Page 1 of 4

“The most fascinating thing about the investment business today is that people will agree on the micro facts, but they hesitate to add it all up,” Mohamed El-Erian recently told a rapt audience of sovereign wealth fund officials. As CEO and co-CIO of $1 trillion asset management giant Pacific Investment Management Co., El-Erian urged the group to embrace new ways of approaching the markets. “Once people acknowledge that the facts are changing, then they have to be open to the notion that when it is all brought together, the world is going to look different,” the former International Monetary Fund deputy director and Harvard University endowment chief explained. “When markets are faced with all these new facts, it takes time and takes overwhelming evidence. That is why there is this amazing volatility in markets, not just weekly, but daily—because people are flip-flopping between old normal, new normal. The inclination as a market is to go back to the old normal, but the reality is leading people to the new normal.”

El-Erian wasn’t speaking at the World Bank in Washington. Nor was he at the World Economic Forum in Davos. He was in Juneau, Alaska — population 31,000 — on an unseasonably warm morning in late May, delivering a two-hour presentation on the state of the world economy to officials of the Alaska Permanent Fund Corp., which oversees the Alaska Permanent Fund, a $33.3 billion sovereign wealth fund set up more than 30 years ago to ensure the financial security of future generations of Alaskans against the time when the oil fields on the North Slope run dry. The APFC hired Pimco early this year to advise it on protecting those assets from the market’s unforgiving ways, but El-Erian wasn’t the only big-name money manager traveling to Alaska. Robert Prince, co-CIO of Bridgewater Associates, also was on hand to give his own three-hour presentation. Last year, APFC chief investment officer Jeffrey Scott persuaded the fund’s trustees to hire five of the highest-profile U.S. asset management firms to function as what he dubs “external CIOs,” giving them $500 million each to manage as they see fit, as part of a mandate that includes teaching and consulting. The others are AQR Capital Management, GMO and Goldman Sachs Asset Management.

“I’ve recruited a team,” says Scott, 45. “There’s not one voice anymore. There’s six of us now.”

Scott arrived in Alaska’s state capital in 2008, in the midst of the biggest economic downturn in 70 years, with a fierce determination to apply the latest and best thinking on investment management to the Permanent Fund. That would mean changing the way the fund’s assets had been allocated, invested and monitored for nearly three decades. Scott would have to create an industrial-strength risk management tool and redesign staff assignments. Most challenging of all, he would have to convince fund and state officials that this new path would lead the APF to a more secure future.

Scott is going to need all the help he can get. Selling the board, the state legislature and the Alaskan people on even the slightest change to the Permanent Fund portfolio will be a daunting challenge. “Unlike other state funds, the Permanent Fund, because of its dividend and history, is a much bigger part of the state identity,” explains Robert Maynard, CIO of the $10.5 billion Public Employee Retirement System of Idaho. “What you do is under a bigger microscope.” Maynard should know. A former deputy director of the APFC and Alaskan attorney, he lived in the state for 18 years.

Neither a pension fund nor an endowment, the Alaska Permanent Fund is one of the world’s oldest sovereign wealth funds, established in 1976 following a statewide vote. The idea was simple: Take the millions of dollars in royalties and revenue-sharing payments that Alaska receives from oil companies that had purchased land along Prudhoe Bay, and put it in a permanent fund that could be used to generate future income even after the oil revenue is gone. The fund, whose annual dividend payout is a key source of income for the poorest Alaskans and a bolster to the state economy, has been the subject of debate among its constituents for most of its existence. From the taxi driver who will use the fund for his child support payment to the pregnant mother of five who will soon be adding another beneficiary to her household to the indigenous people of the vast interior who depend on the fund for up to a quarter of their annual income, all Alaskans have a stake in its performance.

“This is a huge part of the economic future of the state,” confirms Michael Burns, APFC executive director since 2004. “Our mission is to turn nonrenewable natural resources into renewable financial resources.”

