Trustees aim to protect soaring Alaska Permanent Fund from painful downturn

Pat Forgey
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JUNEAU -- A soaring stock market hit an all-time high this week, as did the $50 billion Alaska Permanent Fund.

Now, some are asking whether the stock market is at risk of a fall, and warning the permanent fund, with its heavy reliance on riskier stock investments, is also at risk.

Among those sounding the alarm is Jay Willoughby, the Alaska Permanent Fund Corp.'s chief investment officer. The publicly owned corporation manages the fund's investments, which provide earnings from which the state pays dividends every year.

Driving the issue have been glorious recent stock market returns. In the 2013 calendar year, the fund's U.S. stocks earned a stunning 37 percent, and foreign stocks earned more than 12 percent. Global equities, a mixture of foreign and U.S. stocks, earned 26 percent for the year.

The permanent fund is now almost half invested in stocks, well above target asset allocation levels.

In addition to last year, 2012 was strong and the permanent fund has now fully recovered – and more -- from the real estate crisis and market downturn of five years ago, and hitting a value of $50.042 billion this week.

"If anybody didn't think it was all about the stock market, the last two years have driven that point home," Willoughby said.

What will do better than stocks?

Now, that heavy -- and profitable -- exposure to stocks has Willoughby concerned. In fact, that's what keeps him up at night, he told the corporation's board of trustees this week.

The permanent fund’s asset allocation policy calls for 36 percent allocation to stocks, with the remainder in bonds, real estate, infrastructure and other investments. But as the stock run-up accelerated, so too did the the fund’s stock purchases. A full 47 percent of its holdings, 11 percentage points above the target, are in stocks, he said.

The problem facing Willoughby and the fund is that other assets are still not expected to do much better.

Bond returns are so low that while the permanent fund is doing better than average, there's not much prospect for big returns there.

"You are constantly beating the benchmarks there," said Greg Allen, an adviser to the fund who works or Callan Associates. "Not by a lot, but by hitting singles all day long," he said.

The fund has less than $10 billion in bonds, compared to more than $23 billion in stocks.

At the same time, real estate valuations have rebounded from lows and are now thought to be fairly priced, said Mike Burns, the fund's executive director. That's got the fund looking overseas for real estate investment opportunities.

Good time to sell?

This might be a good time to sell, Burns said, but that presents its own problems. "Valuations are so high it's attractive to sell, but what do you do with the money?" Burns said.

Willoughby proposed a solution that would allow Alaska to keep its stocks, while reducing the risk of losses. It's called "hedging" -- essentially buying an insurance policy against a market decline.

Buying such a hedge could allow the fund to remain fully invested in the stock market but not face as much risk of losses. But that insurance comes at a cost.

Willoughby gave an example of what it would cost to hedge a $5 billion stock portfolio that would protect the fund if its value dropped more than 7 percent. Such a hedge is priced at about $135 million, he said, meaning that it presents its own risks.

"If we did it in 2008 (prior to the big decline), it would be a great thing. If we did that in 2013, we would have lost $135 million," he said.

But Willoughby said he would have preferred knowing that the fund wasn't at risk. "As the chief investment officer, I would have gotten a lot more sleep," he said. The other option is to sell some of the stock portfolio.

"If you don't have an ability to hedge, you are either in it or out of it," he said.

Fewer safety nets

One of the firms that would like to help Alaska hedge the market, Goldman Sachs Asset Management, made a pitch to the trustees during their meeting in Juneau. Trustees' adviser Jerrold Mitchell said Willoughby was likely correct about the risk facing stock investments, and that by most metrics valuations are high and may be at risk of a fall. But he also said that stock markets tend to "overshoot" and go much higher than valuations would support before falling much further than they should, increasing risk and volatility.

"I think we're in the latter part of the game," he said.

"What concerns me is that we've taken out a lot of the safety nets," Willoughby said. Those were tools that the government used to stabilize markets in 2008, he said.

That included the ability of the government to put taxpayer money at risk in an effort to stave off an even-deeper crisis, a power it no longer has, he said. "There's going to come a time, maybe in the next few years when return of, instead of return on, capital is going to become more important again," Willoughby said.

But Willoughby found some skepticism about hedging around the room, including from trustees.  "We've looked at hedging probably three or four different times," said Bill Moran, board chair and a Ketchikan bank president. "There's a cost to hedging; there's nothing free in the market."

Trustee Larry Hartig, also commissioner of the Department of Environmental Conservation, said he agreed with the concerns about an overheated market and overvaluations. But if you don't invest in stocks, where do you invest? Bonds and infrastructure are also risky, he said. "Where do you put your money? Under the mattress? What do you do with it?" he said.

"I only want to hedge for one reason: because I think there's risk in the market," Willoughby said. And Callan's Greg Allen was even more skeptical.

"The idea that you have the ability to hedge, and you know right when to do it, is so tempting, because then you can be a hero and hit a home run," said. But that's not a realistic expectation, he said.

"I don't believe people can (successfully) time the markets," he said. "I don't believe Jay can do it. I don't believe Goldman can do it."

Contact Pat Forgey at pat(at)alaskadispatch.com.