Legislature(2017 - 2018)SENATE FINANCE 532
01/23/2018 09:00 AM Senate FINANCE
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| Audio | Topic |
|---|---|
| Start | |
| Overview: Alaska Permanent Fund | |
| Adjourn |
* first hearing in first committee of referral
+ teleconferenced
= bill was previously heard/scheduled
+ teleconferenced
= bill was previously heard/scheduled
| + | TELECONFERENCED | ||
SENATE FINANCE COMMITTEE
January 23, 2018
9:03 a.m.
9:03:25 AM
CALL TO ORDER
Co-Chair MacKinnon called the Senate Finance Committee
meeting to order at 9:03 a.m.
MEMBERS PRESENT
Senator Lyman Hoffman, Co-Chair
Senator Anna MacKinnon, Co-Chair
Senator Click Bishop, Vice-Chair
Senator Peter Micciche
Senator Donny Olson
Senator Gary Stevens
Senator Natasha von Imhof
MEMBERS ABSENT
None
ALSO PRESENT
Angela Rodell, CEO, Alaska Permanent Fund Corporation; Bill
Moran, Chair, Alaska Permanent Fund Corporation Board of
Trustees.
SUMMARY
^OVERVIEW: ALASKA PERMANENT FUND
9:04:28 AM
Co-Chair MacKinnon acknowledged the earthquake near Kodiak
that occurred in the morning. She remarked that many people
were concerned about safety, but she understood that most
people were safe from the earthquake.
9:06:00 AM
ANGELA RODELL, CEO, ALASKA PERMANENT FUND CORPORATION,
(APFC) introduced herself.
Ms. Rodell discussed the presentation, "Overview: Alaska
Permanent Fund" (copy on file).
Ms. Rodell looked at slide 2, "The Alaska Constitution":
Over four decades ago, in 1976, Alaskans in an
historic vote amended the Constitution of the State of
Alaska by a margin of 75,588 to 38,518 and created the
Alaska Permanent Fund.
Alaska Constitution Article IX, Section 15
Section 15. Alaska Permanent Fund At least twenty-five
percent of all mineral lease rentals, royalties,
royalty sale proceeds, federal mineral revenue sharing
payments and bonuses received by the state shall be
placed in a permanent fund, the principal of which
shall be used only for those income-producing
investments specifically designated by law as eligible
for permanent fund investments. All income from the
permanent fund shall be deposited in the general fund
unless otherwise provided by law.
Ms. Rodell highlighted slide 3, "APFC's Vision":
"to deliver sustained, compelling investment returns
as the United States' leading sovereign endowment
manager, benefitting all current and future
generations of Alaskans"
? Reflects statutory language and intent as well as
Board and staff aspirations.
? Emphasizes maximizing returns in a fully sustainable
manner.
? Underscores the intention for the Fund to be a
perpetual resource for the State of Alaska.
? Embodies core values of Integrity, Stewardship, and
Passion.
Ms. Rodell addressed slide 4, "APFC's Strategic 5-Year
Plan":
Strategic Priorities FY17-FY21
Gain greater control of resource allocations
Optimize APFC's operational processes and use of
financial networks and resources
Develop best-in-class investment management
capabilities, partnerships, and geographic reach to
maximize investment returns
Enhance talent and staff across APFC
Ms. Rodell highlighted slide 6, "How the Fund Works." She
stated that the slide was a summary of all the in-flows and
out-flows of the fund, and where the controls happened for
those funds. She noted that any inflation-proofing
appropriations and other appropriations would flow into the
principal, which was constitutionally protected under
Article 9, Section 15 of the constitution. She remarked
that the money was invested along side on a pro-rata share
with any amounts in the Earnings Reserve Account (ERA). The
ERA was the receptacle for all the dividends, income, and
gains made from the investments.
9:10:05 AM
Senator Micciche requested the mechanism by which an
unrealized gain became a realized gain. Ms. Rodell replied
that realizing the gains occurred through natural financial
mechanisms. She stated that the value would be unrealized
until the stock was sold. She remarked that the gains from
the sale, would be attributable to the ERA.
Senator Micciche surmised that there was a formal balance
change of realized gains or losses; and an annual true up.
He queried the time of the annual true up. Ms. Rodell
replied that it occurred on June 30 of each year.
Co-Chair MacKinnon explained that the number in the ERA was
not "real money", so it was best to differentiate between
realized and unrealized gains. Ms. Rodell agreed. She
explained that there was a change to the accounting rules
to include unrealized gains in the concept of "income."
Co-Chair MacKinnon queried the unrealized number as of June
30, 2017. Ms. Rodell replied that she agreed to provide
that information.
Co-Chair MacKinnon surmised that it was approximately $2
billion.
Ms. Rodell addressed slide 9, "Assets Under Management in
billions."
She stated that $12.8 billion was in the ERA. She shared
that the unrealized gains in the ERA was approximately $3
billion. The unrealized gains in the principal was
approximately $8 billion.
9:15:26 AM
Co-Chair MacKinnon stressed that the gain was only realized
when the asset was sold.
