The Friday Alaska Landmine column: Is the Permanent Fund’s downhill performance a trend, and if so, what should the Legislature do about it?

The answer to the question is yes, and we believe the Legislature should do three things in response

One of the things that became clear while developing the charts for last week’s column (“Is the current Permanent Fund Board chaos costing Alaskans money”) is the Permanent Fund’s (Fund) relatively poor performance compared to the Permanent Fund Board’s (Board) “Total Return Objective (CPI +5%)” benchmark since the Legislature adopted the “percent of market value” (POMV) draw in 2018.

As we discussed last week, in the current era, the Board’s “Total Return Objective (CPI +5%)” benchmark is essentially a proxy for how the Fund is doing in generating the returns necessary to support the Legislature’s annual POMV draw governed by AS 37.13.140(b). Under that statute:

The corporation shall determine the amount available for appropriation each year. The amount available for appropriation is five percent of the average market value of the fund for the first five of the preceding six fiscal years, including the fiscal year just ended, computed annually for each fiscal year in accordance with generally accepted accounting principles.

The Permanent Fund Corporation (Corporation) publishes monthly reports comparing its actual performance to that and other benchmarks. Here is the comparison based on a rolling 5-year average as of the end of each fiscal year for which performance reports are publicly available on the Corporation’s website, and as of April 2024, the most recent report published by the Corporation as of the time we are writing this column:

The red bars indicate periods during which the Fund’s actual 5-year rolling average return was below that of the “Total Return Objective” benchmark; the numbers indicate the amount by which the Fund’s actual return was below the benchmark. The blue bars indicate the periods during which the Fund’s actual 5-year rolling average return exceeded the benchmark; the numbers indicate the amount by which the Fund’s actual return was above the benchmark.

Viewed from that perspective, the Fund’s overall performance against the now-POMV benchmark appears on the surface to be doing fine. While there were problems in the early part of the last decade, those had evened out by the time the POMV approach was subsequently adopted in 2018, effective for Fiscal Year (FY) 2019. Since that time, the Fund’s overall performance appears to have stayed mostly positive on average.

But using the 5-year rolling average, which is, by definition, dominated by past performance, masks what is happening currently and what may lie ahead.

Here is the same analysis using a rolling 1-year average, which allows a focus on recent performance.

That shows that the Fund’s overall performance has fallen short of the POMV benchmark in four of the past five years and is continuing to fall short in FY24. As the 5-year rolling averages for FY23 and thus far for FY24 already suggest, that means that going forward, we likely should expect several more years of subpar performance when measured on a 5-year rolling average.

In testimony before the Legislature earlier this year, Callan — a widely-respected investment consulting firm and one of the Corporation’s most important advisors — projected that those results would even out over the next 10 years, resulting in a “Total Real (after-inflation) Return” over the period of 5.1% compared to the benchmark of 5%, with a projected probability of 54% that the actual realized real returns would be higher.

But that assumes not only that financial and market conditions remain favorable, it also assumes the Board and Corporation are able to refocus on their fundamental responsibilities. As Callan also pointed out in its testimony, “While the [overall Fund] protected well on the downside in 2022, it failed to capture the market snap-back in 2023,” a time during which the chaos surrounding the Board we discussed in last week’s column was increasing. The facts that, on a rolling 5-, 3- and 1-year basis, the Fund continues to significantly underperform against the benchmark in the most recent performance report — and as importantly, the chaos surrounding the Board continues — suggest that refocus is not happening.

So, if that’s true, what should the Legislature do about it? In our view, three things:

• First, the Legislature should restructure and professionalize the Board.
• Second, the Legislature should reevaluate whether the 5% draw is the right level.
• And third, the Legislature should indefinitely postpone any consideration of merging the principal and earnings reserve accounts into a single fund.

We explain.

The Legislature should restructure and professionalize the Board. Perhaps the most damning thing said about the Board in the midst of its current chaos is the description of it given by the internationally respected Financial Times in its recent, less-than-flattering story about Ellie Rubenstein. There, the Financial Times described it as “a six-person board comprised mainly of financial laymen.”

That might be an acceptable composition if the Board were outward-facing, primarily focused on making community grants, or engaged in other community-focused activities. But it’s not. What its earnings are used for is already established by statute. The Board’s entire attention should be inward-facing, focused like a laser on maximizing returns on investment.

