is hard to make an
argument that the stock market looks very
attractive in the near term, because stock
prices seem to have gotten ahead of
earnings.
357
Page 14: Cumulative Return-Small Cap Equity
Relative to Large Cap Equity, 70 Years
Ended December 31, 1998
360
Page 16: International Equity Returns,
Rolling 5 Year Return for MSCI EAFE
In the 80s the return was extraordinary,
but it was a period of weakness.
Last year the return picked up to over 26
percent.
The permanent fund did much better than the
index.
370
Page 17: Domestic Fixed Income-Fundamentals
This is important as if affects a lot of
state monies including the permanent fund.
Our basic premise in predicting bond
returns is that current yield matters most
Last year we expected the five-year return
from a high quality bond portfolio to be at
5.6 percent. At that time, the yield to
maturity for the bond index was 5.8
percent. As of year-end, it was close to
seven percent. This was a huge change in a
year.
As we look ahead the next five years,
because yields are at this higher starting
point, we expect the bond return to be in
the 6.7 percent range.
384
Page 18: Domestic Fixed Income, Lehman
Aggregate Index 5 Year Returns vs. Lagged
Yield to Maturity
This graph shows the five-year projected
return compared to the actual return.
390
Page 19: 2000 Capital Market Projections
These are all market industries that we use
to project returns.
The only significant change was the change
in the bond return expectation. That was
because of the huge change in interest
rates.
All the equity returns have been shaved a
little bit. They are still higher than bond
returns.
400
Page 20: Five-Year Capital Market
Projections, Higher Returns at the Price of
Higher Risk
You can't get a higher return without
taking more risk. This graph shows this.
405
Page 21: Range of Efficient Alternatives
Using Callan's 5 Year Projections
This shows various alternative policies
ranging from a seven to a nine-percent
return and the risks involved.
The permanent fund policy is between five
and six percent.
414
Page 22: Comparison of Efficient Frontier,
2000 vs. 1999 Projections
This graph looks at the previous
information. There has been a change in the
low risk policies, which makes sense
because the most change is with the bond
projection.
426
Conclusion
427
CO-CHAIR PARNELL
428
MR. KELLY
We would like to take that information Mr.
O'Leary just gave you and show what that
means for the permanent fund portfolios.
Pause on the record
448
TERRY BROWN, CHIEF
INVESTMENT OFFICER,
ALASKA PERMANENT
FUND CORPORATION
Introduce key staff of the Alaska Permanent
Fund Corporation.
(Note: Alaska Permanent Fund Corporation
speakers continually refer to overheads
that are shown but not provided in
hardcover.)
462
RANDY SEARS,
MANAGER OF FIXED
INCOME INVESTMENTS,
ALASKA PERMANENT
FUND CORPORATION
I will speak about our bond portfolio and
our interest rate outlook, which is built
into the portfolio.
We have been experiencing a significant
bear market.
The bond portfolio is about 37 percent of
the total money in the permanent fund
within the asset allocation. That
represents about $10 billion. We manage
about 90 percent internally and distribute
the remaining 10 percent among five
external managers.
Speak to the technology that allows us to
manage the funds from Alaska as if we were
in New York.
Ninety-percent of the portfolio is "single
A" rated or better. It is the conservative
leg of our overall asset allocation.
We are invested across a broad range of
assets within the bond world and we have
worldwide exposure so we have
diversification.
491
The relationship of the permanent fund
within the economy is generally an inverse
one. We see interest rates rise, as the
economy is too strong, which causes the
economy to slow down.
We have seen interest rates rise almost two
percent over two years.
However we are now witnessing increasing
interest rates and continued strong growth.
This is a problem for the federal
government in determining whether the
increase productivity would it dominate the
circumstance in our current environment,
whether the Internet revolution, or whether
growth in a tight labor market and the
potential for a financial bubble will cause
inflation to continue to increase rates.
We believe they will continue to have to
increase rates because inflation has moved
up and is approaching a critical three-
percent level for core consumer inflation.