Senator von Imhof stressed that unrealized earnings did not
automatically become realized each year, because it was
based on investment decisions. Ms. Rodell agreed. She
furthered that there could also be unrealized losses that
were not recognized in the portfolio.
Co-Chair Hoffman queried the legislative appropriation,
which was above the statutory requirement. Ms. Rodell
replied that there was approximately $16 billion deposited
into the principal, attributable to royalties. She shared
that there was an additional $16 billion appropriated
through the inflation-proofing mechanism, and an additional
$7 billion in other appropriations made by the legislature
over the years to the principal.
Co-Chair Hoffman surmised that it was a total of $23
billion. Ms. Rodell agreed.
Senator Micciche remarked that the legislature had seen the
importance of saving the excess of the fund.
Senator Stevens queried the source of the $7 billion. Ms.
Rodell responded that upon creation of the fund and
dividend, the mechanism was that any additional moneys left
behind after the dividend were "swept" into the corpus. She
stated that would constitute those additional
appropriations. She also stated that the legislature may
have determined a portion of the excess revenues into the
fund.
Co-Chair MacKinnon remarked that the state paid back the
constitutional budget reserve (CBR) after an increase in
revenue.
9:21:13 AM
Ms. Rodell looked at slide 7, "Invested as One Fund":
Alaska Permanent Fund Corporation: Investment and
Management of the Fund
One Target Asset Allocation: Stocks, Bonds, Real
Estate, Alternatives
Pro Rata Shares of Each Investment: Principal, ERA
Ms. Rodell discussed slide 8, "Statutory Net Income AS
37.13.140":
? Pursuant to state law (AS 37.13.140), at the end of
each fiscal year APFC calculates and reports on the
net realized gains accounted for during the fiscal
year.
? These net realized gains and investment income are
the funds in the ERA that are subject to appropriation
by a simple majority of the Alaska Legislature.
? Net realized gains = realized gains accumulated
during the fiscal year (-) minus realized losses
accounted for during the year.
? Unrealized gains earned by Principal are part of
Principal, only until realized at which time they are
transferred to the ERA.
Ms. Rodell addressed slide 9, "Assets Under Management in
billions." She stated that the principal had stayed fairly
steady at between $45 billion and $48.7 billion, which
included the unrealized portion of the principal. The ERA
had grown from $6 billion in FY 14 to more than $15 billion
through December 31, 2017.
Ms. Rodell highlighted slide 10, "Principal":
The Principal is built through:
royalty deposits; inflation proofing; and other
special appropriations.
Ms. Rodell discussed slide 11, "Inflation Proofing":
? The Board of Trustees emphasized the importance of
inflation proofing by unanimously adopting Resolution
17-01 during their September 2017 Annual Meeting.
.notdef Directing APFC to identify and pursue
legislative support for inflation proofing the
Principal of the Alaska Permanent Fund to
preserve the purchasing power for all generations
as stated in AS 37.13.020.
? AS 37.13.145 (c) provides the inflation proofing
mechanism which is calculated at the end of the fiscal
year. Historically, the Legislature has included an
estimated amount in the language of the operating
budget to fulfill this statutory obligation.
? The following amounts remain unappropriated at this
time, and have been included in the Governor's
proposed FY19 operating budget:
o FY16 $ 47 million
o FY17 $ 501 million
o FY18 $ 903 million (estimated)
o FY19 $ 943 million (estimated)
Vice-Chair Bishop wondered whether the trustees had
educational training. Ms. Rodell replied that there was a
requirement for annual education. She furthered that there
was not a requirement for the trustees. She stated that
there was an attempt to provide an education session at
each quarterly meeting. She deferred to Mr. Moran.
9:26:42 AM
BILL MORAN, CHAIR, ALASKA PERMANENT FUND CORPORATION BOARD
OF TRUSTEES, explained that there was a joint annual
education between the APFC Board and the Alaska Retirement
Management (ARM) Board. He remarked that the training had
been extensive in a variety of areas. He shared that Callan
had provided training related to a range of issues from the
investment to governance of the fund. He stated that there
were some of the top organizations in the country to
periodically attend the meetings of the board of trustees,
with comprehensive sessions on a range of subjects at the
board's request.
Senator Micciche looked at slide 9, and noted that it
reflected assets under management realized and unrealized
gains. He remarked that there would not be a change in the
principal without the inflation proofing, which did not
occur in FY 16, FY 17, and FY 18. He stressed that, if it
were not for inflation proofing, he felt that the balance
of the corpus would not change. Ms. Rodell replied that it
would change slightly because of the royalty deposits. She
stated that the royalty deposits had been between $200
million and $300 million in the previous couple of years.
She stated that it would continue to slightly increase
because of the royalty deposits.
Senator Micciche surmised that all gains and losses are
realized in the ERA. Ms. Rodell agreed.
Senator von Imhof wondered whether there were any other
endowment funds in the country that separated the principal
from a separate earnings account. Ms. Rodell replied that
there was no other fund in the world that separated the
funds. She stressed that it was a unique construct due to
the constitutional language.
