Two slides, the first in a recent presentation before the Senate Finance Committee by the Alaska Permanent Fund Corporation (APFC), and the second in a presentation earlier this week by the APFC’s “general performance consultant,” Callan Associates, make it crystal clear that the push by some to amend the Alaska Constitution to combine the current two-account Permanent Fund approach into a single account is all about protecting current state revenues, and with that, state spending levels, rather than protecting the Permanent Fund itself.

The Alaska Permanent Fund is established by Art. 9, Section 15 of the Alaska Constitution. As currently written, the provision establishes two accounts. The first is “the principal” (sometimes also referred to as the “corpus”), “which shall be used only for those income-producing investments specifically designated by law as eligible for permanent fund investments.” The second is what is commonly referred to as the Earning Reserve Account (ERA), into which, as provided by law, all “income from the permanent fund shall be deposited.”

Under AS 37.13.140(b), the Legislature has provided that, on an annual basis, it may appropriate “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.” This is what is called the annual percent-of-market-value (POMV) draw from the Fund.

Under the Constitution, however, such a draw is limited to the amount in the ERA because the amount retained in the corpus “shall be used only for those income-producing investments specifically designated by law as eligible for permanent fund investments.” Under the current constitutional system, the corpus cannot be accessed to help support the draw.

In doing so, the two-account system emphatically protects the corpus. The Legislature can only draw up to the amount contained in the ERA. It cannot draw additional amounts from the corpus even if the ERA doesn’t contain enough to fully fund the amount of the draw permitted by the statute.

As we have discussed in previous columns, HJR 10, introduced by Representative Calvin Schrage (I – Anchorage), and SJR 14, introduced by the Senate Finance Committee, propose amending Art. 9, Section 15, to convert the Permanent Fund’s current two-account approach to a single-account approach. As with the current statute, the proposed amendment would limit draws to 5% of the Fund’s average market value.

The proponents attempt to justify the proposed amendment as being needed to “protect” the Permanent Fund from “excess” withdrawals. Their claimed concern is that, at any time and from time to time, the ERA account may contain more than is required to fund the annual POMV draw, and that, when it is, any given Legislature could ignore the statutory limitation and draw more than the five percent currently contemplated by AS 37.13.140(b).

But that is largely a cover story. In the seven years since the Legislature began implementing the POMV draw, no Legislature has drawn more than the five percent permitted by the statute.

Instead, the real concern appears to be that the PFC won’t earn enough on an ongoing basis to fund the five percent draw regularly. If the Permanent Fund isn’t generating enough income to replenish the ERA at the rate at which the Legislature is withdrawing funds, at some point, the Legislature would have to curb its draws to match the amount available in the ERA. 

On the other hand, if the corpus and ERA are merged into a single account, the Legislature could continue drawing the five percent even if the Permanent Fund wasn’t producing earnings at that level. The additional amount above the APFC’s earnings would come from the portion currently treated as the corpus.

From that perspective, rather than “protecting the corpus,” the proposed constitutional amendment appears to serve the opposite purpose. The purpose is to provide access to the corpus when the Fund’s earnings alone are insufficient to cover the POMV draws.

In short, the purpose is to enable ongoing draws to protect state spending levels, even if that means drawing down the corpus. The proposed amendment is really about protecting spending for current Alaskans, not the Permanent Fund corpus for future Alaskans.

The first slide demonstrating that this approach is more than a theoretical concern appears in a APFC presentation to the Senate Finance Committee earlier this month. Here is the slide:

As the annotation highlights, the slide indicates that Callan, the PFC’s consultant on these issues, projects that the Permanent Fund will earn less than 5% – in other words, less than both the current statute and proposed constitutional amendment permit in draws – over the next 10 years. 

Some might attempt to argue that the difference is slight and shouldn’t raise concerns about long-term performance.

But the second slide from Callan’s presentation to the House Finance Committee earlier this week shows that rolling 5-year real (after inflation) returns below 5%, indeed significantly below 5%, are not uncommon.

Looking at historical returns, Callan calculates that, on a five-year rolling average (next-to-last column), the time period underlying both the current POMV statute and the proposed constitutional amendment, the Permanent Fund has earned less than 5% in 17 of the 31 rolling-average 5-year periods since 1995. Put another way, it has met or exceeded 5% on a rolling 5-year average in only 14 of the 31 periods, or less than half the time.

And the misses have not been small. In eleven of the misses (or in 35% of the 31 periods), the Permanent Fund has earned less than 4.5%, in nine of the misses (or 29% of the 31 periods), the Permanent Fund has earned less than 4%, and in seven of the misses (or 23% of the 31 periods), the Permanent Fund has earned less even than 3%.

Under the current constitutional provision, the Permanent Fund corpus would remain protected in all these situations. If the earnings were insufficient to fund a 5% draw, the draw would be limited only to the extent of the balance in the ERA. Under the proposed constitutional amendment, however, in those situations, the Legislature could continue to draw up to the 5% from the combined single account, even if the earnings weren’t enough to support it. The remainder would come from the currently protected corpus.