512
Outlooks in the marketplace and where
interest rates are going to grow.
Barron's combines 25 economists' forecasts
into a consensus view. Currently, that view
is projecting a 6.52 percent yield on
thirty-year US treasury bond by June 2000
and a 6.33 percent yield on that same
instrument by year-end. Currently, the long
bond is yielding about 6.75 percent.
522
Our five external managers predict 6.75
percent bonds and 6.44 percent by year-end,
which is less optimistic but still
constructive.
Unfortunately the consensus is always
wrong. Therefore, I'd rather forecast
direction because the federal government
and the market respond to continuing,
unknown developments in the market.
We have to revise our long-term view
continuously.
The perception is that growth is too strong
and the federal government will tighten.
The problem is that the federal government
is crying wolf. The result is a down
quarter being the best time for investing
because it will bounce back. However, Alan
Greenspan may move from his traditional
pattern and the cycle may turn. We have the
benefits of increased productivity and the
increased internet utilization. We have a
long bear market behind us and it is
unlikely to continue indefinitely. The key
is to determine when that might turn. Most
people want to be optimistic and expect
that the federal government would be ahead
of the game. We do too. We are looking for
an opportunity to benefit from declining
interest rates over the course of the year.
576
CO-CHAIR PARNELL
577
SENATOR WILKEN
Some think the long bond is a direct
indicator of the market's expectation for
inflation and that a three-percent margin
is built in. Do you subscribe to that
theory of direct relationship and do you
use the same three-percent margin?
582
MR. SEARS
That is the case over time. However,
markets typically overreact and if we were
in a period of rising interest rates, it
would be more likely that real rates will
increase to dampen the economy.
590
SF-00 #5 Side B 9:22 AM
PETER NAOROZ,
MANAGER OF REAL
ESTATE INVESTMENTS,
ALASKA PERMANENT
FUND CORPORATION
Our expectations for the real estate
portfolio are slightly higher then Mr.
O'Leary's expectations of 8.3 percent. We
expect a whole lot lower risk.
582
Description of real estate portfolio and
forecast for property types.
Our portfolio consists of 60 direct
investments and 88 "securitized"
investments.
The direct investments are properties like
malls, apartment buildings, office towers,
etc, throughout the US that are
geographically diversified and diversified
by manager. We have ten outside managers.
Our investments are diversified by type of
ownership. We gave changed from
predominately minority investments. We have
a measure of control but not entire
control.
We are actively working with managers today
and will report back to you on the
continued progress of the increased
investment authority given to the fund by
the legislature.
We've been able to grow our portfolio to
$2.4 billion by out-sourcing, rather than
adding additional staff.
Regarding real estate cycles and in stating
our expectations, we need to talk about
where we've come from. (detail of graph
shown but not provided)
In 1996 we were in good shape as far as
property types.
In 1999 markets have changes mostly in
industrial area.
In 2002 we don't want to own power centers,
centers that are larger than community
centers and smaller than malls.
521
CO-CHAIR TORGERSON
How much real estate is located out of the
country?
MR. NAOROZ
We are prohibited by law from investing
outside country
CO-CHAIR TORGERSON
How much is in Alaska?
MR. NAOROZ
Three buildings, an office building in
Juneau, a mortgage that is secured by a
retail center in Ketchikan and a mortgage
secured by an office building in Anchorage.
CO-CHAIR TORGERSON
Do you anticipate increasing holdings in
Alaska?
MR. NAOROZ
Yes.
CO-CHAIR TORGERSON
Share with Committee
MR. NAOROZ
We have two properties identified.
507
SENATOR PHILLIPS
Is the investment in Ketchikan the one with
all the problems?
MR. NAOROZ
All investments are challenges.
SENATOR PHILLIPS
MR. NAOROZ
Our investment is a participating mortgage
with several other funds in Plaza Port
West, a retail shopping center.
501
SENATOR PHILLIPS
Did the owners turn it back?