Senator von Imhof felt that the separation of accounts
would permeate the remainder of the presentation.
9:30:17 AM
Co-Chair MacKinnon remarked that there was a frequency of
turnover of long-term board members. She queried the
longevity of the current board members. Ms. Rodell replied
that the longest serving trustee was Carl Brady, who had
been on the board since 1994. She stated that his four-year
term was appointed in 2015, and would expire June 30, 2019.
She shared that the second longest serving board member was
Bill Moran, who had ten years of service which would expire
June 30, 2018. She stated that there was a new public
member, Craig Richards, who would attend his first board
meeting in February. She stated that the other public
member was Marty Rutherford, who was appointed in 2016 and
her term would expire June 30, 2020.
Co-Chair MacKinnon wondered whether he would be reappointed
to the board by the current administration. Mr. Moran
replied that he had not been told whether or not he would
be reappointed to the board. He furthered that it was not
uncommon for a governor to replace the entire board. He
stated that during the Frank Murkowski administration, it
was found that it was not prudent to appoint an entirely
new board.
9:34:36 AM
Co-Chair MacKinnon remarked that Alaskans wanted to ensure
that the corpus of the fund was protected by those in
control. She remarked that Mr. Richards had served on the
board through the administration, when he worked directly
for Governor Walker, but had now been appointed as the
public member. She remarked that Mr. Richards had testified
in regard to advancing the natural gas pipeline. She
wondered if there was a good foundation for training to
ensure that there was an acceptable risk to the
corporation. Mr. Moran replied that there had been a
complete review and revision of the corporation's
governance process. He stated that within the best
practices, there was a broad array of investment policies
and procedures for the board of trustees and the staff. He
stressed that all of the trustee activities related to
asset allocation and investment supervision were against a
background of a strong policy base that was regularly used
to determine exposures and investments in a variety of
areas.
Co-Chair Hoffman wondered how much the board relied on the
chief investment officer of APFC. Mr. Moran replied that
the chief investment officer was one of the critical
positions in the organization. The board took care in the
vetting of the process. He explained that typically the
executive director would bring a series of candidates
before the board when there was a needed change in the
board. He stated that as they worked into the organization,
they were closely supervised to ensure that there was an
understanding of the board's directions and expectations.
He remarked that it was realistic to assume that positions
like the chief investment officer were mobile positions.
The investment officers had international exposure, and
there were always opportunities. He stated that it was not
realistic to expect that the position would be filled by
the same person for 10 or 20 years. There would be a fair
amount of turnover in those positions.
Co-Chair Hoffman was please to hear that the chief
investment officer was critical to the health of a solid
permanent fund corporation.
9:40:18 AM
Ms. Rodell displayed slide 13, "Board of Trustees":
As the fiduciaries, the Trustees have a duty to
Alaskans in assuring that the Fund is managed and
invested in a manner consistent with legislative
findings: AS 37.13.020
? The Permanent Fund should provide a means of
conserving revenue from mineral resources to
benefit all generations of Alaskans.
? The Permanent Fund's goal should be to maintain
safety of principal while maximizing total
return.
? The Fund should be used as a savings device
managed to allow the maximum use of disposable
income from the Fund for the purposes designated
by law.
Ms. Rodell highlighted slide 14, "Investment Oversight":
Board of Trustees
As Fiduciaries of the Fund, Full Authority to
Make Investment Decisions.
?Provide Authority to Invest Within Set Bands
?Approve Target Asset Allocation
?Adopt Investment Policy
Chief Executive Officer
Assures Strategies Adopted by the Board are
Successfully Implemented
Chief Investment Officer
Makes Strategic and Tactical Allocations to Allow
the Fund to Grow in Value
Portfolio Managers
Responsible for the Investment and Performance
Ms. Rodell addressed slide 15, "The Portfolio $64.0 Billion
as of FY18 Q2." She informed that the pie chart on the
graph represented the board's target allocation of the
fund.
Ms. Rodell looked at slide 16, "Asset Allocation
Structure":
Growth
Tradable/Liquid
Public Equities (stock)
Illiquid
Private Equity
Absolute Return
Allocation Strategies
Income
Tradable/Liquid
Fixed Income Plus (Bonds)
Cash
Illiquid
Real Estate
Infrastructure
Ms. Rodell detailed that allocation strategies were
strategies that overlay the entire portfolio.
Ms. Rodell highlighted slide 17, "Management of the Fund":
The Board of Trustees continue to work towards an
optimal mix of in-house versus external management
capabilities based on resources and opportunities.
Vice-Chair Bishop queried the difference in savings of in
house and out of house. Ms. Rodell replied that it was a
difficult number to "pin down", because the fund had grown
so much over the previous two years. Therefore, money had
to be deployed. She stated that external managers had
increased balances, so it was difficult to determine that
delta. She remarked that there was a continual examination
of the high-cost investments. She remarked that private
equity had higher fees associated than public equity. She
stressed that private equity was an important asset class
for investment. She remarked that there was an examination
of whether the corporation should grow its ability to do
due diligence and direct investing on private equity and
eliminate the higher fees, than to hire public equity
traders in Juneau.