Unlike most public fund investment officers, Scott spent much of his career in corporate treasury, a place where risk management is king. As assistant treasurer at Microsoft Corp. in Redmond, Washington, Scott developed and managed a $56 billion absolute-return global asset portfolio that included investments ranging from cash to commodities. “Microsoft manages assets in a very unique way for a corporate,” explains George Zinn, Scott’s former boss and the company’s treasurer. “We manage for liquidity as well as longer-term risk-adjusted assets.” At Scott’s suggestion and the trustees’ invitation, Zinn sits on the three-member advisory board at the APF, along with Maynard and Jerrold Mitchell, a senior adviser at Boston-based family office Saltonstall & Co. and the former CIO of Massachusetts’ Pension Reserves Investment Management Board.

Scott’s decision to pursue the position in Juneau following a decadelong corporate career and short stints running both a hedge fund and a risk management consulting practice was a surprise to some members of the board. “Jeff was extraordinarily impressive in terms of résumé, background and ability to communicate with the board,” says Fairbanks native Stephen Frank, board chairman and a former state senator and representative. “I was impressed by his willingness to come to Juneau. He had been in the private sector. People have to want to come to Alaska — it’s not Wall Street.” Scott, a ten-year triathlete who could pass for a career military officer, sports a buzz cut and the lean build to go with it. On his way home from the office, he often skis down unmarked trails on one of the surrounding snowcapped mountains. He was looking for a challenge when he arrived in Juneau.

Scott needs to be more than an investment officer. He is a change agent who is sowing the seeds of a new investment management model far from the world’s financial capitals. He began by hiring a dedicated director of asset allocation and risk, former Microsoft colleague Max Giolitti, to create a risk dashboard that would continually monitor and assess the entire portfolio. Then he changed the fund’s traditional asset allocation structure to reflect risk factors such as inflation, deflation and liquidity. “He is one of the first movers in moving to a risk factor analysis, as opposed to an asset-class analysis,” says Pimco’s El-Erian. Scott’s third initiative was to unbundle the Barclays Capital aggregate fixed-income benchmark — a compilation of every major bond category and long the industry standard under its former owner, Lehman Brothers Holdings — then use only the bonds he deemed appropriate for Alaska. “Jeff is not just asking how things have been, but looking forward and asking how things should be, given that the world is changing,” El-Erian adds.

Scott’s investment philosophy is fundamentally different from that of the typical public fund. “Trying to manage to a return is a naive approach to investing,” he asserts. “You need to step back and think about what are the liabilities, how are you going to cover those liabilities, and how can you hedge and manage them.”

He continues: “At public funds there’s a tremendous focus on what they are doing relative to their peers. The biggest concern is relative performance, not absolute performance. There’s pressure from the politicians and pressure from the media.”

The new CIO had to convince the board of trustees and the state legislature that his changes would benefit both the fund and the Alaskan people. To make his case, Scott began by meeting with each trustee individually and holding all-day sessions with them as a group. “He’s done an effective job of making changes,” says Frank, speaking of Scott’s efforts. “He’s brought the board along. He made a pretty extraordinary effort to educate the trustees.”

The board education process has been crucial. But when state legislators learned of the changes, they called the whole enterprise into question. Scott, Burns and Frank had to fly to Anchorage to meet with state senators and representatives to explain the risk management initiative. Burns says he hired his CIO for his high energy level and communication abilities. “We hired him, not his approach,” he explains.

Selling the board of trustees and the state legislature on the new asset allocation and risk management concepts was only the beginning of the plans Scott is making to prepare the Alaskan fund to weather the volatile events of the new-normal investment scenario. “We’re not going to be able to replenish the oil on the North Slope,” he says. “The Permanent Fund is the second most important asset in the state of Alaska, next to that oil.” Oil production peaked at 2 million barrels a day in 1988; current daily production is 700,000 barrels.

Single Page    1 | 2 | 3 | 4
Related Topics: Jeffrey Scott· Alaska Permanent Fund Corp.· Alaska· sovereign wealth funds