MR. NAOROZ
We are in discussion with the current
ownership.
SENATOR PHILLIPS
Is the Diamond Mall an example of a power
center?
MR. NAOROZ
No. A power center is five or six boxes
anchored by one large store.
SENATOR PHILLIPS
MR. NAOROZ
There is one across the street from the
Diamond Mall.
492
REPRESENTATIVE
WILLIAMS
Using the graph shown on the overhead,
could you have predicted the trouble with
the mall in Ketchikan? How could you have
protected our interest?
482
MR. NAOROZ
Yes. That's why you diversify. This
investment was made ten years ago in the
form of a loan. There are different risks
that you underwrite as a lender than risks
that you underwrite as an equity owner. We
ask the people who underwrite our lend-
lease mortgages to look at them as equity
investments.
469
REPRESENTATIVE
WILLIAMS
How could you have found out that the owner
was having problems earlier?
MR. NAOROZ
Spend time in the market and meet with the
owner.
REPRESENTATIVE
WILLIAMS
What about the rest of the investments?
There was a good indication that Ketchikan
was going to have some hardships with the
closure of the pulp mill.
MR. NAOROZ
We were aware of market conditions in
Ketchikan. We look at all the investments
and on a total return, we will be fine.
455
CO-CHAIR PARNELL
454
MICHAEL BELL,
MANAGER OF EQUITY
INVESTMENTS, ALASKA
PERMANENT FUND
CORPORATION
Equity investments
Currently, we have a total $14.9 billion
invested in equities. This is about 54
percent of the total fund. That is an
increase over last spring and is a natural
result of the increased authority given by
the legislature. We have a target of 53
percent with a range of three percent.
Of this money, $9.8 billion is invested in
stocks of US companies. The remaining $5.1
billion is invested outside the US in
equities of foreign companies.
The fund's foreign equity investments range
all over the globe from the international
developed markets of Japan, United Kingdom,
France and Germany to emerging markets,
such as Taiwan, Poland, Turkey, South
Africa, etc.
We have $7.9 billion in domestic large-cap
equities, $1.9 billion in domestic small-
cap equities, $4.5 billion in international
developed markets and about $630 million in
emerging markets.
The corporation has retained 13 equity
managers under contract to manage the fund
assets under strict investment guidelines.
Speak in detail about the relationship with
these managers.
The equity markets in general mirror what
you've heard from Mr. O'Leary.
The five-year outlook for US markets is
returns in the range of eight to nine
percent.
Overseas world developed markets rose 27
percent in 1999.
Japan's equity markets continue to be our
favorites.
Our managers feel that the overseas index
will perform slightly better than the US
market over the next five years at about
ten-percent.
Emerging markets are the permanent fund
corporation's newest markets. In 1999,
those investments rose over 66 percent. Our
managers say, "emerging markets generally
do well during a period of rising global
economic activity." We would expect good
returns from these areas.
Our managers are forecasting an annual
return of 16 percent over next five years.
373
CO-CHAIR PARNELL
What do you consider an emerging market?
MR. BELL
Turkey, Poland, South Africa, etc. that
have a smaller economy than Germany or
France.
364
SENATOR PHILLIPS
Which markets have the highest volatility?
MR. BELL
Emerging markets.
SENATOR PHILLIPS
Can you give us a range?
MR. BELL
It can decline. However, we went through an
extensive process to review the
appropriateness of making investments in
these markets. We felt that with a small
portion of the fund we could afford to make
that investment and bear the risk.
SENATOR PHILLIPS
What percent of the total investments does
this represent?
MR. BELL
Less than two percent.
346
SENATOR WILKEN
The legislation adopted last year to
increase the equities portion of the
investments also had basket provision. Did
you use that basket provision?
MR. BELL
Not to date. If our allocation to equities
increases above 55 percent, we would use a
portion of that basket.
SENATOR WILKEN
Was the basket for equities only?
MR. BELL
No.