9:45:54 AM
Senator von Imhof wondered whether the hiring of external
managers would increase the probability or possibility for
the permanent fund to co-invest with other large funds who
were also customers of the same external managers. Ms.
Rodell replied that the external managers provided
interesting opportunities for the fund.
Ms. Rodell looked at slide 18, "Management of the Fund by
Asset Class":
o Publicly traded securities, internally managed means
that APFC investment staff directly buys and sells the
publicly traded securities.
o Private Markets, an investment is considered
internally managed if APFC investment staff directly
conduct the investment and legal due diligence for the
investment and make the decision to invest.
Ms. Rodell looked at slide 20, "Fiscal Year 2017
Performance: Realized Unrealized Gains." She noted that the
total fund, over the previous five years, had returned 8.85
percent. She stated that it had beaten the passive index
benchmark by 1.7 percent. She shared that the passive index
benchmark was all liquid, a 60 percent tilt toward public
equity (as opposed to the permanent fund, which had a 40
percent tilt to public equities in terms of the target),
and it was what would be generated if a computer was
managing the fund. She stated that it showed the amount of
difference of the active management of the corporation had
provided in additional return to the permanent. fund. She
stated that there was also a performance benchmark, which
was the individual asset class performance benchmark that
were accumulated to match the target asset allocation. She
stated that the performance benchmark was beat by 70 basis
points. She stated that it showed the active management of
corporate staff and portfolio managers had generated
additional return over the previous five years. She noted
that the board of trustees had a total fund return
objective of CPI or inflation plus 5 percent. She stated
that 5 percent plus inflation for the five-year period was
calculated at 6.32 percent.
9:50:27 AM
Ms. Rodell highlighted slide 21, "Asset Class Performance."
She stated that the slide was intended to give a sense of
where the returns were driven over the fiscal year, three-
year, and five-year. She noted that the US domestic
equities was a "big push" at 14.6 percent over the five-
year period. She remarked that there were significant
returns from the private equity class at 18.3 percent. She
noted that infrastructure provided another 15 percent in
return to the fund. She stated that the private market
asset classes continued to be an important contributor to
the overall performance of the fund.
Ms. Rodell addressed slide 22, "Callan's Capital Markets
Forecast." She stated that each year Callan developed a
capital markets forecast, which calculated a ten-year
return forecast for each asset category. She shared that
Callan also developed an annualized standard deviation. She
remarked that the annualized standard deviation was the
forecast of how much band width there was around that
number. She shared that there was a ten-year projection of
public global equities of 7 percent with a plus or minus of
18.5 percent. She stressed that it was a volatile type of
asset. She compared that asset to the cash equivalence,
which were projected to earn over the ten-year period 2.7
percent, with only a difference of plus or minus 0.9
percent. She explained that Callan then used all of the
returns against the board's adopted target asset allocation
to come up with a projected total return over the following
ten years based on the board's adopted asset allocation.
She stated that for 2018 the total return forecast was
expected to be 6.5 percent for the next ten years.
Senator von Imhof noted that inflation was 2.25 percent,
and wondered whether Callan considered a standard
deviation. She asked about a range for inflation. Ms.
Rodell replied that there was no range provided by Callan
for inflation. She looked at slide 20. She remarked that
since the fund's inception, there was a total fund return
objective of CPI plus 5 percent at 7.67 percent. She stated
that over the 40 years of the fund, inflation had averaged
2.67 percent. She remarked that, over the past five years,
inflation had averaged 1.32 percent. She remarked that it
was known that there was a low inflation environment, and
given high unemployment rates and high valuations on
assets, there was a sense that inflation would start
increasing again.
Vice-Chair Bishop wondered whether the US Treasury
inflation-protected securities were "t-bills." Ms. Rodell
replied that they were not "t-bills", but they were a
security issued by the US Treasury that was designed to
move with inflation. She explained that they would lose
value when inflation was low, because they were considered
a hedge against inflation.
9:55:26 AM
Vice-Chair Bishop queried some investment examples of the
Global Real Estate Investment Trust.
Vice-Chair Bishop announced that the response could be
provided at a later date. Ms. Rodell replied that Global
Real Estate Investment Trust referred to those real estate
investment trusts that had exposure to real estate around
the world, not only in the United States. She stated that
they were traded securities, so the exposure was through a
liquid market, without buying into actual properties
directly. She stated that one would buy into the trust that
owned underlying properties. She stated that a Global Real
Estate Investment Trust could hold assets around the world.
Ms. Rodell looked at slide 24, "What are the stress tests?"
.notdef At the request of the Board Chair, Bridgewater, one
of our partners with expertise in portfolio
management, developed and presented stress scenario
analyses to the Board of Trustees.
.notdef These analyses demonstrate the effects of stressful
economic conditions on the Fund under assumed draws:
.notdef 5.25 percent years 1-2, and 5 percent years 3-
10
.notdef 5.25 percent years 1-2, and 4.5 percent years
3-10.