Some argue that the solution to the concern is simply to reduce the 5% to a lower number, such as the 4.5% draw rate proposed earlier this week by Senators Bert Steadman (R – Sitka) and Lyman Hoffman (D – Bethel).

But as the chart above from Callan shows, that only reduces the problem somewhat. On a rolling 5-year basis, the Permanent Fund still earned less than 4.5% in 35% of the periods since 1995.

As we recently discussed in a previous column, actually protecting the Permanent Fund in those situations requires expressly limiting the draw to the lower of the target rate (e.g., 4.5% or 5%) or the actual rate earned over the relevant 5-year period. 

That would ensure draws did not exceed actual earnings over the relevant period.

Over the long term, however, the best solution to both ensure draws and protect the Permanent Fund corpus is for the APFC to significantly improve its returns.

As we have explained in previous columns, the APFC’s current returns significantly lag those of other, lower-cost alternatives. As even Callan’s presentation shows (on slides 11 and 12), the APFC’s returns have ranked in the bottom quartile among its peers in both large public funds and large endowments over the most recent one- and three-year periods.

And this is no short-term phenomenon. The APFC’s returns have additionally ranked below the median for large endowments over the rolling 5-year, 10-year, and 20-year periods.

As recent industry reports note, significant changes are underway in the investment approach of some large public funds and endowments. 

For example, a recent Bloomberg article titled “Yale’s Famed Investing Model Falters at a Fraught Time for Colleges” looks at the so-called “Yale model” of investing, an approach that is “popular among philanthropies and pension funds,” and, in recent years, has been looked to as a template also by the APFC. Reflecting on the approach’s significant underperformance in recent periods relative to other funds invested in “old-­fashioned stocks and bonds, through index funds that charge next to nothing,” the article concludes:

… [the model’s] poor recent results have been leading some investment professionals to question Yale’s method, also called the ‘endowment model’ …. ‘It’s not dead,’ says Mark Steed, who oversees the $24 billion Arizona Public Safety Personnel Retirement System, of the Yale model. ‘But it’s in critical condition.’

On the rise are simpler, and more importantly, significantly lower-cost approaches like that of the University of California’s “Blue and Gold Endowment” highlighted in the article:

In establishing his stock-and-bond Blue and Gold Endowment, Bachher credits the insight of another Wall Street outsider, Warren Buffett, the famed stockpicker from Omaha, Nebraska, who nevertheless says the vast majority of people are better off indexing. When he dies, Buffett has instructed that 90% of his wife’s inheritance be put in a stock index fund, with the rest in short-term government bonds. Bachher finds the simplicity of this approach appealing: ‘Close your eyes, come back 30 years from now, and you’d be in a better position.’

Another article, this one in the Wall Street Journal titled “The Ivies Are Having Second Thoughts About Investing in Private Equity,” is equally as direct. Its conclusion? “Private equity is on academic probation.” As explained in both articles, investing in private markets is a central theme of the so-called “Yale model.” According to Callan’s presentation, currently, the PFC has approximately 48% of the Permanent Fund invested in private markets, of which approximately 17% is invested directly in private equity.

Because of the fees, all are significantly more expensive to maintain than the Buffett-recommended low-cost index funds. Even when they produce higher returns (before fees), the portion realized by investors is significantly lower. As we explained in previous columns, the APFC currently pays over 1% of its assets in fees annually.

If the proposed constitutional amendments were adopted, neither the Legislature nor the PFC would have a significant incentive to improve on the PFC’s current performance. The Legislature would continue to draw 5% regardless of whether the PFC earned that rate. In the short run, the draws would not increase even if the PFC significantly improved its earnings, nor decrease if it continued to produce subpar returns. Both would meet their objectives regardless of whether the PFC’s current high-cost, mediocre return performance continued.

As we explained in previous columns, we believe the state’s approach to the APFC needs to be dramatically reset. This should start by requiring that board members have substantial investment experience and expertise at the time of their appointment, and ensuring they meet this requirement through legislative confirmation.

Over the past decade and a half, the Legislature has drained almost every available source of cash it can get its hands on to support continued spending on current Alaskans. First to go was the Statutory Budget Reserve, then the Constitutional Budget Reserve, and most recently, the Legislature is in the process of fully draining the Permanent Fund Dividend.

The Permanent Fund itself is next in line, and, in their current form, the proposed constitutional amendments are the means designed to achieve it. The effort should be rejected, and the energy directed toward the steps needed to significantly improve the APFC’s returns.

Brad Keithley is the Managing Director of Alaskans for Sustainable Budgets, a project focused on developing and advocating for economically robust and durable state fiscal policies. You can follow the work of the project on its website, at @AK4SB on Twitter, on its Facebook page or by subscribing to its weekly podcast on Substack.