337
CO-CHAIR PARNELL
335
REPRESENTATIVE
BUNDE
Will hold question.
334
CO-CHAIR PARNELL
328
MR. KELLY
Introduce next presenters.
CO-CHAIR PARNELL
GREG ALLEN, VICE-
PRESIDENT, CALLAN
ASSOCIATES
Handout: Alaska Permanent Fund Forecast
Model
Page 2: Overview of Presentation
Page 3: MOMA (Mother of Models-All)
The permanent fund corporation asked us to
construct a model that:
projects the future of key dimensions of
the fund
accurately captures the mechanics of the
distribution and inflation-proofing rules,
allows for the testing of different
investment and spending policies (such as
the basket rule),
perform all of this across the full range
of potential capital market outcomes
(taking into account their volatility.)
I have used this model to evaluate
different proposed distribution policies.
The main benefit of the model is to look at
what might happen to the fund assuming a
constant rate of return, and also to look
at what happens in better or worse markets.
271
Page 4: Primary Assumptions.
This uses the capital market assumptions as
of September 1999 and some of the 2000
assumptions, which were only recently
available and make the projections look
better.
We are using the current APFC Asset
Allocation that does not include the basket
rule. We are using the current statutory
dividend formula and the Fall 1999 oil
revenue forecast.
256
Page 5: Asset Allocation Assumptions
This shows the distribution of the
investments.
Page 6: 1999 Capital Market Assumptions
The combining of the asset allocations and
these expected returns generates an
expected return for the fund of about
eight- percent.
244
CHRIS PHILLIPS,
DIRECTOR OF
FINANCE, ALASKA
PERMANENT FUND
CORPORATION
Page 7: Fund Value vs. Principal Balance
This shows the growth of the fund from 1999
to 2010 using the constant eight percent
rate of return. We typically used that
constant rate of return, however the chance
of that actually happening is remote
because the market is volatile.
235
Page 8: Range of Ending Market Value
This is what it will more likely look like.
There is a ten-percent chance that in 2010
the fund value would be $55 billion or
greater. There is a 90 percent chance that
the fund value would be $29 billion or
greater. At the same time, there is a ten-
percent chance that it will be $29 billion
or less.
228
Page 9: Range of Principal Value.
This is less volatile because it only
incorporates the inflation rate. There is
no oil volatility factored into this model.
223
Page 10: Real Fund Value and Principal
This shows the real value of the fund with
inflation calculated back to 1999 dollars.
218
Page 11: Projected Distribution of Income,
(Based on Statutory Income)
This is using the constant rate of return.
212
Page 12: Range of Distributed Income
This shows volatility in that rate of
return.
206
Page 13: Ending Earnings Reserve Balance,
(Both Realized and Unrealized)
We have to track both the realized and the
unrealized earnings rate of return.
201
Page 14: Range of Ending Total Earnings
Reserve
This shows the volatility of that same
total. This is the accumulated net income
of the fund. At the end of 2010 there is a
ten-percent chance that the earnings
reserve balance will be $26 billion. There
is a 90 percent chance it will be $190
million or greater.
195
Page 15: Range of Ending Realized Earnings
Reserve
This is a subcomponent of the above graph
showing the realized earnings reserve
account. This is what drives the
distribution formula.
190
Page 16: Range of Per Capita Dividend
This shows the volatility of per person
dividend. There is a ten-percent chance
that the dividend would be greater than
$4000.
185
SENATOR PHILLIPS
Please repeat
MS. PHILLIPS
177
There is also a 90 percent chance that it
will be greater than $713 and a ten-percent
chance it will be less than that. This
assumes a 1.2 population growth for
eligible applicants.
Page 17: Rate Of Return Observations
The expected rate of return using capital
market assumptions for 1999 is about eight
percent. There are costs to manage the fund
of about .17 percent. The net return to the
fund is about 7.8 percent. Using the long-
term inflation forecast, the median real
growth rate of the fund is 4.8 percent.