.notdef The stress analyses estimate the returns required to
achieve assumed draw outcomes, and compare these
return hurdles to the range of returns implied by
forward-looking Bridgewater assumptions, Callan
estimates, and historical returns (adjusted for
today's cash rates).
Ms. Rodell looked at slide 25, "Bridgewater's
Observations":
.notdef Total returns for savers are likely to be
historically low over the next decade.
.notdef Forecasting future returns is inherently imprecise;
however, there is confidence that low cash rates will
be a drag on all assets for the medium term.
.notdef This development presents a significant challenge to
investors whose spending plans are based on higher
expected returns than are now likely.
Ms. Rodell addressed slide 26, "Methodology":
For each draw assumption two stress tests were
conducted - distinguished by whether the current stock
of unrealized gains are used as an additional lever to
support the balance in the Earnings Reserve.
Stress Test 1
Make payments according to distribution plan (5.25
percent to 5 percent or 5.25 percent to 4.5 percent)
until Earnings Reserve is exhausted (less than 13B
starting buffer)
.notdef This stress test is conservative with respect to
potential distributions (i.e., should represent a
lower-bound for expected payments from the fund).
Stress Test 2
Make payments until overall plan surplus (Earnings
Reserve + Current Unrealized Gains) is exhausted (less
than 20B starting buffer)
.notdef This stress test is less conservative with respect
to distributions (i.e., the worst case distribution
outcomes will be less severe, though the worst case
ending fund size will be more severe).
10:01:09 AM
Ms. Rodell highlighted slide 27, "Assumptions":
Draws
.notdef Scenario 1:
Distributions are Calculated as 5.25 percent of the 5-
Year Average of the Total Fund Size in years 1-2, and
5.00 percent in years 3-10.
.notdef Scenario 2:
Distributions are Calculated as 5.25 percent of the 5-
Year Average of the Total Fund Size in years 1-2, and
4.50 percent in years 3-10.
Distributions
.notdef Limited by either the size of the ERA (Stress Test
1) or the ERA plus current unrealized gains (Stress
Test 2).
.notdef Prioritized over inflation proofing payments
partial payments allowed.
.notdef ERA can be drawn to zero, but never have a negative
balance.
Inflation Proofing
.notdef Assessed on the Principal Fund Balance, excluding
any unrealized gains.
.notdef 2.25 percent Annual Inflation (unless otherwise
noted).
Ms. Rodell discussed slide 28, "Scenario 1":
5.25 percent years 1-2 and 5.00 percent years 3-10
Ms. Rodell displayed slide 29, "Required Return."
Co-Chair MacKinnon wondered whether Ms. Rodell was familiar
with the Monte Carlo runs that the governor did on his
initial proposal almost three years prior, which painted
somewhat of a different picture for the committee. Ms.
Rodell replied that she was not familiar it.
Co-Chair Hoffman wondered whether the 1 in 20 percent,
meant that 1 out of every 5 years it could earn 3.3
percent. Ms. Rodell asked for a repeat of the question.
Co-Chair Hoffman noted that that there was a 20 percent
probability for the 3.3 percent annual rate of return. Ms.
Rodell agreed. She explained that the odds of falling short
and missing that target was 20 percent, or 80 percent that
target would be beat.
10:05:08 AM
Co-Chair Hoffman surmised that the probability for that
occurrence was one out of five years. Ms. Rodell agreed.
Senator Micciche felt that each year had the same odds, so
the years should be examined individually. He noted that SB
26 was not moved in a vacuum. He felt that the evaluation
did not consider the Monte Carlo approach, which had a much
lower probability of failure. He felt that the presentation
was unnecessarily pessimistic. He noted that any
consideration on a POMV required an evaluation every three
years on the actual performance of the fund. He wanted to
see the background data on the level of conservatism in one
year, versus the discussion from the year prior.
Senator von Imhof shared that she had attended the
Bridgewater presentation. She noted that there was some
discussion about separating out the ERA, and how it would
affect the stress test. She wondered, to what degree, would
separating the ERA from the Corpus affect the stress test.
She noted that other foundations had managed to pull 5
percent a year in perpetuity, and yet managed to be an
ongoing concern. She stressed that no other fund in the
world separating an ERA from the Corpus.
Ms. Rodell looked at slide 30, "Stress Test Example: 2007-
2016(5.25 percent to 5.00 percent Scenario)." She stated
that the slide only showed the stress scenarios. She
remarked that Bridgewater had developed a database over 100
years of securities activity. She stated that there were
models to create proxies for asset classes that did not
exist 100 years prior. She remarked that there was a robust
database to draw the conclusions. She stated that each grey
line represented a different ten-year period applied to the
target asset allocation of the fund passed by the board of
trustees. She announced that it assumed that the board made
no changes as a result of what was happening in the market;
it assumed that the trustees make no changes based on what
requirements came to them in terms of use of the fund. She
stressed that the slide showed a scenario of what could
happen if there was a requirement to make the draw. She
noted that the blue line highlighted what had happened to
the markets from 2007 to 2016. She stated that applying
that market activity to the current target asset allocation
generated the shown results. She explained that it meant
that, in 2019, the losses of 30 percent would wipe out the
ERA. She stated that the fund continued to stay invested,
and made 27.9 percent, but it had not recouped an amount
available for a contribution out of the ERA. She noted that
starting in 2021, those contributions continued to be made
going forward through 2027. She stressed that it was
designed to gain parameters.
