GENERAL SUBJECT: PRESENTATION BY ALASKA PERMANENT FUND CORP. CAPITAL MARKETS OUTLOOK Joint Meeting with the 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 465-2618. After the 21st Legislative session they will be available through the Legislative Library at 465-3808. Time Meeting Convened: 4:05 PM Tape(s): SFC-99 # 4, Side B Side A PRESENT: x Senator Parnell x Senator P. Kelly x Senator Torgerson Senator Leman x Senator Phillips Senator Green x Senator Donley Senator Adams x Senator Wilken ALSO PRESENT: Representatives: Austerman, Phillips, Bunde, Green, Davies, Mulder, Smalley, Therriault, Williams, Grussendorf, Kohring, Joule, Davis Senator Mackie, Lynn Thurber, Lasalle Advisors; Bill Price, Dresdner RCM Global Investors; Michael O'Leary, Callan Associates; Byron Mallott, Executive Director, Alaska Permanent Fund Corp. Jim Kelly, Research and Liaison Officer, APFC Joan Cahill, Communications Assistant, APFC Eric Wolfort David Teal, Director, Division of Legislative Finance Ginger Blaisdell, Fiscal Analyst, Division of Legislative Finance TAPE LOG SPEAKER DISCUSSION 4B Co-Chair Sean Parnell Introduction of Senators and Representatives present Byron Mallott Introduction of APFC speakers 988 Michael O'Leary Background of when presentations are made We estimate a general forecast and ask investment managers to make specific forecasts PF estimates relatively conservative 947 APFC Manager Survey - overhead Some members are specialists and we ask for their estimates 939 Inflation Expectations - overhead All responses uniformly expect inflation to remain relatively low - between 2 and 4 % 926 S&P 500 One Year Return Projections - overhead 5 managers anticipate negative returns - that surprised me Clay Finley is European firm-think that's why negative 6 managers expect 0-10% 3 expect slightly more than 10% 905 That's conservative uniformly 5 Year S&P 500 Projections Slightly More Optimistic-handout 888 Small Cap Return Forecasts-handout Smaller cap stocks doing better - long term trend Since 1994 large companies doing much better Managers saying that will change to smaller companies doing better Representative Bill Williams Any reasons for that? Michael O'Leary My sense is that earning growth has stalled and larger ratio between smaller and larger companies 863 Representative Con Bunde Byron Mallott My understanding is there will be a bill to modify Representative Green Does this include some companies that might not make it? Michael O'Leary Small companies to us are big companies to the real world - examples International arena - diversification makes sense Before didn't make sense - looks like that might be changing Managers are more optimistic for international stocks-handout Returns measured in US dollars Co-Chair Sean Parnell Housekeeping-ask members to state name for record when speaking 4A Michael O'Leary Significant event is decline in interest rates Most expect 5year bond returns to fall in a range of 5-6.5% 2 firms have slightly higher forecasts Real Estate Outlook-handout Managers generally felt optimistic Five year estimate fall in 10-12% range The Economic Environment for the Next Five Years-handout Despite troubles in Asia and Russia, feel economy will remain strong - always danger of recession Callan's 1999 Capital Market Projections-handout Five year capital market projections Introduce Bill Price and gave qualifications Bill Price Challenge today is to put global outlook into perspective The longest post-year period of positive growth Should have had a normal downturn partly because of boost put into Also placed a variable into economy common stock market before Gulf War of household sector outlooks only 17.5% were income in stocks now gone up to 40-43% Has created an industry-money manager Has drawn precedent amounts of funds into stock market Since 1982 interest rates declined making other money earning methods necessary - therefore stock market investments Market itself and sense of positive feedback of making money easily - tends to create adaptive expectations Historically has led to overpriced markets Alan Greenspan difficult job to slowly lower expectations plus global responsibilities Buyer of last resort to bail out Asian and Latin American countries - US is the buyer Because of that there is a responsibility we share Don't want to create picture of impending doom-but want to lean against popular belief Word of caution Managers are trained in much more disciplined fundamentals Internet stocks-not what PF owns As we look across we see lowering of growth 4A Bill Price Actually experiencing negative growth while stock market is going up Companies can't raise prices Good news-inflation expectations continue to be low Interest rates also remain relatively low May go up to 4.5% Rely on corporate bonds for higher returns Exports will be down this year As reserve currency of the world are being deluged by Capital spending we see as negative - over-invested in past several years 3 legs of economy Positive overall gain for the year 1._ % Rep. Davies Real Estate - people waiting for the bottom to fall out - does that lead to expectation that dividend should go up Bill Price Talking about cyclical risk - not talking about Depression- talking about normal cycles Policy responses have become much more