168
Page 18: Range of One and Five Year Returns
for Total Fund
This projects the range of the fund return
and shows how the five-year range is more
predictable.
155
Page 19: Summary Observations
There is a ten-percent chance using the
market volatility model the fund's total
return will be as low as negative four-
percent or as high as 23.8 percent.
There is a 20 percent chance the fund will
generate a negative return in any given
year but only five-percent chance of a
cumulative negative return over five years
There is a ten-percent chance that the
fund will be able to support the dividend
without using the earnings reserve limit.
There is a 70 percent chance that the fund
will support inflation-proofing every year.
143
Page 20: Payout as a Percent of Market
Value
Typical payout method of large endowment
funds and preferred by the fund's board of
trustees.
The payout rate is set below the long-term
projected inflation rate, making inflation
proofing a priority.
This is a stable payout method.
126
MR. KELLY
Thank again for including the percent of
market value component in the plan adopted
the previous year. It will lead to better
performance of the fund over the long term.
111
CO-CHAIR PARNELL
Announced he has had no word on whether
there will be a delay of the House Session.
We've heard about the environment that the
permanent fund and out budget deliberations
operate in.
Want to hear more from Mr. Allen.
86
SENATOR WILKEN
Last year's presentation, you were asked
about overall volatility and you answered
if the Dow Jones took a 20 percent hit, the
permanent fund would take a six-percent
hit. I've used this to assure people. Is
that still true this year?
72
MR. O'LEARY
Suggest Mr. Allen show the history of 1973
and 1974 as a stress test.
CO-CHAIR PARNELL
67
MR. ALLEN
Underlying the model of the fund is capital
market behavior.
0
SFC-00 #6 Side A 10:09 AM
MR. ALLEN
Continued to detail the market situation in
the 1970s.
16
MR. O'LEARY
Bonds were no great place to be during that
period.
18
MR. ALLEN
Inflation was very high.
The market value dropped so far that it got
below the principal value.
Under this scenario and using the inflation
proofing and dividend rule, all of the
earnings would be paid out.
58
MR. KELLY
That is a reason we've talked about a using
a percentage of market value to calculate
the dividend rather than using realized
earnings.
MR. ALLEN
The worst year was still only $250 million
less than the current year in terms of the
payout.
By the early 1980's things began to shift.
MS. PHILLIPS
That is an indication that you weren't able
to inflation-proof as much as you wanted
until 1983.
113
MR. ALLEN
We don't want to limit what we base our
decision making process on. Therefore, we
built this model so we could run different
situations.
Continue to detail how the model works.
121
MR. O'LEARY
The reason the news is so good is because
of where the fund is today with the
reserve. If the reserve were smaller, the
reading wouldn't be nearly as good.
127
CO-CHAIR PARNELL
By reserve, do you mean unrealized and
realized earnings?
Yes.
129
SENATOR WILKEN
Can I update my statement from last year to
say, "Your permanent fund can take a 15
percent hit and a 20 percent the next, and
we would still be able to pay you a
dividend in excess of $1000, still
inflation-proof the fund and have $250
million excess."
135
MR. ALLEN
Yes. If equity market took a 15 percent hit
one year and 20 percent the next year, the
fund could still pay a dividend of over
$1000 for five years. You could not
inflation proof as much as you like because
you would be paying out all the excess.
This is only true because we are going into
a period with an earnings reserve balance
of $6.1 billion. If you transferred $4
billion into the principal to preserve the
fund, you would not have the ability to
payout the same amount.
159
CO-CHAIR PARNELL
Currently we don't have that ability in
statute anyway.
162
MR. ALLEN
Clarification of realized and unrealized.
164
MR. KELLY
The dividend formula is based on realized
income only. The constitution prohibits
paying out the principal. The other money
is income but not available for
distribution.
This is the reason we consulted a law firm
to review the changes in statute.
172
CO-CHAIR PARNELL
What are the two or three key indicators
you are advising the permanent fund to
watch for in terms of asset allocations? Is
it inflation, a particular segment of the
world, etc.?