10:10:59 AM
Co-Chair MacKinnon looked at slide 20, and noted the
previous years and the since-inception returns that were
much higher than the scenario. She outlined the details of
the returns of the various years, which had beat the market
projections. She wondered whether the run scenario based
the permanent dividend draw in current state statute in the
underlying model calculations for removal of money from the
fund and interest. Ms. Rodell replied that it did not speak
to the amount for dividend or other purposes. She stressed
that it said that pulling 5.25 percent stepping down to 5
percent. She stressed that what happens to the draw amount
was not in the analysis. She explained that the analysis
was saying that if one only earned 4.5 percent per year for
the next ten years, one would exhaust the ERA. She
furthered that earning more than 4.5 percent, one would be
in the triangle space between the 4.5 percent line and the
6.3 percent line. She stated that earning 6.3 percent or
better in each of those years, one would not use any of the
ERA. She stated that it also assigned probabilities to the
odds of falling short. She explained that the odds of
having a year with less than 6.3 percent was one in two, or
precisely 48 percent. She stated that the odds of having
one year of less than 3.3 percent or lower was 20 percent.
Co-Chair MacKinnon looked at inflation proofing, and
whether it was included in the underlying structure that
was not on the risk analysis. She wondered whether there
was a calculation of moving from the ERA to the corpus
inflation proofing. Ms. Rodell replied in the affirmative,
and stated that it imbedded in the annual return, which
imbedded a 2.25 percent inflation amount calculated moving
into the corpus. She stated that it would make the draw
second to the contribution of the 5.25 percent.
Co-Chair MacKinnon wondered whether that number was
available in totality in terms of billions of dollars that
was used in the underlying. Ms. Rodell looked at slide 30,
and noted that in 2027 there would be cumulative
distributions to the state in the stress test of $22.6
billion. She furthered that there would be missed inflation
proofing payments of a negative $2.6 billion, because it
was the second priority. She explained that there would be
a real value of the principal at that point of
approximately $41 billion.
10:15:27 AM
Co-Chair MacKinnon noted that there was a significant
amount of time to reach a $10 billion total value. She
remarked that moving from $10 billion to $30 billion seemed
like a long period of time. She recalled that there had
been a range of value at $34 billion, and she noted that
the value was currently doubled. She queried what was
anticipated under the current assumptions that the board of
directors had placed on asset allocation in the doubling
process. Ms. Rodell replied that looking at the fund values
in the economic crisis in the 2008 to 2009 timeframe, the
total assets under management were approximately $29
billion. She stressed that in the recent ten years the
state was sitting at approximately $65 billion of assets
under managements. She noted that the markets had done well
since the financial crisis, but there were some flat years.
She looked at 2015 as a flat return year. She stressed that
the most significant contributor to fund growth was
removing the allowed list of investments that occurred in
2005 and 2006. She stated that it gave the trustees the
full "plate" of investments to choose from, and using the
prudent investor rule as its guideline. The board had put
together a diversified asset allocation, and allowed to
invest in private equity that had contributed 18 percent
over the last five years in terms of return and fund value.
Vice-Chair Bishop wondered whether the stress test took
into consideration Senator Micciche's comments about the
three-year built in adjustment. Ms. Rodell replied in the
negative. She explained that it assumed a straight-forward
draw of 5.25 percent stepping down to 5 percent.
Vice-Chair Bishop remarked that the disclaimer on slide 30
looked "in the rear-view mirror." He felt that the
committee was wise to include the three-year lookback
average. H
10:19:50 AM
Co-Chair Hoffman wondered why there was no addendum to
examine the versions from the legislature, and their impact
on the stress tests. He felt that the results would not be
as "bleak" as what was displayed on slides 29 and 30. Ms.
Rodell replied that APFC did not ask for a specific bill to
be modeled.
Co-Chair Hoffman noted the assumption in the Bridgewater
report filtering through to 2019, and having a 30 percent
asset portfolio was substantial. Ms. Rodell replied that
the analysis applied a specific time period of actual
results on balances going forward.
Senator von Imhof felt that there was a sidetrack from the
real conversation. She wondered how other foundations
differently managed their assets, and successfully have a 5
percent on a perpetual basis while manage to maintain as an
ongoing concern. Ms. Rodell did not know, but she explained
that looking at the Yale Endowment, which was considered a
premier endowment to be modeled after. The calculation of 5
percent was based on 5 percent of spending. She stated that
the spending was adjusted based on the amount of the draw,
and was not based on 5 percent of the value of the
endowment. She remarked that there were many different
rules, depending on which endowment was considered. She did
not have a solid answer on the best way forward. She stated
that the analysis was designed to give information about
what could happen if there was a "retched" set of market
circumstances.
