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The challenge of adolescence: dealing with the Alaska Permanent Fund.

The Challenge Of Adolescence: Dealing With The Alaska Permanent Fund

At 14 years of age, this offspring of the state's oil assets presents new management challenges.

Do you know where your Alaska Permanent Fund is tonight? Is it safe from the ravages of inflation and legislative invasion? Is it generating surplus earnings for present and future generations?

Alaska's 14-year experiment with a colossal savings account has often generated the same anxiety experienced by a mother and father waiting for a child to come home from a first date. In fact, analysts often refer to the fund's "infancy" or "adolescence" when debating its maturity, performance and prognosis.

There are strong indications that the Alaskan public doesn't fully grasp some of the crucial complexities facing the fund in its second decade. The inexorable decline in Prudhoe Bay oil production and the diminished revenues (and Permanent Fund deposits) that result are precipitating a near-term crisis that threatens two of the fund's most important facets: dividends paid to residents and inflation-proofing to protect the corpus of the fund for future generations.

When Gov. Walter Hickel abruptly dismissed three Alaska Permanent Fund Corp. trustees earlier this year, concerns about the future of the $10 billion nest egg deepened. Hickel was criticized from several quarters for tossing management of the fund into political mud, jeopardizing its earning ability in the investment marketplace.

Byron Mallott, one of the trustees dismissed, says that neither in reality nor in perception should politics drive management of the Permanent Fund on a day-to-day basis. "It just shouldn't be subjected to political influence by a new administration."

According to Mallott, the fund is a business that seeks to be profitable in a competitive environment where stability is highly esteemed. If trustees become tainted with a political brush, stability is questioned and "the fund begins to lose its competitive edge in the investment community," he adds.

"Whether or not there was a specific policy reason for the change, the fact that there was a change in the majority of non-government members (of the board of trustees) makes change much more likely than was the case before," Mallott asserts. "There was real surprise and I believe some alarm about what the changes may portend. That's still an open question."

At least two possibilities seem to haunt Hickel's critics. First, that the governor will seek to use fund earnings to underwrite pet capital projects, upsetting the delicate balance between the dividend program and inflation-proofing, and second, that he will do so without thorough public consultation.

Commissioner of Administration Millett Keller, one of the new governmental trustees, bristles at the reaction to Hickel's move. "That fear is insulting and ridiculous," he says. Keller adds that the present trustees are people of high integrity, as are the people who were replaced.

"There's no single genius keeping the fund alive and well. (When a new team takes office), we expect them to change the government. That's why we have elections," he says.

Keller expects fund management to be business as usual. "The purpose of the Permanent Fund is to produce dividends, and I think it's going to stay that way. The question then is how to produce the biggest return. The administration has no plans to change the administration of the fund," he says.

The facts as of early May suggested that fears about Hickel's motives in replacing most of the trustees have been exaggerated. The new members have met three times and have taken no new initiatives. They did vote to increase fund investment in domestic stocks from 25 to 30 percent and correspondingly to reduce investment in bonds from 55 to 50 percent.

"Nothing radical, no new approach," says Jim Kelly, research and liaison officer for the Alaska Permanent Fund. "They're not interested in rocking the boat." He adds that the new members think the fund is working and are going to act "like fiduciaries."

Marc Langland, another trustee who was asked to leave, agrees there probably isn't a hidden agenda in Hickel's move. But he says the relation between the Permanent Fund's staff and trustees is a "very fragile situation" that can be adversely affected by trustee turnovers. "Continuity of terms makes it flow better. It's not foregone that it's all going to hell in a handbasket, (but it) will not lead to the best management of the fund. I just don't think it was thought through well enough. What it means is yet to be seen."

Also yet to be seen is how the legislature, the administration, even the "shareholders" of the fund will respond to an anticipated crossroads: By the end of this decade, the combination of Earnings Reserve monies and investment earnings likely will be insufficient to both inflation-proof the principle and pay the level of dividends to which shareholders have become accustomed.

