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 Page 19