Diversification, not just S&P 500, is what Permanent Fund needs
Rep. Mia Costello, 58, wants to make it a state law that the Alaska Permanent Fund Corporation invest at least 25 percent of its assets into an index fund that tracks the S&P 500.
At today’s market value, that is more than $22 billion. One-third of that would be invested in just seven companies, the tech giants dubbed the Magnificent 7.
Costello, who has been kicking around the Legislature for a long time, also wants to delete from state law language that requires the fund to “maintain a reasonable diversification among investments, unless, under the circumstances it is clearly prudent not to do so.”
The best thing about her bill, HB 373, is that it has had no hearings. The Legislature should keep it that way.
Plucking an exact number out of the air about how much the Permanent Fund should put into the S&P 500, regardless of what asset allocation research might say, shows a lack of understanding of our financial situation.
Her bill reflects an attitude that because the S&P 500 has performed exceptionally well in recent years, now must be the perfect time for the Legislature to dictate future investments based on past performance, without bothering to ask the Permanent Fund trustees, the fund staff or its consultants.
A related issue is the clamor by those claiming the Permanent Fund must be doing something wrong because it has not matched the gains of the S&P 500 in the past few years.
Aside from acting as if hindsight is the roadmap for the future, they are blind to the need for diversification. This means taking less risk, especially important during those periods when specific investments, including the S&P 500, collapse. It’s happened before. It will do so again.
Costello introduced her S&P 500 mandate on February 23.
Two days later, financial consultants Callan Associates, longtime chief consultants to the Permanent Fund, gave an excellent presentation to the Senate Finance Committee about investments, the S&P 500 and the performance of the Permanent Fund over time.
Here is that presentation. I recommend it to everyone for its depth and clarity. Here are Callan’s slides.
Steven Center, a Callan vice president, said that the Permanent Fund has “lagged other large public funds,” most of them state-sponsored pension plans, over the last three years.
The fund has also lagged large endowments over the last three years, but not over the last 10 years and 20 years. The Permanent Fund has a lower risk profile than typical endowments, he said, with a higher allocation to fixed income investments, 20 percent.
The asset allocation model of the Permanent Fund is becoming more like that of major endowments.
The big run-up in stock prices is a major factor in relative performance because public retirement systems have about 45 percent of their assets invested in the stock market, while the Permanent Fund has about 32 percent of its assets in the stock market.
Even so, he said, over the last 5 years, 10 years and 20 years, the fund’s performance has been above the median for public funds.
Unlike a retirement fund, which has a defined time horizon—the lives of its beneficiaries—the Permanent Fund is designed for perpetuity. That is a key reason for the lower stock exposure and a different asset allocation strategy.
In addition to the percentage of total assets in the stock market, another factor is the impact of the so-called Magnificent 7 in the S&P 500, the seven large companies that have driven so much of the growth over the last 5 years—Apple, Microsoft, Alphabet, Amazon, Meta, Nvidia and Tesla.
“The Permanent Fund’s public equity portfolio, like most active public equity portfolios of institutional investors, has been underweight to those Magnificent 7 stocks,” Center said.
“It is very difficult for an active manager to overweight very large positions, when they are as large as these Magnificent 7 stocks are,” he said. “It takes a lot of gumption to say I’m going to hold 8 percent of my portfolio in Apple.”
Underweight means holding less of a given company, compared to its index, while overweight is the opposite.
During this discussion, Tok Sen. Mike Cronk asked: “A lot of people out there are like, ‘How come we just don’t invest in S&P 500 and call that good?’”
Greg Allen, the CEO of Callan, said it would be irresponsible to handle public money that way and the Permanent Fund would be the only institution in the world to call that good.
“It's great when you're the only one in the world doing something and you’re right. It's much tougher to hang on when you’re wrong. The reason you don't do it that way is because you lose all that diversification,” he said.
“The S&P 500 has been an amazing investment for the last 7 years, 10 years,” he said.
The Magnificent 7 tech stocks represent about 35 percent of the 500-company index. Putting all of the Permanent Fund into the S&P 500 would be the same as investing $30 billion into those seven companies.
“There's no planet on which that's considered diversified in the institutional investment world,” Allen said. “And you'd be subject to massive criticism when the piper has to be paid and the entire portfolio goes down 40 percent, which is what happened to equities in the global financial crisis” in 2008-2009.
“So you can only afford to take a certain amount of risk in a fund like the Permanent Fund. I mean, there's a lot of Monday morning quarterbacks out there,” he said. “We get this all across our client base. Everybody's sitting in your shoes, in the Permanent Fund's shoes.”
He said with hindsight, people say, “How could you be so stupid? You could have just indexed this thing in S&P 500.”
“This is a very unique moment in time where one asset class outperformed by that much. And we didn’t know back in 2020, that it was going to work out that way.”
When COVID hit, many people thought it was the end of the global financial system.
“And if you were all in stocks, you took the full brunt of that.”
The Permanent Fund has taken one commodity and turned it into a globally diversified renewable resource investing in “just about everything that generates a return.”
“You're never gonna be the top performing thing because you are not 100% in the thing that does the best. But if you’re in them all, you’re gonna have a smoother ride. And if you do it right, you'll be able to earn competitive returns. It’s what the Permanent Fund has done.”
There are always better investments in hindsight, he said. “But looking forward—safety first—and try to earn a return along the way.”
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(I hope you will join me at an online presentation and panel discussion March 31 about key issues regarding the future of the Alaska Permanent Fund, organized by Alaska Common Ground, a nonpartisan group that focuses on Alaska public policy.
The evening is to begin with an overview by veteran Alaska attorney and former Rep. Cliff Groh on the structure and governance of the fund.
A panel discussion, with questions from the online audience, will follow. The other panelists are former Senate President Rick Halford, who served in the Legislature for more than 20 years, and former Attorney General Craig Richards, a former trustee of the Permanent Fund and a longtime Alaska lawyer.)