In the early days of the Alaska Permanent Fund, this juncture was scarcely foreseen. The fund was established by constitutional amendment in 1976 as a way to save some of the state's gushing oil wealth for the proverbial rainy day when the gush would inevitably diminish to a trickle. The amendment passed by a margin of two to one.

Dave Rose, executive director of the fund since its inception, says the decision by proponents not to define the ultimate goal of the fund was a factor in its wide appeal and ultimate approval. "There were at least three major and widely differing reasons for voters to support the constitutional amendment and the unique appeal of each was used in order to secure the needed plurality," Rose wrote in a recent issue of the Alaska Public Affairs Journal. Those reasons were:

* To save a portion of the wealth created by the development of the state's non-renewable natural resources to benefit all generations of Alaskans;

* To remove a percentage of natural resource revenues from the legislative spending stream by direct deposit into a dedicated fund;

* To provide an investment base that would generate an income stream which later could be used to replace declining state oil revenues.

Once the Permanent Fund was established and deposits were being made, people who had been able to agree the fund should be created, but not why, began to diverge in their thinking about how the swelling savings account should be managed. The debate still continues, but after several years, a management framework began to fall into place.

Overall, the fund has been managed conservatively and has remained largely free of political jostling. Investments are made by six trustees -- four public members and two cabinet officers, all designated by the governor. Staggered terms were established to assure continuity.

By law, at least 25 percent of all mineral lease rentals, royalties, royalty sale proceeds, federal mineral revenue-sharing payments and bonuses received by the state are deposited in the Alaska Permanent Fund. From 1977, when the initial deposit was made, through the end of February 1991, assets of the fund grew to $11.6 billion, an undeniable financial management success story.

Also through the end of February, the Permanent Fund had earned nearly $7.8 billion from investments. Of this, about $3.2 billion has been paid out in dividends. Of the remaining earnings, roughly $2.6 billion had been used for inflation-proofing. Some earnings have been added to the principal by special appropriation. About $500 million is being held in the Earnings Reserve Account, which has been designated by the trustees as a reserve for future inflation impact and dividend payments.

The Permanent Fund inspires reverence. Staffer Kelly calls it "the most exciting example of economic democracy on the planet," essentially a financial compact between the current and future generations of Alaskans that allows today's shareholders to draw dividends, while preserving the body of the fund for those yet to come.

Former trustee Langland says it's "a very special institution in the world economy."

According to Scott Goldsmith, an economist with the University of Alaska Anchorage's Institute of Social and Economic Research, the fund has been a tremendous boon to the state's economy, even though it lacks the visual impact of roads, bridges and docks. "It's a real diversification of the economy, a stabilizer in a passive sense. To my mind, that's a benefit," says Goldsmith.

Although voters and fund architects decided the account was not to be a trough to quench real or imagined thirst for public infrastructure development, guidelines were established to permit investment within the state. Despite their aloofness from politics, fund managers responded to this sentiment. And, as did so many other Alaskan institutions who got involved in the tricky business of investing in home mortgages and banks, the fund got burned.

But such glitches have not stalled the fund's overall earning momentum. The setbacks helped to gain attention for the need to modify investment policies.

To keep abreast of financial trends and to diversify fund investments, the legislature added international investments to the Alaska Permanent Fund's list of approved investments in early 1989. Fund managers bought the corporation's first non-U.S. securities in October 1989 and as of Feb. 28, 1991, had acquired $410 million in international stocks -- 3.5 percent of total assets.

In response to warnings from budget analysts that the state was fast approaching a "fiscal gap" between spending levels and revenues, the Alaska Legislature in 1989 established the Commission on the Future of the Permanent Fund. Creation of this nine-member panel, chaired by then-Rep. Red Boucher of Anchorage, was an effort to come to grips with the long-delayed question of what the fund is supposed to be doing.