A good example of another state sovereign wealth board formed for a similar purpose is The University of Texas/Texas A&M Investment Management Company (UTIMCO), a corporation formed explicitly “to generate superior long-term investment returns to support The University of Texas and Texas A&M University Systems” from revenues derived from state lands set aside to support the universities. Under Texas law, a majority of the seven-member UTIMCO Board must be composed of persons with “substantial background and expertise in investments.”

Like UTIMCO and similar boards, Alaska’s Permanent Fund Board should be composed of serious people with “substantial background and expertise” in the matter at hand — developing and implementing successful investment strategies. By contrast, the self-created chaos surrounding Alaska’s current Board makes it seem more like something out of The National Lampoon’s Animal House.

As part of its restructuring and professionalization, the appointment of board members should also be made subject to legislative confirmation to ensure that the members are properly and publicly vetted against that standard.

The Legislature should reevaluate whether the 5% draw is the right level. If the Permanent Fund is not capable of comfortably sustaining a real (after-inflation) 5% return across a reasonable time period, then the Legislature should reset the draw rate at what the Fund is capable of comfortably sustaining. Setting the draw rate at something higher than the Fund is capable of comfortably sustaining over time is little more than a recipe for gradually liquidating its value.

Many Alaskans refer to Norway’s similar but much larger “permanent fund” — the Government Pension Fund Global — as a guide for how the Alaska Permanent Fund should be handled. Here is how the Norwegian government describes the “fiscal rule” it has established to govern withdrawals from its fund to help pay for its government:

Transfers from the Fund to the central government budget shall, over time, follow the expected real return on the Fund. … At the inception of the fiscal rule, the expected real rate of return of the Government Pension Fund Global was set at 4 percent. In the spring of 2017 the estimate was reduced to 3 percent.

Some will likely argue that unless the Legislature sets the draw rate at a higher level, Alaska will not have sufficient funds to pay for the current level of government it has established. But that’s false.

Norway also has a higher level of government spending than can be supported by a 3% (or even a 4%) draw rate from its fund. It simply makes up the difference by balancing the draw with equitable, broad-based taxes on the current generation to pay for the level of government costs for which the current generation is voting.

By requiring that its current citizens have some financial stake in the outcome, the rule also ensures that government costs reflect a balance between what Norwegians want from government and the overall amount they are willing to pay for it. Alaska’s government should reflect the same balance.

The Legislature should indefinitely postpone any consideration of merging the principal and earnings reserve accounts into a single fund. Some, including previous Permanent Fund Boards, have proposed that the Legislature adopt and Alaskans pass a constitutional amendment that would merge the Permanent Fund principal and earnings reserve accounts together. The most recent effort is reflected in the Board’s “Trustees Paper Volume 10: A Rules-Based Permanent-Endowment Model for Alaska.”

While the current two-account structure has some drawbacks, one of the major benefits is that it puts a hard stop on the Legislature or the Permanent Fund Board’s ability to drain the Fund beyond the then-current level of the earnings reserve account. Put another way, it is a highly effective means of ensuring that neither body is able to impair the value of the principal, what one Corporation presentation refers to as the “permanent part of the Permanent Fund.”

Merging the two accounts in the manner proposed by the Board would remove that safeguard and expose the Fund to impairment and, potentially, ultimate depletion either through unjustified overdraws by the Legislature (among other things, in a continuing effort to stave off taxes) or by underperformance by the Board.

Frankly, the self-created chaos surrounding the Board and its recent underperformance against its own benchmarks have caused us to lose confidence in the direction the Board is leading the Corporation. Similarly, given the Legislature’s continued use of Permanent Fund Dividend (PFD) cuts to stave off taxes on those in the top 20%, non-residents, and oil companies, we also have low confidence that the Legislature actually would act to rein in overdraws if it meant requiring taxes, even if the need became excruciatingly apparent.

As a result, we think the Legislature should use this opportunity to take a breath on the proposed merger of the principal and earnings reserve accounts into a single fund, deferring further action at least until the future performance of the Board (and the Legislature) justify much greater confidence in their decision-making processes.

That may take some time. Until it happens, the Legislature should postpone any further consideration of merging the two accounts into a single fund.