10:26:44 AM
Senator Micciche felt that the fund was healthy because of
the objectives of maximum returns and conservative
management of state assets. Ms. Rodell agreed.
Senator Micciche understood that he was grateful for the
proper objectives, and be careful to not stress the growth
of the corpus of the fund.
Senator von Imhof noted that she was fond of Ms. Rodell
personally, and wanted to do right by the state. She was
concerned, because there was $13 billion in the ERA, and
wanted to protect the permanent fund. She wanted to examine
a structured draw that was controlled, predictable, and
sustainable over time. She noted that in 2004 the board
recommended that the ERA be collapsed into the corpus to
make one large fund. She stated that having the entire fund
be able to capture the excess income helped the fund grow.
She felt it was like "super inflation-proofing." She noted
that there would be years the fund returns would be
negative.
10:32:34 AM
Co-Chair MacKinnon appreciated the conservative look to
protect the corpus, which was the goal of the
administration and all legislators. She noted that everyone
experienced the economic crisis. She wondered how the state
was prepared for a bear market, and whether there was an
emergency plan. Ms. Rodell responded that the challenge was
not knowing when or where the "bear" comes. She stated that
there was a hedge fund strategy that was counter cyclical
to the activities in the market, which would protect from
the downside.
10:36:03 AM
Co-Chair MacKinnon felt that there was current volatility
in oil and gas production, and also volatility in
investment earnings over time. She appreciated the
cautionary note in the previous scenario.
Co-Chair Hoffman felt that House and Senate had passed
versions of SB 26, and the payout in the Senate version was
conservative. He felt that it would reduce the stress test,
because it was a 4.5 percent to 4.75 percent draw. Ms.
Rodell replied that she would address that question in the
next scenario.
Co-Chair MacKinnon recalled the move to take all the money
from the ERA to fund government. She queried how that
affected the management. Ms. Rodell replied that there was
discussion about how to use the fund. She stressed that $1
billion of cash was available to meet capital calls. She
remarked that the debate about the ERA, there seemed to be
consensus building around the $2.5 billion to $2.75 billion
draw that would be in SB 26. She stated that the cash
reserves were moved to the $3.5 billion mark, to include
$2.5 billion for the state. She explained that the cash
would not be deployed into an illiquid asset class, such as
private equity, because it could not be used to turn over
to treasury. She stated that there would be a short-term
duration of use of the fund, which argued for using it into
liquid fixed income securities that would not lose value.
She remarked that the amount moved up closer to $5 billion,
and then resulted in a total draw of approximately $725
million. She stated that then there was an immediate
deployment of the excess into the public equities and fixed
income, and moved into private asset as they become
available.
10:42:53 AM
Co-Chair MacKinnon noted a conversation about advance
funding a portion of the budget. She recalled the
possibility of deploying money managers on behalf of
Alaskans in the case of a government shutdown. She stressed
that she wanted to protect retirement and benefits. She
believed that the statutory authority was needed to
maintain operations. Ms. Rodell replied that an
appropriation was required to operate the permanent fund.
The appropriation paid for both the corporate operations
and the external manager contracts. There were provisions
made with the custodial bank, which would come into effect
in the event of a shutdown.
Ms. Rodell highlighted slide 31, "Scenario 2: 5.25 percent
years 1-2 and 4.50 percent years 3-10." The scenario
recognized the glide into an ongoing draw.
Ms. Rodell addressed slide 32, "Required Return (5.25
percent to 4.50 percent Scenario)." She stated that the
required annual return decreased, because the required
amount was stepped down. She stated that in order to
maintain the $13 billion in the ERA, and the $7 billion in
the unrealized gain, an annual return of 5.9 percent was
required over the following ten years.
10:46:31 AM
Senator von Imhof wondered how the risk profile would shift
if it stayed at 5 percent. Ms. Rodell replied that there
may be slight shifts up and down, and meet somewhere
between the 5.9 percent and 6.3 percent.
Senator von Imhof queried whether the "shock" at the
beginning of 5.25 percent would have an effect to shift
down in risk. Ms. Rodell replied in the negative, because
eliminating the shock in the first two years, but
increasing the distribution requirement in years 3 through
10 from 4.5 percent to 5 percent.
Ms. Rodell continued to discuss slide 32. She noted that
the odds of falling short would also reduce. She stated
that the odds of maintaining the 5.9 percent annual return
would be 56 percent.
Co-Chair MacKinnon wondered whether more staff would be
required to manage more volatility or liquidity. Ms. Rodell
replied that the staffing levels were affected more by the
plan.
10:50:41 AM
Ms. Rodell discussed slide 33, "Stress Test Example: 2007-
2016 (5.25 percent to 4.50 percent Scenario)." She remarked
that the cumulative distributions were lower, and was
expected because there was a less take at 4.5 percent, with
the same effect of a large market selloff in the second
year of 30 percent with a 20 percent recovery the following
year.