The commission determined that the public had made its position clear on four points:

* The Permanent Fund dividend is to be retained;

* Through inflation-proofing, the principal of the fund is to be preserved;

* Current state spending is too high;

* Permanent Fund earnings are not to be used to support state government in the foreseeable future.

While the commission made several recommendations to address long-term fund management issues, the arrival in Juneau of a new administration has provided ample distractions. Also, shifting political fortunes have robbed the commission's report of some of its champions, including Boucher, former Sen. Jan Faiks and former Revenue Commissioner Hugh Malone.

Although there are some Permanent Fund measures in the hopper this year, none of the proposed bills take on the big issues. Also missing are the often numerous proposals to raid the earnings of the fund for purposes other than dividends and inflation-proofing.

According to Kelly, some years have seen as many as 50 or 60 proposals for earnings distribution. "I'm happy to report there's nothing happening. For the first year ever, there are no legislative proposals for distributing the earnings of the fund. Finally, they're getting the message," Kelly says.

Anchorage Sen. Pat Pourchot has introduced legislation to make technical corrections in Permanent Fund statutes and plans to use the bill as a vehicle to generate discussion on longer-term issues, such as the proposal to pay for inflation-proofing before earnings are taken for dividends. This would alter a delicate balance between use of the fund today and the strategies needed to preserve the principal for the future.

"It's a tough question because you're talking about taking away a chunk of people's Permanent Fund dividend checks. You need to get a lot of people behind it before you take action on it," says Pourchot staffer Deborah Bonito.

Former trustee Langland believes the education and involvement of the public is crucial to resolving the future of the fund. "I don't think most people understand that inflation-proofing comes after dividends. We have a responsibility to explain that issue. We've got an opportunity to make some changes right now. And we've got the money," says Langland.

According to Mallott, the task is complicated by two "almost contradictory" impacts the dividend program has had on the Alaskan psyche and political landscape. "The dividend program has begun to act like a sleeping pill or a tranquilizer on the public, which has come to focus its perception of the fund's success strictly on the size of the dividend. It has given the fund a constituency not beholden to the governor or the legislature. At the same time, the dividend has become something of a dose of smelling salts for legislators who have become increasingly forced to look hard at fiscal realities, while keeping their hands off the Permanent Fund," Mallott says.

ISER's Goldsmith, who conducted much of the analysis of Alaska's hard economic realities that will be the basis for legislative and public debate, is a strong proponent of protecting the fund's principal. According to Goldsmith, some of the subtleties of fund management are as important as the broad issues, but are understood "only in a vague way."

He says, "Even people who are versed on the fund aren't versed on the subtleties. The reason it's important is that we're talking about a $10 billion fund. If there's a change that can increase earnings by one percent, that's $100 million. I think that's one of the issues the public just hasn't been interested in."

Goldsmith, too, celebrates the dearth of legislative measures dealing with the Permanent Fund. "Many bills in past years have been attempts to earmark where earnings should go, masquerading as plans to deal with the long-term revenue decline. They were not really addressing the main problem, or didn't allow enough flexibility. The less we fiddle with it now, the better," says Goldsmith.

The economist is among those who feel the fund is already in its adolescence and heading toward maturity. Those observers are concerned, though, that the road to adulthood could be impeded by the state's failure to develop fiscally responsible spending policies.

Despite the current lull in Permanent Fund discussions, the sheer size of the account ensures the debates over the next couple of years will be vigorous and well-attended, regardless of how well anyone understands the implications of options on the table. "Attention rivets on both the earnings and assets of the fund because it becomes the biggest game in town," says Goldsmith.
COPYRIGHT 1991 Alaska Business Publishing Company, Inc.
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Title Annotation:includes related article on the Board of Trustees; governor Walter Hickel and other public officials try to map out its purpose and management
Author:Richardson, Jeffrey
Publication:Alaska Business Monthly
Date:Jun 1, 1991
Words:2338
Previous Article:Refining rivalry.
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