185
MR. O'LEARY
I'll try to underscore that we hope for the
best outcome, but plan for less and
maintain diversification. It is easy right
now to get caught up in the 86-percent
returns of NASDAC. That is good but it
shouldn't be all that you have. We see a
tendency for people to be influenced and
chase what's been hot recently.
That has never been an issue with the
permanent fund and the board has acted
opposite as seen with their involvement
with emerging markets.
Keep a long-term perspective; keeping
reasonable expectations and maintaining
broad diversification are the measures.
Regarding specific capital market areas, if
we saw that inflation was going to greater
than what we anticipated, we would
thoroughly analyze the implications with
the board.
220
SENATOR WILKEN
We should sit back and rub our bellies. We
are the only public governing body in
America having a discussion like this.
I don't appreciate what seeing last few
years in the stock market.
229
MR. O'LEARY
There was a time in 1970s when leading
financial journals stated, "real returns
on common stocks will continue to be
negative." This was because at any time in
the 1970s after 1974 real returns had been
negative.
There were headlines "are bonds dead?"
because bonds weren't great throughout the
1970s but better than stocks in 1973-74.
At extremes, the common wisdom is to not
diversify and concentrate on what's doing
well.
252
MR. ALLEN
253
CO-CHAIR PARNELL
255
REPRESENTATIVE
BUNDE
Regarding Senator Mackie's proposal to
distribute the permanent fund in one lump
sum.
One of the premises of establishing the
dividend was to provide continued public
income though the yearly payout. Would a
one-time cash-out undermine that premise?
268
CO-CHAIR PARNELL
We will be hearing bills on this matter. If
I were on the fund, I would be hesitant to
comment on a plan at this point.
274
MR. KELLY
276
REPRESENTATIVE
BUNDE
The public is very interested. I believe
that giving them more information sooner is
better.
280
MR. KELLY
It is a longstanding tradition of the board
to neither support nor oppose changes to
the use of fund earnings. Our job is to
protect the fund as directed by you. That
position has continued to work well for us.
MR. GRUENING
289
REPRESENTATIVE
WILLIAMS
You fired of one of the investors this
year.
292
MR. KELLY
The board took that action took yesterday.
The manager was under-performing. It was
determined that money could produce better
a rate of return if invested in small-cap.
That was a decision of the board.
300
MR. GRUENING
We weren't making an asset allocation
decision. When a manager doesn't meet our
standards, they are put on notice. Some of
our biggest assets are performing over
their benchmarks
312
REPRESENTATIVE
MULDER
Do you have a general rule of thumb on how
much it costs to manage the money? What is
that amount and how have we been doing in
terms of managing it for less?
316
MR. KELLY
The basis point of cost is 17 basis points.
The corporation has asked for just under
$50 million in the budget.
323
MR. GRUENING
324
MR. O'LEARY
It is deceptive to look just at the total
number; you have to look at the asset
category. International equity and domestic
equity is more expensive to manage than
fixed-income. Real estate is also
expensive. Active is more expensive than
passive.
248
REPRESENTATIVE
MULDER
How does that translate back to the budget?
MS. PHILLIPS
The current budget request for FY01 is
under $50 million. This covers fees for the
managers and the cost to run the fund in
Juneau.
REPRESENTATIVE
MULDER
MS. PHILLIPS
That is 17 basis points.
357
REPRESENTATIVE
BUNDE
You said you currently have about $4
million in cash. How is that used?
361
MR. BROWN
This is residual cash from transactions
with spin-off. We ask managers to have less
cash on hand because we want it fully
invested.
368
REPRESENTATIVE
BUNDE
Considering the numbers you deal with, $4
million is not that much.
369
CO-CHAIR PARNELL
The presenters will be available for
questions throughout the day.
372
Adjourn 10:34 AM
SENATE FINANCE COMMITTEE
LOG NOTES
1/20/00
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