Ms. Rodell highlighted slide 34, "Summary Comparison." She
noted that the two were fairly close, but provided a range
of outcomes. She explained that at the end of ten years,
based on Callan's capital market forecast, there would be a
distribution under the base case a total of $31.521
billion. She noted that it was different than the stress
case. She remarked that it was under the median outcomes.
She remarked that the reduced distribution was $29 billion.
The fund would have grown to $75.3 billion, or $78.2
billion under the lower 4.5 percent draw. The ERA would
continue to accumulate at $14.3 billion. She furthered that
there would be "built up" unrealized gain, because there
would be no rebalancing, therefore the unrealized gains
would be allowed to accumulate to $21.4 billion, with no
missed inflation-proofing payments.
Co-Chair MacKinnon noted that the additional legislative
appropriations would be taken as "more" rather than
"inflation-proofing", because of the statutory language.
Ms. Rodell agreed. She furthered that the legislature also
appropriated specific inflation-proofing payments.
Ms. Rodell stated that the Appendix was provided for
informational purposes.
Co-Chair Hoffman remarked that there was a $2.5 billion
deficit in the governor's budget. He remarked that there
was a short funding of credits that may not happen if the
bonds were not sold. He stated that the deficit may
actually be $2.7 billion to $2.8 billion. He noted that
there was an additional $2.3 billion that the governor
wanted to "backfill" the inflation proofing from the ERA.
He stated that the total was above $5 billion, at a "hit"
to the ERA. He queried that scenario's impact on the fund.
Ms. Rodell looked at slide 11. She stated that the draw was
roughly $2.6 billion. She remarked that adding that amount
to inflation proofing rolled into the corpus, and was
invested in the fund's earnings.
10:55:28 AM
Co-Chair Hoffman noted that the governor declared a $2.5
billion deficit, but there was no inclusion of credits.
Co-Chair MacKinnon wondered whether the ERA was identically
invested to the permanent fund. Ms. Rodell replied in the
affirmative.
Co-Chair MacKinnon surmised that the $2.3 billion of
possible inflation proofing would be a technical book
entry, versus a reallocation of asset. Ms. Rodell agreed.
Co-Chair MacKinnon surmised that the draw from the markets,
without bill passage, would be instability in drawing the
current budget shortfall. She noted that the governor's
proposal had a smaller draw on the CBR, which may not be
the best way to use the remaining assets.
Senator Micciche announced that it might be $2.2 billion.
Co-Chair MacKinnon she stressed that there was a continued
issue of the CBR.
Senator Micciche noted the difference in earnings from last
year. He remarked that $5 billion in savings at 12 percent,
there would be an additional $600 million. Ms. Rodell
agreed.
Senator Micciche felt that the management of the CBR had
cost many billion dollars over the years. He queried a
better way to manage the CBR, while managing the need for
some liquidity. He noted that liquidity had a bottom line.
He felt that the expectation of liquidity was a very
expensive way to manage the liquid assets. Ms. Rodell
replied that the subaccounts provided a challenge for many
DOR commissioners, because there was a recognition that
some investments were lost. She recognized that the money
was relied upon.
11:01:20 AM
Senator Micciche felt that there could be an in between. He
stressed that there was a desire for maximum return in the
asset allocation, and what could be done with the CBR in
the past. He felt that there could be a focus on a greater
return with a level of conservatism. Ms. Rodell replied
that there was a challenge because the returns on the
investments were at historic lows with cash rates at 1.3
percent versus the 3 percent in the past. She felt that
there was a struggle because risk was required to see any
return. She remarked that DOR was bound by statute based on
what was in the CBR.
Co-Chair Hoffman stated that the CBR was classified as a
"rainy day fund." He noted that the question should be
"when is it raining?"
Co-Chair MacKinnon queried comments on the current bills
that may affect the management of the permanent fund. Mr.
Moran emphasized that it would be a mistake to
underestimate the importance of the annual inflation
proofing to the funds. He stated that the change in
purchasing power over time had a compounding effect. He
stressed that the goal of managing for future generations.
Senator Olson wondered there was a confirmation of fears
that in the near future there would be hyperinflation. Mr.
Moran replied that no one could predict the future.
Senator Olson felt that the double digit hyperinflation was
almost inevitable. Mr. Moran responded that he was not an
expert, but understand the compounding effect. He noted
that small changes in the purchasing power resulted in
large dollar amounts over the long term.
Co-Chair MacKinnon wondered whether the board's resolution
that the people should vote on a percent of market value
draw would be the right way to manage the assets. Mr. Moran
replied that the board was still in favor of that approach
to the distribution to the fund.
Co-Chair MacKinnon discussed the week's schedule.
ADJOURNMENT
11:06:59 AM
The meeting was adjourned at 11:06 a.m.
| Document Name | Date/Time | Subjects |
|---|---|---|
| 012318 APFC 2018 Overview Presentation .pdf |
SFIN 1/23/2018 9:00:00 AM |
Alaska Permanent Fund Corporation |