sophisticated Nothing irresponsible about equity position Question of unrealized gains separate issue Much more mechanical No accident that last year better stocks limited to better group Breakdown of earning of S&P 500 2B 4:52 PM Bill Price Continued detailing eschew of 500 stocks Talking about overextended sector of the market If you realized those gains the challenge would be to reinvest those assets with same returns if you could do in short period of time Doesn't really affect those posture but does affect the dividend Issue that needs to be addressed - beyond us right now The average 3-5 year annual rate about 20% Price earnings ration to its growth rate Small stocks slightly more volatile now have higher returns and better evaluations Begin to take some of those profits off the table and reinvest in smaller companies that are doing better Diversity of managers Rep. Bunde Refer to discussion of IRS ramifications if provide residents with straight earnings - want to talk about later Michael O'Leary Introduce Lynn Thurber and list qualifications as real estate expert 115 Lynn Thurber Perspective that we will be able to provide higher returns than stock managers Low inflation and slow economic growth May be surprising that we predict high growth in private industry We believe to be strong in private real estate industry Vacancy rates as low as 6 % in quality office space That supply and demand basis allows for higher rental rates and property values Stopping pipeline of new construction for areas of high vacancy Will see higher vacancies but moderate Then when this pipeline finished won't see new pipeline until after 2001-vacancies will slowly fill up during that time In place leases giving annual return of 9% Leases long term - turnover will be for rentals which will have higher return because of higher rents Property types and sectors Greatest appreciation and return in single family Multi family apartments in balance Area of concern is retail Regional malls given too much space - square footage in US 5 times as rest of the world We expect them to become entertainment centers Sectors of the country SW and SE greatest Sector very disappointing -18% ** Publicly traded rates Occurred year after 37% return rate 1997 number of investors came into market looking for growth then left no longer saw growth opportunity Correct to see that - tax changes, other things Our view is that they overreacted Average return of 7.5% better than other stocks Companies already have imbedded growth Also they bought a number of properties and seeing income Stock price is below underlying assets We believe they will provide 7.5% dividends 4B Lynn Thurber Conclude 272 Michael O'Leary Bill Price Increased portfolio by 40% last year Senator Gary Wilken Money supply and inflation forecast questions Are the 2 working together Bill Price Huge money growth part of US policy to optimize employment Excess of supply of goods relative to demand Huge import from out of country Improvements in technology All factors together When you put too much money in economy it can't absorb extra goes into financial account Alan Greenspan very nervous because he created it Driven up bond prices Excess liquidity is our concern What would happen if the fed rose interest rates to reign in supply - people won't expect Rep. Williams Is that why market so volatile today? Bill Price Characteristic of market later stage 20% of market done over computer That is part of reason for volatility It's just noise - just gets more volatile and gives less information Co-Chair Sean Parnell Follow-up - same said for Y2K issue - is it just noise? Bill Price Most bull markets end with a shock - Lt. Gov. statement So much said about issue it can't be a surprise Think much more serious issue outside US Enough of a trauma to end market? Hard to tell Senator Pete Kelly If more problem outside US - will it actually work to our benefit by slowing down their economy and production Bill Price Doubt it - will cause disruption in their economy in their system with banking industry Senator John Torgerson Predictable time when portfolio might not perform as expected? Bill Price Personal view - yes Longest recorded bear market - gold Can allow demand to slowly go up Michael O'Leary About year ago permanent fund thought good example to have a model for a management tool Overhead-Range of Ending Market Value Byron Mallott February meeting presentation 4B Michael O'Leary When making long term tend to think in average terms Model designed to faithfully project market value Starts with September quarter which was bad Shows the range of possible outcomes over next 5 years Not only what's the average but what's the range around the average Give full average not just middle of the road Jim Kelly Ask to explain colors in overhead Michael O'Leary How active are the managers in projecting gains Look at turnover rate in the portfolio Byron Mallott We have not figured into model one-time $4billion transfer Rep. Green Percentiles up the scale to 2001 then slacking coming back up in 2003 Michael O'Leary Given current policy expect a little less than 8 percent Co-Chair Sean Parnell Thank presenters Rep. Mulder Thank presenters 523 Co-Chair Sean Parnell Adjourn 5:32 PM SENATE FINANCE COMMITTEE LOG NOTES 1/21/99 Page 1