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Private Equity Helps SWF Alaska Permanent Fight Oil Slump

To weather market turbulence and capture new opportunities, resource-dependent U.S. sovereign wealth funds are diversifying their asset mix.

Alaska Permanent Fund Corp. is coping better than many other investors with the market volatility that started this past summer. The Alaska Permanent Fund, the sovereign wealth fund managed by APFC, began its 2015–’16 fiscal year down 4.4 percent for the quarter ended September 30, but rebounded, posting a 2.1 percent return for the three months ended December 31.

Although APFC missed its own benchmark for the quarter, that performance is notable, given how heavily Alaska relies on oil and that there is a slumping commodities market. Before the latest drawdown, the fund managed to take profits by selling stocks and continuing to reduce its dependency on commodities. Other U.S. sovereign funds that built their wealth on natural resources have taken similar steps to diversify.

Changes to the Permanent Fund have been in the works for a few years, and they’ve readied its portfolio to withstand what looks like a choppy 2016, says Angela Rodell, CEO of Juneau-based APFC.

“We thought our positions in many companies were at their high-water mark in 2014,” Rodell explains. After taking those profits, APFC used the cash to boost allocations to private equity, which accounts for about 6 percent of its portfolio, and to build out co- and direct investments. The fund doubled the size of its private equity group last year from two to four staffers, and it’s hunting for a new CIO. The role has been temporarily filled by Jim Parise, AFPC’s director of fixed income, while Rodell searches for a more permanent replacement after Jay Willoughby resigned last fall.

Rodell also started writing bigger checks to fewer external managers. “It makes our participation more valuable to the manager and gives us a stronger negotiating position,” she says. Those larger sums help her to extract bonuses like revenue-sharing opportunities or strategic partnerships, which can mitigate the cost of fees paid on other investments.

To mitigate downside risk, APFC has reoriented its equities portfolio toward longer-term value opportunities, Rodell adds. That shift started in 2008; along with the recent move into private equity, APFC has made the portfolio less correlated to market fluctuations and less dependent on commodity prices. As a result, the fund now has a more sustainable asset mix and more cash in savings for future generations.

“Our royalty from energy has been steadily declining, so we’ve had to focus on other investments to ensure that we’re always well funded and can be responsive to the cash needs of the Department of Revenue,” Rodell says.

For the state to fill this year’s $3.8 billion budget deficit, Alaska North Slope crude would need to be about $113 a barrel — a price that hasn’t been seen since 2014. As of February 18, ANS stood at $32, according to the Alaska Department of Revenue.

While Alaska struggles to find other economic diversifiers, Governor William Walker wants to use cash from the Permanent Fund without endangering its longevity. Walker has proposed drawing $3.3 billion, or about 4.5 percent of the fund, each year to pay for budget items.

For Rodell, the amount isn’t as important as how and when the state government would need it. “The question is if they want a single check, or if we can distribute that money out quarterly,” she says. “If I can do it on a quarterly basis, then we can continue to earn interest over the year on what hasn’t been distributed yet, so we have to consider what makes the most sense.”

To remain tactical, Rodell also keeps about 20 percent of the Permanent Fund’s portfolio in a mix of liquid instruments and cash. That gives her the option of taking advantage of new investment opportunities or having ready access to cash.

For sovereign wealth funds that depend on natural resources, adopting a tactical approach is part of the new normal. In a recent presentation to the Alaska legislature, Harvard Kennedy School of Government fellow Malan Rietveld cited performance data to make his case that resource-based funds used to living off the luck of their geography must now consider a more rules-based investment strategy that focuses on asset classes such as private equity, credit and equities.

Consultants who work with public funds tend to agree. As such funds diversify their investments, it’s important to focus on building relationships that create long-term value, says Michael Koenig, a managing director at Hamilton Lane, a Bala Cynwyd, Pennsylvania–based private markets investment specialist: “In private equity, for example, we advise our clients to have a core allocation to the asset class, but you want to strategically pace those investments so they make sense within a total portfolio.”

Diversification has helped the New Mexico State Investment Council (SIC), manager of New Mexico’s permanent funds, to withstand recent market turbulence. Like APFC, the Santa Fe–based SIC grew on the back of local resources. When Robert (“Vince”) Smith took over as deputy state investment officer for New Mexico in 2010, he launched an asset allocation audit. After reaching the same conclusions as APFC’s Rodell, he scaled back exposure to public equities heading into 2015.

“We see a shift in the return pattern of equities that will be impactful over the long term,” Smith says. “So we started to reorient to other asset classes as part of our risk mitigation strategy.”

For SIC, that meant capturing opportunities in floating-rate debt and increasing private equity from 10 to 12 percent of the portfolio. Each year Smith and his team set an annual view of their market expectations and invest in themes based on that view. In 2015 this approach led them to floating-rate debt, which helped to keep losses down. The total value of New Mexico’s permanent funds fell by 1.2 percent last year, from $20.2 billion in 2014 to $19.95 billion as of December 31, according to preliminary estimates by SIC.

Smith says there’s no magic asset mix, but by creating annual plans the fund can stay dynamic and shift allocations to respond better to market conditions, he adds. This year New Mexico’s oil production is expected to drop for the first time since 2008 because of global oversupply, making tactical investment decisions that much more important.

“Investors must be willing to look at a lot of different opportunities in the market today to stay truly diversified,” Smith says. “We’re looking at investments we believe will be supported by the future environment, and we want to avoid getting hung up on a particular asset class or investment idea, because the environment is always changing.”

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